Key Points and Methods of Litigation for Disputes Involving Liability for Damaging Company Interests
Preface
Disputes over liability for damaging company interests refer to disputes arising from the abuse of shareholder rights by shareholders, or the violation of laws, administrative regulations, or the company's articles of association by directors, supervisors, and senior management personnel, which leads to damage to the company's interests. In terms of nature, disputes over liability for damaging company interests are special types of tort liability disputes within the field of company law. In practice, there are various ways of damaging company interests. When a company faces infringement, it can adopt either direct litigation by the company or shareholder representative litigation to protect its own legitimate rights and interests.
01 Types of Liability Disputes Involving Damage to Company Interests
According to the different entities causing damage to the company's interests, it can be divided into disputes over the liability of shareholders for damaging the company's interests and disputes over the liability of directors, supervisors and senior management personnel for damaging the company's interests.
The dispute over shareholders' liability for damaging the company's interests refers to the conflict where shareholders abuse their rights and cause losses to the company, and they should bear the responsibility for compensation. Article 132 of the General Provisions of the Civil Code, Article 3 of the Judicial Interpretation of the General Provisions of the Civil Code, and Article 21 of the Company Law all stipulate the prohibition of rights abuse. Company shareholders should exercise their rights in accordance with the provisions of laws, administrative regulations, and the company's articles of association, etc. Once they abuse their rights and cause losses to the company, they shall bear the responsibility for compensation.
The dispute over the liability of company directors, supervisors, and senior management for damaging the company's interests refers to the disputes arising when directors, supervisors, and senior management cause losses to the company while performing their duties. Articles 180, 181, 183, 184, 185, 186, and 188 of the Company Law clearly define the duties of loyalty and diligence of directors, supervisors, and senior management towards the company, and stipulate the compensation liability of directors, supervisors, and senior management as well as the company's right to exercise the power of appropriation over the illegal income of directors, supervisors, and senior management. If company directors, supervisors, and senior management fail to perform their duties in accordance with laws, administrative regulations, and the company's articles of association, causing losses to the company, they shall bear the liability for compensation.
02 Jurisdiction Court
Regarding the determination of the jurisdiction for disputes over liability for damaging company interests, the provisions of Article 22 and Article 29 of the Civil Procedure Law, as well as Article 3 and Article 24 of the Interpretation of the Supreme People's Court on the Application of the Civil Procedure Law of the People's Republic of China, have stipulated the relevant legal application for jurisdiction. However, in judicial practice, there are different viewpoints.
Viewpoint One: Acts that harm the company's interests constitute an infringement. According to Article 29 of the Civil Procedure Law, such cases should be under the jurisdiction of the courts in the place where the infringement occurred or the defendant's domicile.
For instance, in the case of Shanghai Higher People's Court (2021) No. 374 of Civil Jurisdiction, the court held that disputes over liability for damaging the company's interests essentially fall under the category of "litigation initiated due to an infringement act", and should be under the jurisdiction of the court in the place where the infringement occurred or the defendant's domicile.
For another example, in the case of Supreme People's Court (2018) Higher People's Court Civil Jurisdiction Final 42, the court also held that disputes over liability for damaging the company's interests fall under infringement disputes and should be under the jurisdiction of the place where the infringement occurred or the defendant's domicile.
Viewpoint 2: Shareholder representative lawsuits involve the organizational relationship of the company, and should be under the jurisdiction of the people's court of the company's place of residence.
For instance, in the case of Supreme People's Court (2018) Supreme Court Civil Jurisdiction Final No. 90, the court held that this case involved issues such as the determination of company shareholder status, the preconditions for representative litigation, the determination of the status of the parties in representative litigation, and the attribution of the benefits of victory, which were of a nature related to the company's organizational law, and should be under the jurisdiction of the court located in the company's place of registration.
For instance, in the case of Jiangsu Higher People's Court (2020) Su Civil Jurisdiction Final No. 171, the court held that according to the "Civil Case Classification Rules" of the Supreme People's Court (Document No. 41 of 2011), the claim of liability for damaging the company's interests falls under disputes related to the company and should be under the jurisdiction of the people's court of the company's place of residence.
