November 2024
Serials Research Part Three on the New Systems Under the New Company Law: Exploring the Direct Compensation Liability of Directors and Senior Executives to Third Parties Under Article 191 of the New Company Law (Mainland China)
November 2024
Jolene Chen and Teresa Huang
The newly revised Article 191 of the Company Law innovatively establishes a system of direct compensation liability for directors and senior executives toward third parties. This provision breaks away from the traditional "director—company—creditor" chain of responsibility, as outlined in Articles 62 and 1191 of the Civil Code, which stipulate that when a company’s legal representative or employees cause harm to others in the course of their duties, the company bears external liability, with internal recourse available. Article 191 of the Company Law stands as an independent provision, not tied to other clauses regarding a company's liability toward third parties, and should be understood as a general rule governing the liability of directors and senior executives to third parties. The establishment of this article strengthens the duty of diligence for directors and senior executives, significantly enhancing the protection of third-party rights. Therefore, this article will provide a preliminary exploration of the legislative intent, practical significance, applicable scenarios, and forms of liability under Article 191.
1. Strengthening the Duty of Diligence for Directors and Senior Executives and Improving the Liability Mechanism
The primary aim of Article 191 of the Company Law is to regulate the duty of diligence for directors and senior executives. The article states: "When a director or senior executive causes harm to others in the course of performing their duties, the company shall bear liability for compensation; if the director or senior executive is found to have acted with intent or gross negligence, they shall also bear liability for compensation." The core of this provision lies in determining whether directors and senior executives have fulfilled their reasonable duty of care during the performance of their duties, i.e., whether they have exercised the duty of diligence.
Both the old and new versions of the Company Law stipulate the duty of diligence that directors and senior executives owe to the company. However, under the old Company Law, when a director’s actions caused harm to a third party, the typical approach was for the company to bear external liability, followed by internal recourse against the director or senior executive at fault. After compensating the third party, the company could seek recourse against the responsible director or senior executive as per Articles 147 and 149 of the old Company Law. In practice, however, companies rarely pursued recourse after assuming liability, leading to a loss of company interests and ultimately harming the interests of third parties as well.
Thus, Article 191 of the Company Law does not increase the liability of directors and senior executives but ensures the effective enforcement of legal responsibilities by granting harmed third parties the right to directly claim compensation from directors and senior executives. This helps to more effectively protect third-party rights.
2. Effectively Curbing Actions that Harm Creditors and Strengthening Protections for Third Parties
In practice, instances of directors abusing their powers to intentionally harm creditors are not uncommon. The Kangmei Pharmaceutical case (Case No. (2020) Yue 01 Min Chu 2171) serve as a typical example. On November 12, 2021, Kangmei Pharmaceutical, a publicly listed company, was ordered to pay compensation of 2.459 billion yuan. The company’s actual controllers, Ma Xingtian and his wife, along with four former senior executives, including Qiu Xiwei, were found guilty of orchestrating financial fraud and were held jointly liable for 100% of the compensation due to their intentional misconduct. Additionally, 13 other senior executives were held jointly liable based on their degree of fault, bearing 20%, 10%, and 5% of the compensation, respectively. Although this case falls under securities law, the issues it reveals are similarly present in limited liability companies and ordinary companies limited by shares. For example, cases where directors or senior executives exploit their access to information and their positions to lavishly spend company funds, pay themselves exorbitant salaries, or even transfer company assets, often leaving the company unable to repay its debts, are all too common.
The establishment of Article 191 of the Company Law aims to effectively curb such behaviors. In situations where other regulations, such as securities law, may not apply to hold directors or senior executives personally liable, Article 191 ensures that the legitimate rights and interests of third parties are still protected.
3. Two Conditions under Which Directors and Senior Executives Bear Responsibility
According to a literal interpretation of Article 191, two conditions must be met for it to apply: first, the harm must occur while performing their duties; second, the harm must result from intentional misconduct or gross negligence.
Both of these conditions must be satisfied for Article 191 to apply. When determining whether a director or senior executive was "performing their duties," we must consider whether the act falls within their scope of responsibilities and whether the behavior is related to those duties. As for whether there was intentional misconduct or gross negligence, this should be assessed in light of the business judgment rule. If the harm to the third party was not caused by intentional misconduct or gross negligence, but rather by ordinary negligence, the third party may only seek compensation from the company, not directly from the director or senior executive in their personal capacity.
