chapter 8 fiduciary duties

Chapter 8 Fiduciary Duties

• Introduction: One Controversial Case

• John v. Robinson (Del 1985) • The charter stated that under any circumstance, the

shareholders shall waive the right to hold all directors liable for mismanagement or any wrongdoing.

• Robinson, one of the directors, was involved in an interest-conflict transaction causing great damages to the shareholders.

• Q: Could shareholders be entitled to hold Robinson liable?

Classification of Corporate Rules

Enabling Rules

Distributional rules & Structure Rules

Supplemental Rules

• Mandatory Rules: Fiduciary Rules

• A case recently heard by court in Shanghai

Mike is a managing director and CEO of a real estate company. Price of the house in Shanghai was increasing from 2002-2006, then dropped at the 2006 year end.

Framework of Fiduciary Duties

• Theoretical Framework 1930s, A.Berle & G.Means Modern Company and Private Property Separation of Ownership and Management

• Regulatory Framework duty of care Fiduciary duties duty of loyalty

• Who shall undertake duties of fiduciary? Directors, officers, controlling shareholders, actual contr

oller

General Provision in Chinese Corporate Law

• Article 148 • Directors, supervisors and senior management

personnel shall comply with the provisions of laws and administrative regulations and the articles of association of the company and bear fiduciary duties towards the company.

• Directors, supervisors and senior management personnel shall not abuse their rights to receive bribes or other illegal income and shall not convert company assets.

http://newsletters.cch.com.sg/nxt/gateway.dll?f=id$fn=default.htm$id=CCHCLICK:WCHBP/CHAPTER13518C#Article_148

Chinese Regulations of Fiduciary DutiesFiduciary Duties

General Regulations — Article 148

Detailed Regulations — Article 116 — Article 117 — Article 149 Item 1 (1)~(8) — Article 151

Damages — Article 149 Item 2 — Article 150

Remedies Derivative Suit — Article 152

Suit Direct Suit — Article 153

Section One: Duty of Care

Definition and Standards of Care

the Business Judgment Rule

Overcoming Business Judgment Presumption

Remedies for Breaching the Duty of Care

The Structure of Duty of Care

the board

decision making

oversights function

judicial review

the duty of care

BJR

Standards on Duty of Care

Statutory Standards

MBCA§8.30 (1997 revised) (directors)

~in good faith

~reasonably believes to be in the best interests of the Co.

~become informed in performing their decision-making and oversight functions with the care a person in like position would reasonably believed appropriate under the circumstances.

Standards on Duty of Care

Common Law Standards

The Delaware Supreme Court has stated a party challenging a business decision must show either the directors failed to act:

~in good faith ~in the honest belief that the action taken was

in the best interest of the company

~on an informed basis

ALI Principles§4.01(a)

specifying ordinarily prudent person standard.In general, these judicial standards also apply to

officers.

Facets of Duty of Care

Good Faith require directors: (1)honest; (2)not have a

conflict of interest; (3)not involved in illegal activity.

Reasonable Belief

substance of decision-making: furthering Company’s interest

Reasonable Care

procedures of decision-making and oversight: “Informed basis” ,“ordinary care” ,“like position”

, “under similar circumstances”rarely held liable for mere mismanagement

B.J.R (safe harbor)

• B.J.R ： rather than a prescription of standards of behavior, but a judicial “hands off” attitude——a golden rule of Company law

• B.J.R ： a rebuttable presumption—— directors’ performance are honest and well-meaning, decision are informed and rational undertaken.

• B.J.R ： not statutorily codified but continues to be developed by the courts, dilute the statutory standards.

Operation of B.J.R

• B.J.R. operates at two levels:

(1) It shields directors from personal liability;

and

(2) it insulates board decisions from review.

• The burden of rebutting the business judgment presumption rests on the party challenging a director’s actions or board decision.

• Encourages risk-taking “nothing ventured, nothing gained”

• Avoids judicial meddling Judges are not business experts, and plaintiffs have inc

entives that may be odds with the company and body of shareholders. So corporate statutes specify uniformly that corporate management is entrusted to the board.

• Market Pressure Alternative Mechanism poorly managed—stock price falls and hard to raise ne

w capital—vulnerable in proxy fight or takeover—managers replaced—manager less attractive in the executive job market.

Justification for the BJR

Reliance Corollary: Delegation of Inquiry and Oversight Functions

• Reliance Corollary: Directors cannot be expected to learn and know about the full range of the corporation’s business.