According to the search results from the Supreme People's Court's precedents, the vast majority adopt the first viewpoint. That is: disputes regarding liability for damaging the company's interests should be under the jurisdiction of the court where the infringement occurred, the place where the consequences occurred, or the defendant's domicile.
03 Determination of the Plaintiff's Legal Standing
The company filed a lawsuit as the plaintiff.
In general, the company should be listed as the plaintiff to demand that the infringer bear the liability for compensation. At this time, the legal representative of the company shall represent the company in the lawsuit, and the legal representative shall be listed as the litigation representative of the company. The complaint form shall be affixed with the company's official seal and the legal representative's seal. According to Article 189, Paragraph 1 of the Company Law, shareholders who meet the holding conditions can, based on the actual situation, submit a written request to the company's board of supervisors or board of directors to file a lawsuit regarding the infringement. In this case, the plaintiff remains the company. Specifically:
First, according to Article 23, Paragraph 1 of the "Supplementary Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China" (Amended in 2020), when directors or senior management personnel harm the interests of the company, shareholders can submit a written request to the board of supervisors or the supervisor of a company without a board of supervisors to file a lawsuit; at this time, the company should be listed as the plaintiff, and the chairperson of the board of supervisors or the supervisor of the company should act as the representative of the company to conduct the lawsuit on behalf of the company. When filing the lawsuit, the lawsuit petition does not need to be stamped with the official seal, but evidence must be provided to prove that the litigation representative is qualified as the entity. For example: In case (2024) Shaanxi 0824 Civil Initial 1511, the court held that: The purpose of the shareholder representative lawsuit is to fully utilize the internal supervision mechanism of the company. As long as the board of supervisors representing the company or the supervisor of a limited liability company without a board of supervisors meets the entity requirements, there is no need to require the company to stamp the official seal in the lawsuit petition or obtain the authorization of the legal representative. (2023) Zhejiang 01 Civil Appeal 10730, the Intermediate People's Court of Hangzhou, Zhejiang Province also held that: Legally, the chairperson of the board of supervisors or the supervisor of a limited liability company without a board of supervisors represents the company to file a lawsuit, and has the right to file a lawsuit on behalf of the company, without the need to obtain the company's authorization.
Second, according to Article 23, Paragraph 2 of the "Supplementary Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China" (Amended in 2020), when a supervisor or another person causes damage to the company's interests, shareholders can submit a written request to the board of directors or the directors to file a lawsuit; at this time, the company should be listed as the plaintiff, and the chairman or the executive director should act as the representative of the company to represent the company in the lawsuit.
2. Shareholder Representative Litigation
The plaintiff shareholder qualification in shareholder representative litigation
Under certain circumstances, shareholders can file shareholder representative lawsuits as plaintiffs. The Company Law has added a dual representative lawsuit system, where shareholders of the parent company, after fulfilling the preconditions, can initiate representative lawsuits on behalf of their wholly-owned subsidiaries. According to Article 189 of the Company Law and Article 28 of the "Nine-Minute Guidelines", the plaintiffs who have the right to file shareholder representative lawsuits include:
First, shareholders of a limited liability company. Second, shareholders of a joint stock company who have held, individually or collectively, more than one percent of the company's shares for a continuous period of one hundred and eighty days or more (if the company has been established for less than one hundred and eighty days, they only need to continue holding the company's shares after its establishment); Third, actual investors. If the actual investor can prove that more than half of the other shareholders are aware of their investment fact and have not raised any objections to the actual investor's exercise of shareholder rights, even if the business registration change has not been completed, they also have the right to file a shareholder representative lawsuit.
(2) Even if an infringement occurs and one becomes a shareholder of the company, it does not affect the lawsuit.
Article 24 of the "Nine Judicial Precedents" stipulates: "If a shareholder initiates a shareholder representative lawsuit and the defendant argues that the plaintiff was not a shareholder of the company at the time the act occurred, thereby claiming that the plaintiff is not an eligible plaintiff, the court will not accept this defense." That is to say, even if one becomes a shareholder after the act that harms the company has occurred, they still have the right to file a lawsuit.
