Reviewing related-party transaction damage liability disputes

In recent years, incidents where controlling shareholders or directors, supervisors and officers (DSOs) harm company interests through improper related party transactions (RPTs) have become increasingly common.

The concealed nature of such transactions presents two main challenges: first, the difficulty in obtaining evidence of related relationships; second, the fact that unfair transactions are often hard to detect in the course of ordinary business operations. Furthermore, the classification of certain special benefit transfers or disguised asset reductions as RPTs remains subject to debate.

This article interprets judicial review directions and relevant legal provisions in such cases.

Q: What are prerequisites for applying RPT damage liability disputes?

A: To bring a claim under this course, the existence of an RPT must be confirmed. Although the law does not provide a precise definition, article 265 of the Company Law stipulates that a “related relationship” includes a company’s controlling shareholder, actual controller, DSOs and enterprises directly or indirectly controlled by any of them, as well as other relationships that may result in the transfer of the company’s interests. Accordingly, transactions between the company and such related parties are considered RPTs.

To determine whether a transaction constitutes an RPT, it is first necessary to identify the parties involved and confirm the existence of a related relationship. Only then can the question of whether the transaction falls within the scope of an RPT can be assessed.

In this context, the term “transaction” should be interpreted broadly to include not only conventional commercial dealings, contracts and transfers, but also other acts involving the transfer of benefits or impairment of company assets such as cancellations, set-offs and guarantees.

Q: Which aspects should be examined to determine if the RPT harms the company’s interests?

A: The examination focuses on two aspects. First, procedural compliance: whether the party has fulfilled its information disclosure obligations and complied with the procedures stipulated by laws, administrative regulations and the company’s articles of association, such as whether the transaction was approved by the general meeting of shareholders, and whether the directors of the listed company abstained from voting when required.

However, even if procedures are followed, if the transaction is essentially unfair and materially harms company interests, the actor remains liable for compensation.

According to article 1 of the Supreme People’s Court’s Provisions on Several Issues Concerning the Application of the Company Law (V), if an RPT harms company interests, and the plaintiff company claims compensation from the controlling shareholder, actual controller or DSOs under article 84 of the Civil Code and article 21 of the Company Law, the court will not support a defence based solely on compliance with disclosure or approved procedures stipulated by laws, administrative regulations and the company’s articles of association.

Second, substantive legality: the fairness of the transaction price. Proving price fairness is often difficult. Courts typically consider the contract terms and the parties’ rights and obligations – whether performance aligns with normal commercial practice, and whether the price deviates from market value – to determine whether the company has suffered a loss.

In practice, defendants often argue that the company remains profitable and thus has not been harmed. However, substantive fairness should be assessed holistically, rather than inferring no harm solely from continued profitability, to avoid post hoc reasoning; focusing on whether company interests have been transferred, and whether the company would transact with a third party on the same terms.

It should also be noted that the burden of proof for overall fairness of the RPT generally lies with the defendant. However, if the transaction has undergone lawful procedures – with full disclosure or shareholder approval – the burden then shifts to the plaintiff to prove that the transaction was substantively unfair.

Q: Who bears liability for compensation?

A: According to article 22 of the Company Law, the parties liable for compensation are the controlling shareholder, actual controller, or DSOs who use their related relationship to harm company interests. Whether the related company bears joint and several liability remains disputed in practice, with some views holding that this should not be addressed under this cause of action.

Q: How is loss determined?

A: Loss is usually calculated as the difference between the improper RPT price and the ascertained fair transaction price, with this difference constituting the compensable amount. In practice, there are divergent views on how to determine the fair price. Reference bases include the company’s transaction prices with third parties, historical transaction prices (precedents), project profit margin, auction or tender prices, and audit or valuation reports issued by qualified institutions.

Q: How is the validity of an RPT contract determined?

A: The validity or voidability of an RPT is not governed by the Company Law, but should be determined in accordance with the Civil Code. If the transaction falls under circumstances rendering a civil legal act void under the Civil Code, the RPT contract may be declared invalid.

Q: What is the difference between liability disputes arising from RPTs and disputes over liability for harm to company interests?

A: The evidentiary focus differs. Disputes over damage to company interests arise from shareholders, actual controllers or DSOs abusing their rights or breaching statutory duties, thereby harming company interests. The focus is on whether there has been a violation of law, administrative regulations or the articles of association, regardless of the specific means used to harm the company or shareholders.

In contrast, RPT liability disputes centre on whether related-party transactions have harmed the company’s interests, with the means of harm specifically being the RPT itself. The approach to proving and determining losses also differs between the two types of disputes.

Huang Wenjun is a partner and Wang‎ Yi is an associate at Ronly & Tenwen Partners