In investment and financing projects, investors often seek to appoint directors to the investee company to ensure a certain degree of voice. Given that directors have such specific legal obligations as duty of loyalty and duty of diligence to the company, they may be exposed to the legal risk of failing to properly perform their duties.
This article discusses main risk scenarios and prevention tips relating to company directors, especially investor directors.
Q: How can risks concerning conflicts of interest and non-compete obligations be prevented?
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A: If directors leverage their positions to pursue business opportunities of the company without proper consent of the shareholders’ meeting or board of directors, resulting in conflicts of interest – or run the same business, violating non-compete obligations – the income derived from such activities shall belong to the company. If the director appointed by the investor also owns shares or holds concurrent positions in other peer investee companies, there is a risk of conflicts of interest or violation of non-compete obligations.
In terms of regulatory attitude, the listing rules require issuers to disclose the directors’ concurrent positions and their external investments related to the issuer and its business, including the resolution of conflicts of interest.
According to relevant listing cases, it is quite common for investor directors to hold concurrent positions in other investee companies. If there are multiple part-time positions, or if other investee enterprises are in the same industry, it may prompt inquiries.
Acceptable explanations for regulatory authorities are:
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- The investor director is mainly to ensure the investor enjoys the right to know and is not directly involved in daily operation and management of the investee enterprise;
- The director has attended all board meetings of the issuer, and the concurrent job does not affect his or her diligent performance of duties for the issuer; and
- There are no transactions, financial dealings or conflicts of interest between the part-time enterprise and issuer, and the latter has also set up and implemented a prevention mechanism against conflict of interest.
Recommendations. Investment documents should disclose external holdings and concurrent positions of the investor directors and agree on exemption clauses, while investor directors should avoid involvement in daily operation and management of the investee company.
Investor directors should also obtain approval of the shareholders’ meeting or board meeting in a timely manner of new holdings and concurrent positions.
Finally, they should diligently perform their duties by attending and voting at meetings, abstain from voting on affiliated matters, and refrain from disclosing business opportunities or other confidential matters of the company to rivals.
Q: How can risks concerning information disclosure be prevented?
A: Directors of listed companies should ensure, as one of the information disclosure obligors, that information disclosed by the company is true, accurate and complete. Failure to do so may result in the imposition of regulatory measures or administrative penalties, and may incur civil or criminal liabilities.
If a listed investee company commits disclosure-related offences – including false records, misleading statements, material omissions and improper disclosure – the directors may be held liable accordingly.
In terms of regulatory attitude, once a listed company is convicted of information disclosure offences, its directors can hardly be exempted from liability unless they can prove their fulfilment of diligent duty.
It should be noted, in particular, that according to relevant cases:
- Directors cannot be exempted from liability merely based on their participation in board meetings or inquiries on relevant matters if they fail to consistently understand, investigate and verify the situation, or discover anomalies that should have been discovered;
- Directors cannot be exempted from liability merely because they have internally made no guarantee disclaimers or exercised their right to object, if they sign or vote in favour of documents when they are unable to guarantee that the information disclosed is true, complete and accurate; and
- Directors cannot be exempted from liability naturally by claiming that they do not have a professional background, are not involved in the daily operation and management of the company, or rely on the opinions of professional institutions.
Recommendations. Directors of listed companies should actively understand the company’s operating conditions and conduct reasonable investigation to verify the disclosed information.
If they discover or suspect the company violates the law on information disclosure, directors should actively exercise their right to object by voting against the disclosure and refusing to sign on the resolution.
Q: How can common risks concerning operation and management of the company be prevented?
A: Common risk scenarios in company operation and management include:
- Illegal acts. When a company commits illegal acts such as commercial bribery, money laundering and false invoicing, the directors may be held liable if they have directly or indirectly intended to violate the law – such as approving or authorising, or indulging or acquiescing – despite knowing or should have known such illegal acts;
- Decision making. Directors who fail to fulfil their duty of diligence and make wrong business decisions may be liable for the resulting losses of the company; and
- Exercising veto rights. Directors may breach the duty of loyalty when they exercise their veto rights for interests of the investor, rather than the company, for instance, vetoing subsequent financing to avoid diluting the investor’s shareholding, or vetoing other brokers to select an investor-affiliated one.
Recommendations. If directors discover or suspect the company of illegal acts, they should conduct reasonable investigation and verification and take positive actions such as avoiding signing relevant resolutions or documents to stop or oppose the implementation of such acts.
They should also ensure attendance at board meetings and seek external consultants’ advice on matters of professional deliberation, abstain from voting on affiliated matters, and reasonably exercise their veto right.
Q: Any other risk prevention tips for directors?
A: It is advisable to incorporate exemption clauses in investment documents, clarifying that the company should exempt or indemnify investor directors from compensation or other civil liabilities incurred while performing their duties towards third parties, unless the director has committed illegal acts, serious dereliction of duty or fraud.
In addition, investors may also require investee companies to purchase liability insurance for their directors.
Chen Huan is a partner and Yao Guanggui is an associate at AnJie Broad
AnJie Broad Law Firm
19/F Tower D1, Liangmaqiao Diplomatic Office Building
19 Dongfang East Road, Chaoyang District
Beijing 100600, China
Tel: +86 10 8567 5988
Fax: +86 10 8567 5999
E-mail: chenhuan@anjielaw.com