(3) During the period of shareholder representative litigation, shareholders should not lose their shareholder status.
During the litigation process, if the shareholders of a limited liability company transfer all their shares to others or are removed from the company, they will lose the qualification to continue representing the company as a shareholder in the lawsuit. If the shareholders of a joint stock company transfer some or all of their shares, resulting in their remaining shares not meeting the requirement of one percent of the total shares, they will lose the right to represent as shareholders. If a shareholder loses the qualification to represent as a shareholder in the lawsuit, the court will reject the lawsuit.
For instance, in the case of Beijing No.1 Intermediate People's Court (2017) Jing 01 Civil Appellate No. 9059, the court held that although the plaintiff had the status of a shareholder at the time of filing the lawsuit, during the court's trial, he transferred all his shares to others and completed the business registration change procedures, thereby losing the qualification to continue as a shareholder representative in this lawsuit. He was not an appropriate plaintiff for this case and his lawsuit request should be rejected.
(4) Preparatory Procedures for Shareholder Representative Actions
Shareholder representative litigation is a remedy measure taken when the internal supervision mechanism of the company fails. This litigation procedure can only be initiated after exhausting all internal remedies within the company. According to Article 189 of the Company Law, the preconditions for shareholder representative litigation need to meet one of the following conditions: First, the board of directors or the board of supervisors refuses to file a lawsuit after receiving a written request from shareholders; second, the board of directors or the board of supervisors fails to file a lawsuit within 30 days from the date of receiving the written request from shareholders; third, the situation is urgent and immediate filing of a lawsuit will cause irreparable damage to the company's interests.
If the preconditions for the shareholder representative lawsuit are not fulfilled in accordance with the law and regulations, the court will rule to dismiss the lawsuit on the grounds that the plaintiff is not qualified. For example, in the case of the Supreme People's Court (2021) Supreme Court Civil Appeal Case No. 5307, the court held that: One of the preconditions for a shareholder to file a representative lawsuit is that he must first submit a written request to the relevant authorities to file a lawsuit with the court; otherwise, the lawsuit should be dismissed. When the company's supervisory board receives a written request from the shareholder to sue the infringer, it should file the lawsuit in the capacity of the supervisory board and not in the name of an individual supervisor. Before the supervisory board files the lawsuit, it must first fulfill the preconditions of the shareholder's written request to the supervisory board to file the lawsuit. The court dismissed the company's application for a retrial on the grounds that the time when the shareholder filed the lawsuit was earlier than the time when the supervisory board made the resolution, and there was no situation where the preconditions could be waived.
(5) Exemption from the Preceding Procedures for Shareholder Representative Actions
Article 25 of the "Nine Judicial Precedents" stipulates the exemption of the pre-procedure requirements for shareholder representative litigation. That is, if the relevant authorities of the company have no possibility of filing a lawsuit, the court shall not reject the lawsuit on the grounds that the plaintiff has not fulfilled the pre-procedure requirements. In judicial practice, it mainly takes the following forms: First, after the shareholders submit a written request to the board of directors or the board of supervisors, there is no possibility of filing a lawsuit; Second, the relevant authorities of the company do not exist, or the company is in an operational deadlock, making it impossible for the shareholders to make a request; Third, after the company files a lawsuit upon the request of the shareholders, the shareholders refuse the lawsuit request without the consent of the shareholders.
For instance, in the case of Shanghai First Intermediate People's Court (2020) Huaian Civil Appellate No. 5086, the court held that in this case, where there was only a confrontation between the minority shareholders and the sole absolute controlling shareholder and the actual controller, the actual controller, as the defendant in this case, had a direct interest relationship with the case. The company's relevant authorities might be controlled by the interested party and lose their independence. Therefore, when the 10% shareholder submitted a written application to the company's relevant authorities, there was no possibility for the company's relevant authorities to file a lawsuit, and there was an exemption situation for the前置 procedure.