• Statutes: MBCA§8.42(c)-(e) : directors can rely on

information and advice from proper persons. MBCA§8.42(b) under some statutes, it also

extends to officers

Persons can be relied on: (1) other directors [committees of board] (2) competent officers (3) employees (4) outsider experts [lawyers and accountants]

Reliance Corollary: Delegation of Inquiry and Oversight Functions

• Requirements & Limitations on Reliance Corollary

• -To claim reliance, directors must have become familiar with the information or advice and have reasonably believe that it merited confidence.

• -Directors remain subject to general standards of care in judging reliability and competence of source of information (MBCA §8.30).

Directors cannot hide their heads in the sand and claim reliance if they have reasonable suspicions that make reliance unwarranted.

• -Management directors have a correspondingly greater duty to independently verify information.

Overcoming B.J. Presumption

burden

fraud, illegality or a conflict of interestthe lack of a rational business purposegross negligence

~action not in good faith~decision not reasonably believed to be Company’s best interests~decision not adequately informed~action from lack of objectivity or independence~a sustained failure to be informed in oversight function~receipt improper financial benefit

The court

Revised MBCA

~charter provision limiting liability~the statutory safe harbor for conflict interest transactions

MBCA§8.31

Overcoming B.J. Presumption

• Not in Good Faith

• Irrational Decision—Waste

• Gross Negligence

• Inattention

Not in Good Faith—Fraud, Illegality, or Conflict of

Interest

Fraud Directors knowingly or recklessly misrepresent a material

fact on which the board relies to the corporation’s detriment can be held liable under a tort deceit theory.

Conflict of Interests Director’s liability and action’s validity is dependent on fai

rness standards that apply to interest-conflicted transactions.

Illegality Breach of duty of loyalty

Irrational Decision—Waste

Rational basis: how much of a business justification is sufficient?

• Rational purpose test:

even board decision that in hindsight seem patently unwise or imprudent are protected from judicial review so long as the business judgment was not-

~improvident beyond explanation…Del

~removed from the realm of reason…ALI.P

Gross Negligence

• Directors must make reasonable efforts to inform themselves in making decisions.

• Trans Union(Smith v. Van Gorkom)del.1985

• A CEO (Van Gorkom) who initiated, negotiated and advocated a merger agreement whose terms may have favored the acquirer (Prizker)

• Shareholders brought a class action challenging the board’s failure to become sufficiently informed.

Gross Negligence

• Trans Union(acquired) Prizker (acquirer)

• Board of Directors

(5 managing directors &

5 outside directors) $ 55

• Van Gorkom (CEO)

• Roman (CFO)

Gross Negligence

• Errors by a board composed of five management directors and five eminently qualified outside directors, according to the court, directors had:

• -failed to inquire into Van Gorkom’s role in setting the merger’s terms:

• -failed to review the merger documents;• -not inquired into the fairness of the $55 price, and the

value of the company’s significant, but unused, investment tax credits;

• -acted without inquiry the view of the company’s CFO (Roman) that the $55 was within a fair range.

• -not sought an outside opinion from an investment banker on the fairness of the $55 price; and

• -acted at a two-hour meeting without prior notice and without there being an emergency.

Gross Negligence

• Directors asserted they had been entitled to rely on Gorkom’s oral presentation outlining the merger terms, but the court held no reliance was warranted:

• -Van Gorkom did not explain that he, not Pritzker, suggested the $55 price;

• -Van Gorkom had not read the merger documents;

• -Directors did not inquire about senior management, who strongly objected to aspects of the agreement, including the price;

• -Directors never questioned Romans about the basis for his opinion;

Who can be relied on?

• Shall it be at any circumstance, the director seek outside opinion?

——Decision Making Process

• Shall it be at any circumstance, the directors’ liabilities are the same?

—— Discrimination on the Liabilities of directors

Two directors, One specialized in architecture, the other in finance.

——Allen v. Roydhouse,232 F 1010, P.1015.• Other directors are entitled to trust the colleague with

the qualification of CPA(UK) 。 ——Re Cladrose Ltd.(1990) BCLC204, p.208.

Inattention

• Oversight Functions of directors:

(1) go beyond decisions making

(2) requires directors to inquire into managers’ competence and loyalty

• Judicial review has varied depending on whether the director is inattentive to mismanagement, management abuses or illegality.

Inattention

• Inattention to mismanagement: • Case: A director whose “only attention to the affair of

the company consisted of talks with the president [who was a friend] as they met from time to time” was sued after the business failed because of the president’s poor business judgment.