4. Interpreting the Nature of Liability for Directors and Senior Executives as Supplementary Liability
The draft revision of the Company Law, released on December 24, 2021, originally included Article 190, which stipulated: "When a director or senior executive, in the course of performing their duties, causes harm to others due to intentional misconduct or gross negligence, they shall be jointly and severally liable with the company." However, in the final version, the term "joint and several liability" was replaced with "liability for compensation." According to Article 178 of the Civil Code, joint and several liability must be explicitly provided by law or agreed upon by the parties, and the current Article 191 of the Company Law does not explicitly provide for such joint liability.
Based on the views of Liu Guixiang, a full-time member at the vice-ministerial level of the Judicial Committee of the Supreme People's Court and a second-level senior judge, published in the Journal of Law Application (Issue 6, 2024), the liability of directors to third parties under Article 191 should be understood as supplementary liability. This means that the company should bear responsibility first, and only if the company is unable to fulfill its obligations would the director be required to assume supplementary liability within the scope of the company’s unpaid obligations. In order to balance the personal liability of directors and senior executives with the protection of third-party interests, this interpretation seems reasonable. We should closely follow how this form of liability is applied in judicial practice.
Related Articles
The contents of all newsletters of Shanghai Lee, Tsai & Partners (Content) available on the webpage belong to and remain with Shanghai Lee, Tsai & Partners. All rights are reserved by Shanghai Lee, Tsai & Partners, and the Content may not be reproduced, downloaded, disseminated, published, or transferred in any form or by any means, except with the prior permission of Shanghai Lee, Tsai & Partners.
The Content is for informational purposes only and is not offered as legal or professional advice on any particular issue or case. The Content may not reflect the most current legal and regulatory developments. Shanghai Lee, Tsai & Partners and the editors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The contributing authors' opinions do not represent the position of Shanghai Lee, Tsai & Partners. If the reader has any suggestions or questions, please do not hesitate to contact Shanghai Lee, Tsai & Partners.
Jolene Chen and Teresa Huang
The newly revised Article 191 of the Company Law innovatively establishes a system of direct compensation liability for directors and senior executives toward third parties. This provision breaks away from the traditional "director—company—creditor" chain of responsibility, as outlined in Articles 62 and 1191 of the Civil Code, which stipulate that when a company’s legal representative or employees cause harm to others in the course of their duties, the company bears external liability, with internal recourse available. Article 191 of the Company Law stands as an independent provision, not tied to other clauses regarding a company's liability toward third parties, and should be understood as a general rule governing the liability of directors and senior executives to third parties. The establishment of this article strengthens the duty of diligence for directors and senior executives, significantly enhancing the protection of third-party rights. Therefore, this article will provide a preliminary exploration of the legislative intent, practical significance, applicable scenarios, and forms of liability under Article 191.
1. Strengthening the Duty of Diligence for Directors and Senior Executives and Improving the Liability Mechanism
The primary aim of Article 191 of the Company Law is to regulate the duty of diligence for directors and senior executives. The article states: "When a director or senior executive causes harm to others in the course of performing their duties, the company shall bear liability for compensation; if the director or senior executive is found to have acted with intent or gross negligence, they shall also bear liability for compensation." The core of this provision lies in determining whether directors and senior executives have fulfilled their reasonable duty of care during the performance of their duties, i.e., whether they have exercised the duty of diligence.
Both the old and new versions of the Company Law stipulate the duty of diligence that directors and senior executives owe to the company. However, under the old Company Law, when a director’s actions caused harm to a third party, the typical approach was for the company to bear external liability, followed by internal recourse against the director or senior executive at fault. After compensating the third party, the company could seek recourse against the responsible director or senior executive as per Articles 147 and 149 of the old Company Law. In practice, however, companies rarely pursued recourse after assuming liability, leading to a loss of company interests and ultimately harming the interests of third parties as well.
Thus, Article 191 of the Company Law does not increase the liability of directors and senior executives but ensures the effective enforcement of legal responsibilities by granting harmed third parties the right to directly claim compensation from directors and senior executives. This helps to more effectively protect third-party rights.