(6) Shareholder Dual Representative Litigation
The Company Law has added a new type of dual representative litigation for shareholders. It stipulates that if the directors, supervisors or senior management of a wholly-owned subsidiary infringe upon the legitimate rights and interests of the wholly-owned subsidiary, the shareholders of the parent company can submit a written request to the board of supervisors or the board of directors of the wholly-owned subsidiary to initiate litigation or directly file a lawsuit in their own name. At this time, the shareholders of the parent company are the plaintiffs, while the shareholders, directors, supervisors or senior management of the subsidiary are the defendants.
04 Types of Liability Disputes Involving Damage to Company Interests
According to Articles 21, 22, 179, 180, and 265 of the Company Law, Article 23 of the Judicial Interpretation (II) of the Company Law, Article 23 and 24 of the Judicial Interpretation (IV) of the Company Law, and Article 1 of the Judicial Interpretation (V) of the Company Law, the defendants in disputes involving damage to the company's interests are: company shareholders, directors, supervisors, senior management personnel, and the company's actual controller who constitutes a "de facto director", etc.
1. Identification of senior management personnel of the company
The Company Law specifies the scope of senior management personnel: the company's managers, deputy managers, financial officers, the secretary of the board of directors of listed companies, and those stipulated in the company's articles of association. In judicial practice, courts conduct the following reviews: First, whether they fall within the scope of senior management personnel as defined by the Company Law and the articles of association; second, whether they actually hold the management and operation rights of the company; third, whether there are procedures for appointment and dismissal.
For instance, in the case of Beijing No.3 Intermediate People's Court (2020) Jing 03 Civil Appellate No. 8429, the court held that the determination of senior management personnel should not be limited to the provisions of the Company Law and the contents recorded in the company's articles of association; instead, a substantive review should be conducted to determine whether they actually exercised the rights of senior management personnel.
2. Determination of the Company's Actual Controller
Article 180 and Article 192 of the Company Law respectively stipulate the "de facto directors" and "shadow directors and shadow senior executives" systems. That is, the controlling shareholders and actual controllers of the company may also become co-defendants due to joint infringement.
3. Determination of the defendant in the case of company liquidation
Article 23 of the Judicial Interpretation on the Company Law stipulates that when the members of the liquidation team engage in liquidation affairs and violate laws, regulations or the company's articles of association, causing losses to the company, the company may claim compensation liability from them. If the company is dissolved after liquidation, qualified shareholders can file a lawsuit with the liquidation team members as the defendant and other shareholders as the third parties in the court.
05 Acts that Harm Company Interests and Liability for Compensation
Although the Company Law has listed the prohibited behaviors of directors and senior management personnel, due to the extensive nature of company interests, it is difficult to exhaust all the behaviors that harm company interests through legislation. The most common situations that harm company interests in practice include four types: misappropriation or embezzlement of company funds, related-party transactions, acquisition of company business opportunities, and non-compete restrictions, etc. As mentioned earlier, disputes over liability for damaging company interests are tort liability disputes in the field of company law. In the process of hearing disputes over liability for damaging company interests, courts mainly determine them based on the constituent elements of tortious acts, such as the act of damage, the result of damage, and the causal relationship.
1. Embezzlement or misappropriation of company funds
The misappropriation or embezzlement of company funds is the most common type of act that harms the interests of the company. Such acts usually directly result in the loss of the company's assets. The main manifestations include: transferring company funds to personal accounts, transferring company funds to third-party accounts, collecting payments on behalf of the company, conducting excessive expense reimbursements beyond the limit, and using company funds for high-end consumption, etc. According to the provisions of the Company Law, if shareholders or directors, supervisors, and senior management violate the laws or the company's articles of association and improperly use company funds, causing losses to the company, they shall bear corresponding compensation responsibilities. According to Article 1 of the Judicial Interpretation (V) of the Company Law, even if the directors, supervisors, and senior management have completed the internal approval procedures when using company funds, if they actually harm the company's interests, they still need to bear compensation responsibilities; if the amount or duration of misappropriation or embezzlement of company funds reaches the standard for criminal prosecution, it may constitute the non-state employee bribery crime, the crime of embezzlement of funds, or the crime of misappropriation of funds as stipulated in the Criminal Law, Articles 163, 271, and 272.
The company's shareholders or directors, supervisors and senior management transfer the company's funds to their personal accounts.