• Learned Hand: • (1)The passive director, though he had technically

breached his duty of care, could not be liable because nothing indicated he could have prevented the business failure.

• (2) It would be impossible to know whether the director could have saved the business or how much he could have save.

Inattention

• Inattention to management abuse• Court have been less forgiving when a director

fails to supervise management defalcations.

• Directors turned on a blind eye to managers with their hands in corporate till.

• Liability hinges on whether the director knew or had reason to know of the management abuse.

Inattention

• Inattention to illegality• The court held that business judgment rule shields dir

ectors who had failed to detect antitrust violations (price-fixing or bid-rigging) by midlevel executives.

• The MBCA care standards regarding directorial oversight functions also reflects this view: “the director may depend upon the presumption of regularity, absent knowledge or notice to the contrary.”

——Official Comment, MBCA §8.30 (b)

Remedies for Breaching the Duty of Care

• 1. Personal Liability of Directors • Most Courts: vote for/acquiesced/failed to

object• MBCA§8.24(d) :Attending shall be assumed to

have agreed to the action, unless minutes of the meeting reflect the director’s dissent or abstention.

• Some courts: challenger to show D’s action/inaction

• 2. Enjoining Flawed Decision• enjoin/rescind action/unprotected by the BJR

Entrenchment ( 巩固地位的交易 )

Self-dealing transaction( 自我交易 )

Executive compensation ( 管理者报酬 )

Flagrant diversion ( 转移公司资产 )

Usurping corporate opportunity ( 滥用公司机会 )

Parent-subsidiary dealings ( 母子公司交易 )

Selling out ( 权钱交易 )

Promoter’s early dealings with the corporation ( 公司发起人与公司的早期交易 )

Duty of Loyalty

Chinese Regulations of Fiduciary DutiesFiduciary Duties


Detailed Regulations — Article 116 — Article 117 — Article 149 Item 1 (1)~(8) — Article 151

Damages — Article 149 Item 2 — Article 150

Remedies Derivative Suit — Article 152

Suit Direct Suit — Article 153

Nature of Self-dealing

A simple contrasting example:

Corporation A is selling a house worth $102,000

B is a business man

C is a business man and a director of corporation A

Types of transactionParties to a transaction

Purchasing price

Market transaction: A B $ 102,000

Self-dealing transaction: A C $ 2,000


Why the purchasing price of the house is only $ 2,000 in a self-dealing transaction?

Director C——(Seller) a director of corporation A ——raise the price

——(Buyer) a business man ——lower the price

Answer:

Question:

Conflict of

Interest—Reason


Definition of Self-dealing

﹡The conduct of a fiduciary in a transaction

﹡that consists of taking advantage of his or her position

﹡and acting for his or her own interests

﹡rather than for the interests of the corporation.

conflict of

interest

Two broad categories of Self- Interest


Direct Interest

Self- Interest

Indirect Interest



e. g.

①sale & purchase of property

②loan to & from

③furnishing of services

Direct Interest

—corporation & director



Indirect Interest

——corporation & person or entity (in which director has a personal or financial interest)

e. g.

①with director’s close relatives

②with an entity in which the director has a significant financial interest

③between companies with interlocking directors

Judicial Suspicion of

Self-dealing Transactions

Two basic assumptions

Historical development of fairness test

Judicial Suspicion of Self-dealing Transactions

Two basic assumptions:

Assumption2: group dynamics ——identify with their interested directors even if they don’t have an interest in the transaction

——Judicial suspicion of procedural fairness

Assumption1: human nature ——advance their own interest rather than the corporation’s interest

——Judicial suspicion of substantive fairness

Judicial Suspicion of Self-dealing Transactions

Historical development of fairness test

Late 1800s: rule of voidability ——regardless of fairness ——flatly prohibited ——voidable at the request of the corp

oration

Since early 1900s: Safe harbor test ——substantive and procedural fairness tests ——abandon the flat prohibition ——be valid if properly approved

“Safe harbor tests” in four statutes:

①Delaware GCL § 144

②1984 MBCA § 8.31

③1989 MBCA § 8.61 (Subchapter F)

④ALI Principles of Corporate Governance

Statutory “safe harbors”


Statutory “safe harbors” in four statutes

Three basic principals of “Safe harbor tests”:

①disinterested directors’ approval, or

②disinterested (qualified) shareholders’ approval, or

③fairness

Analysis of similarities and differences of the four statutes in details


﹡Analysis of similarities of the four statutes in details

★ Burden of prove in the litigation

Directors or shareholders Burden of prove Content

Disapproved Defendant (Interested directors) Validity

Approved Plaintiff Invalidity


Objective test: terms of the transaction—principally the price

Corporate value: corporation’s needs and scope of its business

★ Two aspects of Substantive Fairness Standard


﹡Analysis of differences of the four statutes in details

★ Interested persons in a self-dealing transaction:

Statutes Interested persons

Delaware GCL § 144 Directors + Officers

1984 MBCA § 8.31 Directors

1989 MBCA § 8.61 (Subchapter F)

ALI Principles of Corporate Governance

★Disclosure in a self-dealing transaction

☆ Content of disclosure in a self-dealing transaction: ﹡Existence and nature of conflict of interest ﹡Material information

☆ Disclosure requirements in a self-dealing transaction:

Statutes Disclosure requirements

Delaware GCL § 144 ﹡fully disclosed: at the directors’ & shareholders’ approval

﹡disclosed or not: when judge determines the fairness

1984 MBCA § 8.31

1989 MBCA § 8.61 (Subchapter F)


﹡fully disclosed: in any circumstances



★Quorum requirements in the directors’ & shareholders’ approval

☆ Quorum requirements in the directors’ approvalStatutes Quorum requirements

Delaware GCL § 144 Majority (at least one disinterested director)

1984 MBCA § 8.31 Majority (at least two disinterested directors)1989 MBCA § 8.61 (Subchapter F)


☆ Quorum requirements in the shareholders’ approval

Majority of disinterested or qualified shareholders


★Judicial review of the directors’ & shareholders’ approval

☆Judicial review of the directors’ approval

statutes Judicial review of directors’ approval

Delaware GCL § 144 Substance

1984 MBCA § 8.31

1989 MBCA § 8.61 (Subchapter F) Diluted Substance (Rational: care, best interest, and good faith)

ALI Principles of Corporate Governance Diluted Substance (Reasonable)

☆Judicial review of the shareholders’ approval

Statutes Judicial review of shareholders’ approval

Delaware GCL § 144 Substance

1984 MBCA § 8.31

1989 MBCA § 8.61 (Subchapter F) Process

ALI Principles of Corporate Governance Diluted Substance (waste or gift)

General Remedy

Exceptions to Rescission

Remedies for self-dealing

Remedies for self-dealing

General Remedy ——— Rescission （废除）

Rescission:

Returns the parties to their position before the transaction

Exceptions to Rescission ——— Damages （赔偿）

Damages:

The profit made by the director in the self-dealing transaction

Chinese Regulations and Comments

Who shall undertake the fiduciary duties

• Persons directly subject to fiduciary duties directors, supervisor and senior manager

• Person indirectly subject to fiduciary duties controlling shareholder, actual controlling party


• Article 148• The directors, supervisors and senior managers shall comply

with laws, administrative regulations and the articles of association.

• What are senior managers? Are CFO and CTO senior manager?

• They shall bear the obligations of fidelity and diligence to the company.

• No director, supervisor or senior manager may take any bribe or other illegal gains by taking the advantage of his authorities, or encroach on the properties of the company.

Definition of Senior Managers

• Article 217 The "senior manager" refers to the manager, vice

manager, person in charge of finance of a company, and the secretary of the board of directors of a listed company as well as any other person as stimulated in the articles of association.

Article 124 Listed companies shall appoint a board secretary to be

responsible for preparation of meetings of the shareholders’ meeting and board of directors, keeping of documents, management of shareholders’ information and handling of information disclosure etc.

The Qualification of Directors, Supervisors and Senior Managers

• Q: Who shall be deprived of qualification?• 1. A person aged at 17• 2. A person sentenced for 5-year in prison for

conviction of rape but now released from the jail • 3. A person chaired as CEO of a company which was

bankrupt in the end• 4. A person who acting as a legal representative of a

company which business license was revoked for a

breach of law• 5. A person who has great amount of debts for having

purchased a big single house

Regulations on the Qualification

• Article 147 The following persons shall not act as a director, supervisor

or senior management personnel:• (1) a person who has no civil capacity or who has limited

civil capacity;

• (2) a person who has been convicted for corruption, bribery, conversion of property or disruption of the order of socialist market economy and a five-year period has not lapsed since expiry of the execution period or a person who has been stripped of political rights for being convicted of a crime and a five-year period has not lapsed since expiry of the execution period;


• (3) a person who acted as a director, factory manager, manager in a company which has been declared bankrupt or liquidated and who is personally accountable for the bankruptcy or liquidation of the company; and a three-year period has not lapsed since the completion of bankruptcy or liquidation of such company;


• (4) a person who has acted as a legal representative of a company which has its business license revoked or being ordered to close down for a breach of law and who is personally accountable, and a three-year period has not lapsed since the revocation of the business license of such company; and


• (5) a person who is unable to repay a relatively large amount of personal debts.