2. Effectively Curbing Actions that Harm Creditors and Strengthening Protections for Third Parties
In practice, instances of directors abusing their powers to intentionally harm creditors are not uncommon. The Kangmei Pharmaceutical case (Case No. (2020) Yue 01 Min Chu 2171) serve as a typical example. On November 12, 2021, Kangmei Pharmaceutical, a publicly listed company, was ordered to pay compensation of 2.459 billion yuan. The company’s actual controllers, Ma Xingtian and his wife, along with four former senior executives, including Qiu Xiwei, were found guilty of orchestrating financial fraud and were held jointly liable for 100% of the compensation due to their intentional misconduct. Additionally, 13 other senior executives were held jointly liable based on their degree of fault, bearing 20%, 10%, and 5% of the compensation, respectively. Although this case falls under securities law, the issues it reveals are similarly present in limited liability companies and ordinary companies limited by shares. For example, cases where directors or senior executives exploit their access to information and their positions to lavishly spend company funds, pay themselves exorbitant salaries, or even transfer company assets, often leaving the company unable to repay its debts, are all too common.
The establishment of Article 191 of the Company Law aims to effectively curb such behaviors. In situations where other regulations, such as securities law, may not apply to hold directors or senior executives personally liable, Article 191 ensures that the legitimate rights and interests of third parties are still protected.
3. Two Conditions under Which Directors and Senior Executives Bear Responsibility
According to a literal interpretation of Article 191, two conditions must be met for it to apply: first, the harm must occur while performing their duties; second, the harm must result from intentional misconduct or gross negligence.
Both of these conditions must be satisfied for Article 191 to apply. When determining whether a director or senior executive was "performing their duties," we must consider whether the act falls within their scope of responsibilities and whether the behavior is related to those duties. As for whether there was intentional misconduct or gross negligence, this should be assessed in light of the business judgment rule. If the harm to the third party was not caused by intentional misconduct or gross negligence, but rather by ordinary negligence, the third party may only seek compensation from the company, not directly from the director or senior executive in their personal capacity.
4. Interpreting the Nature of Liability for Directors and Senior Executives as Supplementary Liability
The draft revision of the Company Law, released on December 24, 2021, originally included Article 190, which stipulated: "When a director or senior executive, in the course of performing their duties, causes harm to others due to intentional misconduct or gross negligence, they shall be jointly and severally liable with the company." However, in the final version, the term "joint and several liability" was replaced with "liability for compensation." According to Article 178 of the Civil Code, joint and several liability must be explicitly provided by law or agreed upon by the parties, and the current Article 191 of the Company Law does not explicitly provide for such joint liability.
Based on the views of Liu Guixiang, a full-time member at the vice-ministerial level of the Judicial Committee of the Supreme People's Court and a second-level senior judge, published in the Journal of Law Application (Issue 6, 2024), the liability of directors to third parties under Article 191 should be understood as supplementary liability. This means that the company should bear responsibility first, and only if the company is unable to fulfill its obligations would the director be required to assume supplementary liability within the scope of the company’s unpaid obligations. In order to balance the personal liability of directors and senior executives with the protection of third-party interests, this interpretation seems reasonable. We should closely follow how this form of liability is applied in judicial practice.
Related Articles
- Serials Research Part One on the New Systems Under the New Company Law: The Protection System of Creditor's Rights and Interests Under the New Company Law (Mainland China)
- Serials Research Part Two on the New Systems Under the New Company Law: How to Transit from "Registered and Subscribed Capital System" Under the New Company Law? (Mainland China)
- Serials Research Part Four on the New Systems Under the New Company Law: Discussion on Shareholder Liability and Corporate Veil Piercing in One-Person Companies (Mainland China)
The contents of all newsletters of Shanghai Lee, Tsai & Partners (Content) available on the webpage belong to and remain with Shanghai Lee, Tsai & Partners. All rights are reserved by Shanghai Lee, Tsai & Partners, and the Content may not be reproduced, downloaded, disseminated, published, or transferred in any form or by any means, except with the prior permission of Shanghai Lee, Tsai & Partners.
The Content is for informational purposes only and is not offered as legal or professional advice on any particular issue or case. The Content may not reflect the most current legal and regulatory developments. Shanghai Lee, Tsai & Partners and the editors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The contributing authors' opinions do not represent the position of Shanghai Lee, Tsai & Partners. If the reader has any suggestions or questions, please do not hesitate to contact Shanghai Lee, Tsai & Partners.