For instance, in the case of Shanghai No. 2 Intermediate People's Court (2020) Huaian Civil Appeal Case No. 2326, the court held that the defendant not only used his personal credit card to spend on behalf of the company and purchase personal items, but also repeatedly withdrew funds from the company to cover his daughter's expenses and other personal reasons. As a result, it was difficult to distinguish the purpose of the funds, and the resulting legal consequences should be borne by the defendant.
For instance, in the case of Jiangsu Province Nanjing Intermediate People's Court (Case No. 2024) Su 01 Civil Appeal No. 12921, the defendant failed to provide evidence to prove that there were legitimate reasons for transferring the company's funds to his personal account, or that such transfer had been used for the company's business operations, thereby harming the company's legitimate rights and interests. Therefore, the defendant should return the funds and compensate for the losses.
(2) The company's shareholders or directors, supervisors, and senior management transfer the company's funds to a third party's account.
In the case of Supreme People's Court (2019) Supreme Court Civil Appeal No. 1407, the court held that the defendant, without any reasonable reason, transferred the company's funds to another person's account. Therefore, the defendant and the recipient should jointly return the funds transferred from the company's account and compensate for the interest losses.
(3) Shareholders or directors and senior executives of the company collect payments on behalf of the company
In the case of Beijing Higher People's Court (2024) Jing Civil Reconsideration No. 38, the court held that Zhao, as a senior manager of the company, did not deliver the 60,000 yuan received to the company after receiving it, thereby damaging the company's interests. He should bear the responsibility for repayment. If the amount is large, depending on the different purposes of the funds, such as whether it was appropriated for personal use, whether it was lent to others or used for illegal acceptance of bribes by using his position to seek benefits for others, it could constitute the crime of embezzlement by a person in a position, the crime of misappropriation of funds, or the crime of accepting bribes by non-state functionaries. It may also result in the simultaneous establishment of all three crimes or multiple crimes being punished concurrently.
(4) The company's shareholders or directors, supervisors, and senior management members engage in excessive expense reimbursements beyond the permitted limits.
Excessive expense reimbursement that exceeds the limit is a type of behavior that harms the company's interests. However, in practice, the plaintiff has a relatively high probability of losing the case. This is mainly because the amount of the expense reimbursement is not large, and shareholders or directors, supervisors, and senior management can easily provide evidence to prove that their business operations comply with the provisions of the shareholders' agreement or the company's articles of association, and are acts performed in the interest of the company while fulfilling their duties.
For instance, the People's Court of Jiading District, Shanghai (Case No. 22464 of 2023, Shanghai, China);
For instance, the People's Court of Chancheng District, Foshan City, Guangdong Province (Case No. 2022粤0604民初13575) etc.
2. Self-Transactions and Related Party Transactions
Self-transaction is a specific form of related-party transaction. The self-transaction behavior of directors, supervisors and senior management refers to the transactions conducted between them and the company they are in. Depending on whether the directors, supervisors and senior management directly act as one of the parties in the transaction, it can be divided into direct self-transaction and indirect self-transaction. Related-party transactions do not necessarily lead to adverse consequences. Normal related-party transactions can play roles such as reducing transaction costs and risks, and strengthening cooperation among enterprises. Therefore, the Company Law does not completely prohibit related-party transactions but rather aims to prevent the use of related relationships from harming the interests of the company. Article 182 of the Company Law stipulates that when directors, supervisors and senior management directly or indirectly conduct transactions with the company, they should report relevant matters of the transaction to the board of directors or the shareholders' meeting, and have the board of directors or the shareholders' meeting make a resolution in accordance with the provisions of the company's articles of association.
For instance, in the case of Beijing No. 3 Intermediate People's Court (2020) Jing 03 Civil Appellate No. 7060, the court held that the transfer of the equity held by the company's directors in a third-party company to the company was a self-transaction. This transaction did not go through the shareholders' meeting resolution and did not fulfill the obligation of information disclosure. It did not meet the procedural fairness standard, and thus did not meet the substantive fairness standard either. The income obtained by the company directors based on this unjust self-transaction should belong to the company.