• Where the election or appointment of a director, supervisor or senior management personnel is in violation of the aforesaid provisions, such election or appointment shall be void.

General Regulations

• Article 217• (2) Controlling shareholder shall mean a shareholder

who contributes to 50% or more of the capital of a limited liability company or a shareholder who holds 50% or more of the shares of a company limited by shares or a shareholder who is able to exercise significant influence on the resolutions of the shareholders’ meeting or a shareholders’ general meeting even though it contributes to less than 50% of the capital or holds less than 50% of the shares.

• (3) Actual controlling party shall mean a party which exercises actual control over a company as investor or through other agreements or arrangements even though it is not a shareholder of the company.

Detailed Regulations— Article 116. 117

• Article 116 No company may, directly or via its subsidiary, lend

money to any of its directors, supervisors or senior managers.

flatly prohibited policy, why? Shall company lend money to shareholders? Art. 149(3)

• Article 117 • A company shall regularly disclose to its shareholders

the information about remunerations obtained by the directors, supervisors and senior managers from the company.

Detailed Regulations: Interested Transaction

• Article 16 (Section 2) In the case of a company providing guarantee for a

shareholder or the actual controlling party of the company, a resolution passed by the shareholders’ meeting or a general meeting is required.

Shareholders stipulated in the preceding paragraph or shareholders controlled by the actual controlling party stipulated in the preceding paragraph shall not participate in the resolution in respect of the matter stipulated in the preceding paragraph. Such a resolution shall be passed by a simple majority of votes cast by other shareholders attending the meeting.

Detailed Regulations: Interested Transaction

• Article 125• Where any of the directors has any relationship with

the enterprise involved in the matter to be discussed at the meeting of the board of directors, he shall not vote on this resolution, nor may he vote on behalf of any other person.

• The meeting of the board of directors shall not be held unless more than half of the unrelated directors are present at the meeting. A resolution of the board of directors shall be adopted by more than half of the unrelated directors. If the number of unrelated directors in presence is less than 3 persons, the matter shall be submitted to the shareholders' meeting of the listed company for deliberation.

Detailed Regulations: Duty of Loyalty — Article 149 Item 1 (1)~(2)

• Article 149

• No director or senior manager may have any of the following acts:

• (1) Misappropriating funds of the company;

• (2) Depositing the company's funds into an account

in his own name or in any other individual's name;

Detailed Regulations : Duty of Loyalty — Article 149 Item 1 (3)

• (3) Without the consent of the shareholders' meeting, shareholders' assembly or board of directors,

loaning the company's fund to others

or providing any guaranty to any other person

by using the company's property as in violation of the articles

of association;

Detailed Regulations : Duty of Loyalty — Article 149 Item 1 (4)

• (4) Signing a contract or trading with this company

by violating the articles of association

or without the consent of the shareholders' meeting

or shareholders' assembly;

Questions for Analyses & Discussion

• Question :Ⅰ categories of self-interest: Signing a contract

or trading with this company

— direct interest

— Disadvantages?

(indirect interest)


• Question :Ⅱ

exemption condition: articles of association

or shareholders' meeting

or shareholders' assembly

—The reasons? — Advantages & Disadvantages? — Why not the board of directors?

Cases for Discussion

• Case :Ⅰ One director was involved in a self-dealing action. He argu

ed that the article of the association prescribed interested transactions would be valid with the approval of the board of director. And he did get such a approval from the board.

• Questions for Discussion: Shall the director be held liable for the action? Who shoul

d bear the burden of proof?

Detailed Regulations: : Duty of Loyalty — Article 149 Item 1 (5)

• (5) Without the consent of the shareholders' meeting

or shareholders' assembly,

seeking business opportunities for himself or any other person by taking advantages of his authorities,

or operating for himself or for any other person any like

business of the company he works for;


• Question :Ⅰ — definition of corporate opportunities?

interests & expectancy test or line of business test or fairness or intrinsic fairness test

or two-step analysis

or categorical rule (close corporation) & selective rule (public corporation)


• Question :Ⅱ

justification for taking a corporate opportunity:

consent of the shareholders' meeting

or shareholders' assembly

—any other justifications?

corporate refusal

corporate inability

in good faith and not compete with corporation

third party’ unwillingness

ultra vires or other legal incapacity


• Question Ⅲ :

— legal attitude toward

“competition with the corporation” ?

prohibited

or restricted

or allowed

Cases Analysis

• Case :Ⅰ One senior manger of a company was seeking to

rent an apartment for the company’s employees. With efforts and time consuming, he found an apartment for sale in the East China University of Politics and Law. Then the manager bought this apartment for himself.

