Should directors and senior executives be liable for compensation? 

By Wang Kun and Mei Yu, Tiantai Law Firm
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in accordance with the Company Law, directors and senior executives shall bear fiduciary duties to the company. If they violate laws, administrative regulations or the articles of association, and cause losses to the interests of the company or shareholders, they shall be liable for compensation. In recent years, the number of civil dispute cases caused by directors and senior executives in participating in companies’ operation and management has gradually increased. Should they bear corresponding compensation liability for their misconduct?

Wang Kun Tiantai Law Firm Company Law
Wang Kun
Associate
Tiantai Law Firm

The conditions

Directors are the main force in the internal governance of the company, managing the company affairs internally and carrying out economic activities on behalf of the company externally. Senior executives refer to the company’s managers, deputy managers, financial officers, secretary of the board of directors of listed companies and other personnel specified in the articles of association.

In order to ensure that the above-mentioned personnel exercise their powers properly, the Company Law and other relevant laws provide that these personnel should fulfill their fiduciary duties and abide by laws, administrative regulations and the articles of association. If the company or shareholders’ interests are damaged due to their behaviour in violation of the above-mentioned provisions, they shall have the right to hold them liable. That is to say, the conditions for directors and senior executives to bear compensation liabilities include violating laws, administrative regulations or the articles of association, and causing losses to the company or shareholders.

Mei Yu Tiantai Law Firm Company Law
Mei Yu
Associate
Tiantai Law Firm

The circumstances

Conflict of interest. This is mainly manifested in the fact that the directors and senior executives, without the consent of the shareholders’ meeting, take advantage of their positions to seek business opportunities belonging to the company for themselves or their related parties, and operate businesses similar to those of the company where they work for themselves or for others, which leads to competition with the company. Under such circumstances, the interests of the company and shareholders will inevitably be damaged.

Unauthorized disclosure of company information. Under normal circumstances, the company will formulate a strict information disclosure system to protect the legitimate rights and interests of the company and shareholders from damage. However, in practice, directors and senior executives, as the main managers of the company, usually have a knowledge of, and oversee many, business secrets of the company.

If they disclose or falsely disclose the company’s business secrets and other information without authorization, the normal operation of the company will inevitably be affected and the interests of the company and shareholders may be damaged.

Significant economic losses cause by negligence. The company’s profits and losses are closely related to many factors, including the market. However, if the company’s losses are caused by the negligence of directors and senior executives – including but not limited to mistakes in decision-making and improper operation – they should also be liable for compensation pursuant to the above-mentioned relevant laws and regulations.

In practice, to claim compensation from directors and senior executives on this ground, it is necessary to first make a comprehensive judgement on whether they are obviously at fault subjectively, whether their actions occur in the course of performing their duties, and whether they have caused significant losses to the company or damaged shareholders’ interests.

Capital contribution. Directors and senior executives are responsible for the business operation and management of the company, and the full performance of capital contribution obligations by shareholders is the basis for the normal operation of the company. Therefore it is necessary for the directors and senior executives to supervise the shareholders to perform their capital contribution obligations, to ensure the normal operation of the company.

If shareholders fail to perform or fully perform their capital contribution obligations, directors and senior executives are obligated to call for capital contribution from shareholders; otherwise, they will be regarded as violating their fiduciary duties and causing losses to the company by means of passive inaction. Of course, directors and senior executives, after taking liability, can claim compensation from shareholders who have not made full capital contribution.

Take liability independently

In addition to the right of recovering compensation under the above-mentioned capital contribution case, under normal circumstances, if directors and senior executives are elected – which means they assume the positions of the company in an independent capacity – they should compensate for the damages caused to the company or shareholders with their personal property.

If the directors and senior executives are appointed, that is, they do not assume the positions of the company in an independent capacity but are entrusted by shareholders, then do the shareholders need to bear joint and several liability with the directors and senior executives for the losses incurred? After searching relevant cases, it is clear that the adjudication authorities are more inclined to consider that although directors and senior executives are appointed by shareholders, the appointments cannot be completely equated with, or recognized as, the behaviour of shareholders.

Directors or senior executives are not managed and controlled by shareholders, and thus have no legal obligation to be accountable to shareholders of the company. Therefore, shareholders should not bear corresponding joint and several liability for the losses caused by directors and senior executives.

To sum up, when directors and senior executives violate laws, administrative regulations or articles of association, causing damage to the legitimate interests of the company or shareholders, they should bear corresponding compensation liabilities. In addition, in order to decide whether the behaviour of such personnel exceeds or violates the contents of the articles of association, on the one hand, the contents concerning the rights and responsibilities of directors and senior executives, especially their fiduciary duties, should be clearly and carefully stated in the articles of association.

On the other hand, regardless of whether the directors and senior executives are elected or appointed, it is necessary to clearly inform them of, and make sure they are aware of, the above-mentioned contents referred to in the articles of association when they join the company, and at the same time require them to make a commitment to abide by the relevant regulations of the company. In the event of subsequent cases involving the above-mentioned disputes that require them to be liable for compensation, the evidence preserved by the above-mentioned behaviours can also play a corresponding supporting role.

Wang Kun and Mei Yu are associates at Tiantai Law Firm

Wang Kun Mei Yu Tiantai Law Firm Company LawTiantai Law Firm
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