For instance, in the case of Shanghai No.1 Intermediate People's Court (2020) Huaian Civil Appellate No. 3557, the court held that the perpetrator, acting on behalf of the company and conducting transactions with his wife Yang, harmed the company's interests and violated the duty of loyalty, and thus should bear the corresponding legal consequences. Both of them jointly committed the act of infringing upon the company's interests. As co-infractors, they should jointly bear legal responsibility, and the proceeds from this infringement should belong to the company.
3. Seek out business opportunities for the company
According to the relevant provisions of the Company Law, seeking business opportunities for the company refers to taking advantage of one's position to benefit oneself or others by obtaining business opportunities that belong to the company without the consent of the shareholders' meeting or the general meeting of shareholders.
For instance, in the case of Jiangsu Higher People's Court (2012) Su Shang Wai Chong Zi Zi No. 50, the court held that: In our opinion, the factors to be considered when determining a company's business opportunity are as follows: First, the business opportunity is related to the company's business activities; second, the third party has the intention to provide this business opportunity to the company; third, the company has an expected benefit from this business opportunity and has not refused or abandoned it.
For instance, in the case of Shanghai Qingpu District People's Court (Case No. 2019 Huo 17485), the court held that the perpetrator, by taking advantage of his position as the company's general manager, privately arranged the business opportunity that should have been signed by the company with a specific company to his affiliated company, thereby damaging the company's interests and constituting an infringement. The reasons are as follows: 1. The business opportunities from the specific company belong to the company's business opportunities, and this business opportunity falls within the scope of the company's business activities. 2. The perpetrator, by taking advantage of his position, failed to effectively disclose the transaction opportunities to the company and privately arranged the involved business opportunity for his affiliated company.
4. Non-competition Clause
Non-competition restrictions are divided into "statutory non-competition" and "agreed non-competition". Article 21, Article 148, and Article 149 of the Company Law stipulate "statutory non-competition", and the applicable subjects are: controlling shareholders (holding more than 50% of the shares), directors, managers and other senior management personnel. Article 23 and Article 24 of the Labor Law stipulate non-competition restrictions as "agreed non-competition", and the applicable subjects are: senior management personnel, senior technical personnel, and other personnel with confidentiality obligations. In judicial practice, to be considered as violating the non-competition obligation, at least one of the following conditions must be met:
For instance, in the case of Fujian Province Quanzhou Intermediate People's Court (2015) Quanzhou Civil Appellate No. 1817, the court held that the personnel subject to non-compete restrictions were limited to the senior management personnel, senior technical personnel and other personnel with confidentiality obligations of the employer. Since the plaintiff failed to provide sufficient evidence to prove that the three defendants were the controlling shareholders or senior management personnel of the plaintiff, nor could they provide evidence to prove that the plaintiff and the defendant had made an agreement on non-compete restrictions, nor could they provide sufficient evidence to prove that the defendant had caused losses to the plaintiff, therefore the plaintiff's request for the defendant to pay back the income obtained by violating the non-compete obligation to the plaintiff and compensate for the losses was not supported.
06 Conclusion
The failure rate of plaintiffs in disputes over liability for damaging company interests is relatively high. According to the search results of judicial precedents, the proportion of plaintiffs who won all or part of the case in the first instance is less than 20%, while the rate of withdrawal from the lawsuit is as high as over 50%. The fundamental reason lies in that plaintiffs cannot provide sufficient evidence to prove that "executives and directors" violated the duty of loyalty and diligence, caused specific losses to the company, and there was a causal relationship between the two. Therefore, emphasizing and implementing evidence preservation and timely auditing is a key strategy to solve the problem of plaintiffs' difficult burden of proof and significantly increase the probability of winning. For companies, they should do compliance work well in daily life, reduce or avoid the occurrence of behaviors that damage the company's interests through internal governance: First, pay attention to the revision of the articles of association, stipulating the scope of executives and others; second, strengthen the protection of trade secrets and enterprise compliance to reduce the probability of being infringed upon by executives, directors, and senior management; third, strengthen the management of company seals; fourth, pay attention to financial management; fifth, invite notary personnel or lawyers to assist in handling shareholder meeting resolution matters.