• Questions for Discussion: Is that some kind of usurping the corporate oppo

rtunity ?

Detailed Regulations : Duty of Loyalty — Article 149 Item 1 (6)~(8)

• (6) Taking commissions on the transactions between others and this company into his own pocket;

• (7) Disclosing the company's secrets without permission;

• (8) Other acts that are inconsistent with the obligation of fidelity to the company.

Detailed Regulations : Duty of Loyalty — Article 151

• Article 151

• If the shareholder's meeting or shareholders' meeting demands

a director, supervisor or senior manager to attend the meeting as a non-voting delegate, he shall do so and shall answer the shareholders' inquiries.

• The directors and senior managers shall faithfully offer relevant

information and materials to the board of supervisors or the supervisor of the limited liability company with no board of supervisors, and none of them may obstruct the board of supervisors or supervisor from exercising its (his) authorities.

Remedies —Damages — Article 149 Item 2 & Article 150

• Article 149 Item 2

• The income of any director or senior manager from any act in violation of the preceding paragraph shall belong to the company.

• Article 150

• Where any director, supervisor or senior manager violates laws, administrative regulations or the articles of association during the course of performing his duties, if any loss is caused

to the company, he shall make compensation.


• Question:

— The relationship between

seizure of income & compensation?

Executive Compensation

Question:

Why the executive compensation is also a form of self-dealing transaction?

To find out the Answers:

Step1: Who will authorize the compensation?

Who (Chinese regulation)

Who(MBCA & Delaware)

Directors Shareholders’ meeting

Closely held corporation: shareholders’ negotiation

Public corporation: committee of outside directors

Officers Board of directors

Step2:

What if the director is in control of the shareholders’ meeting?

Executive Compensation

——the director will decide his own compensation. ——Self-dealing Transaction

What if the officer is also a director?

——the officer will decide his own compensation.

——Self-dealing Transaction

Forms of Executive Compensation

﹡Salaries （薪水）﹡Bonus （奖金）﹡Stock plans: Stock grants （股票赠与） Stock option （股票期权） Phantom stock （虚拟股票） Stock appreciation rights （股票增值权）﹡Pension plans （退休金计划）

﹡Direct forms:

﹡Fringe benefits: Expense accounts ( 公务开支的报销单，预算拨款） Company residents （公司提供的住宅） Use of corporate jets （使用公司的喷气机）

﹡Indirect forms:

Judicial Review

Statistics of compensation

judicial review of the compensation

Judicial Review

Statistics of compensation

﹡ Contrasting statistics: (Payments in 1993)

A pharmaceutical corporation in New Jersey The USA

CEO Officers The president Congressman

$1,380,000 $600,000-$1,060,000

$200,000 $100,000

Remarks: $1,380,000 ≈ $200,000 × 6.9

Judicial Review

Managing a corporation or managing the whole country?

Question:

Which one is more difficult?

Judicial Review

﹡ Amazing graphs:

Judicial Review

《 the Overcompensation of American Executives 》

“CEOs are paid hugely in good years if not hugely, then wonderfully in bad years.”

The most famous critic:

Judicial Review

Judicial Review

﹡Incentive effect (primary) — maximization of corporation’s value

﹡Tax motivation — avoid double taxation

﹡Squeeze out minority shareholders

judicial review of the compensation

﹡purpose of compensation plans:

Judicial Review

Business Judgment Review (BJR) —Grossly uniformed —Waste

﹡General regulations of compensation:

Substantive Fairness Review—the executive’s qualification, ability, responsibility, time devoted—the corporation’s complexity, revenues, earnings, profits—the possibility of fulfillment of the incentive compensation—the compensation of similar executives in comparable corporation

﹡Without disinterested directors’ approval

﹡With disinterested directors’ approval

《 rule of SEC 》

﹡Disclosure of executive compensation

﹡Disclosure of shareholders’ suggestion of executive compensation in proxy solicitation

﹡Disclosure of the value of stock option of officers

﹡Other necessary regulations of compensation:

Judicial Review

﹡Regulation :Ⅰ

Article 117

A company shall regularly disclose to its shareholders the information about remunerations obtained by the directors, supervisors and senior managers from the company.

﹡Personal comments : Who enforce the regulation?


Article 38 (2) The shareholders' meeting shall determine the matters concerning the director and supervisors remuneration.

﹡Regulation :Ⅱ


Article 47 (9) the board of directors shall making decisions on the remuneration of company's manager, vice manager(s) and the person in charge of finance

Q: any self-dealing in the context of the above provisions?

Remedies—Litigation Ⅰ Derivative Suit

The Nature of Derivative Suit 1. Solution to the dilemma of corporate law

2. Two Suits in One

3. All Recovery to Corporation

4. Reimbursement of Successful Plaintiff’s

Expenses

The Nature of Derivative Suit

1.Equity jurisdiction’s ingenious solutions to the dilemma created by two inconsistent tenets of corporate law

(1) Corporate fiduciaries owe their duties to the corporation

(2) The board of directors manages the corporation’s business, including authorizing lawsuit in the corporate’s name.


2. Two Suits in One

(1)Shareholders sue on behalf of the corporation to enforce rights of the corporation.

(2)The corporation, an indispensable party, is made a nominal defendant, which can compel the derivative suit plaintiff to comply with various procedural requirements.


3. All Recovery to Corporation

Enforcing the corporate rights: any recovery in derivative litigation generally runs to the company.

Shareholder-plaintiff shares in the recovery only indirectly, to the extent her shares increase in val

ue because of the corporate recovery.

Some Exceptions


• Exception: ALI Principles §7.01 (d)

When involving a close corporation, a court may exercise its discretion to allow direct shareholder recovery, provided

the corporation is not exposed unfairly to multiple claims, creditors are not materially prejudiced, and the recovery can be fairly distributed.

•


4. Reimbursement of Successful Plaintiff’s Expenses

Why would a shareholder, particularly a shareholder in a public corporation, undertake the efforts and expenses of a derivative suit?

The prevailing American rule: each litigant bears his own expenses. The universal rule in derivate suit: corporation pays the successful plaintiff’s litigation expenses, including fees.

Theory: the plaintiff (and her attorney) produced benefits to the corporation, and they should be reimbursed for their efforts.

Practice: Plaintiff——Self-appointed Representative, should fairly and adequately represent the interests of the shareholders

The Rules of Chinese Company Law on

Derivative Suit: Article 152 • Article 152

• Where a director or senior manager is under the circumstance as stated in Article 150 of this Law,

the shareholder(s) of the limited liability company

or joint stock limited company separately or aggregately holding 1% or more of the total shares of the company for more than 180 days consecutively

may require the board of supervisors or the supervisor of the limited liability company with no board of supervisors in writing

to file a lawsuit in the people's court.


Derivative Suit: Article 152

• If the supervisor is under the circumstance as stated in Articl

e 150 of this Law,

the aforesaid shareholder(s) may require the board of director

s or the acting director of the limited liability company with no bo

ard of directors to in writing lodge a lawsuit in the people's court.



• If the board of supervisors, or supervisor of a limited liability company with no board of supervisors, or the board of directors or the acting director

refuses to lodge a lawsuit after it (he) receives a written request as mentioned in the preceding paragraph,

or if it or he fails to file a lawsuit within 30 days after it receives the request,

or if, in an emergency, the failure to lodge a lawsuit immediately will cause unrecoverable damages to the interests of the company,

the shareholder(s) as listed in the preceding paragraph may, on their own behalf, directly lodge a lawsuit in the people's court.



• In the event of an infringement of the legal interests

of the company by others which causes the company

to suffer damages, shareholders mentioned in (1)

above may file a lawsuit with a people’s court in

accordance with the provisions of the aforesaid

paragraphs.

Ⅰ. The Qualification of Plaintiff

The following realities invite weak-willed and evil-hearted plaintiff:

(1) The plaintiff may be indifferent to the outcome of the litigation.

The financial interests in the recovery will be small.

(2) The plaintiff’s attorney may be indifferent to the substantive outcome

The fees are usually contingent on a settlement or court award.

(3) The individual defendants usually will prefer settlement rather than

trial. The expenses or costs will be indemnified by the corporation or

covered by insurance.

“Strike suit plaintiff”: waste and abuse judicial resources.

Ⅰ. The Qualification of Plaintiff

• 1. Contemporaneous ownership requirements Most statutes require the plaintiff to have been a sharehold

er when the wrong occurred.(MBCA § 7.41(1)) To make sure shareholders did not buy shares to buy a suit.

Exception: When an undisclosed wrong (such as a pattern of waste) was continuing when the plaintiff aquired her shares. ALI Principles § 7.02(a)(1)

• 2.Contiuning Interests requirements• Some statutes require that the plaintiff continue to be a sh

areholder when suit is brought and then through trial.(Cf. MBCA 7.41(1))

The Rules of Chinese Company Law onQualification of Plaintiff

• qualified plaintiff:• · limited liability company —shareholder(s)

· joint stock limited company —separately or aggregately 1% or more of the total shares more than 180 days consecutively

—Advantages & Disadvantages?

No contemporary ownership rule: encourage litigation

Shareholding requirement for JSC: Fairness & Standing

Ⅱ. The Pre-suit Demand

• Purpose: to prevent abuse of the judicial process and protect the integrity of centralized corporate governance.

• Finding a Corporate Voice: • Who shall have the right to dismiss such suits: Why not sh

areholders?• (1) Shareholders may lack the incentives to evaluate the re

lative costs and benefits of derivative litigation.

• (2) Allowing a shareholders majority to refuse to litigate could entail an expensive and burdensome proxy contest before suit , which would kill derivate litigation.


The Dilemma of board’s power to speak for the corporation:

The BJR rule: The directors, more than shareholders or judges, are better positioned to evaluate whether a claim has merits.

Interest conflicts: When the claim involves charges of a fiduciary breach, corporate law doubts the board’s impartiality.


• Two Balance Schemes

• 1. Demand-required (futility exception) Demand-Required Board decides fate of claim,

subject to review under BJR

Demand-Excused Claim goes forward;

board can not dismiss

• 2. Universal-demand (Waiting period)


Demand-Excused When is demand excused? Various tacks taken by

court.

Board tainted: Only if the shareholder-plaintiff shows that a majority of the current board is either personally interested in the challenged wrongdoing or dominated by the wrongdoer.

Board’s objectivity in doubt: Only if the shareholder-plaintiff can allege with particularity facts that the majority of the directors are disinterested and independent.


• Universal Demand (waiting period) A shareholder wishing to file suit must make a

demand and then wait 90 days, unless

the board rejects the demand

or

waiting would result in irreparable injury to the corporation.

Special litigation committee (SLC) : consists of disinterested and often recently appointed directors , decide whether the litigation should go forward.

The Rules of Chinese Company Law on Pre-suit Demand

• Pre-suit Demand: · directors & senior managers —board of supervisors or supervisors · supervisors —board of directors or executive directors

premises of suit: refusal of suit or failure to suit within 30 days or emergency


• —The reason of dual system• —Advantages & Disadvantages?• (qualification of supervisors’ judgment)• (litigation committee) • —Exemptions of Pre-suit Demand?• (emergency…)

—Burden of proof?

—If the defendant is the third party, to whom shareholder-plaintiff shall make a demand for suit?


• Question Ⅲ : qualified defendant: directors

senior managers

supervisors

anyone impair the corporation

What is the standing of corporation in this lawsuit?

—Corporation: plaintiff or defendant?


• Other Related Questions:

—securities for expenses? —settlement? —monetary and nonmonetary relief? —litigation expenses? lodestar formula or percentage-of-the-recovery or combination method

—D&O indemnification and liability insurance?

Cases for Discussion

• Case :Ⅰ The board of director of Company A made a deci

sion to sell a spare apartment for 100, 000 RMB, while the shareholders thought the price was much lower than expected. Can they bring a suit against the directors?

Questions for Discussion: Business Judgment Rule and Damages Rule

Remedies—Litigation

Direct Suit — Article 153

• Article 153

• If any director or senior manager damages the

shareholders' interests by violating any law, administrative

regulation or the articles of association, the shareholders

may lodge a lawsuit in the people's court.

How to characterize the Direct Suit

Direct suits vindicate shareholders’ financial, liquidity and voting rights.

To compel payment of dividends declared but not distributed

To challenge fraud on shareholders in connection with their voting sale, or purchase of securities

To require the holding of shareholders’ meeting To compel inspection of shareholders’ list or corporate

bonds at records.

Class Actions: Direct Suits Brought by Representative

• When a shareholder sues in his own capacity, as well as on behalf of other shareholders similarly situated, the suit is not a derivative suit but a class action.

• China’s Practice: the right incentive of Judges

1. Experience and Expertise lack

2. Heavy Burden on Trial

Comments in General

• Regulations of duty of care

— only general regulations

• Regulations of duty of loyalty

— difficulties of enforcement

chapter 8 fiduciary duties

Documents