D&O Liability Insurance: Legal Issues Under the PRC Laws
2015-06-25
Harrison Jia, Partner/Attorney of Law，DeHeng Law Offices
Directors and officers liability insurance ("D&O") is liability insurance payable to the directors and officers of a company, or to the organization(s) itself, as indemnification (reimbursement) for losses or advancement of defense costs in the event an insured suffers such a loss as a result of a legal action brought for alleged wrongful acts in their capacity as directors and officers. Such insurance was first marketed in the 1930s by Lloyd's and was firstly introduced into China in 2002 by Ping An Insurance and Chubb Insurance. While most public companies in the US would purchase D&O insurance for their own directors and officers, most Chinese listed companies haven't done so. According to the report, only about 5% of Chinese listed companies in the A share stock exchange have brought D&O insurance for their directors and officers.
Along with the scandals of some Chinese companies listed in overseas stock exchanges such as RINO International listed in the NASDAQ and Sino-Forest listed in the Toronto Stock Exchange, more and more overseas listed Chinese companies have realized the importance of D&O insurance. The same may happen to Chinese domestic listed companies along with the reform of Chinese initial public offering (IPO) rules, especially when the current approval system is switched into the registration system as in the US. Thus, it is important to know about how to constitute D&O liability under the PRC laws.
1. D&O liabilities under the Company Law of the PRC
The conditions for D&O liability could be found in Article 150 of the Company Law of the People's Republic of China(2006), where it stipulates that: "If a director, supervisor or the senior officer causes detriment to the company while performing his/her duties in violation of laws, administrative regulations or the articles of association, he/she shall be liable for the loss so caused." Similar provisions may also be found in the Article 34 of the Detailed Rules for the Implementation of the Law of the PRC on Sino-Foreign Cooperative Joint Ventures provides in respect of the liability of general manager and other senior managerial staff in Sino-Foreign Cooperative Joint Ventures. As for Chinese listed companies, the Governance Principles of Listed Companies (2002) provides that directors have duty of loyalty and duty of care towards the company and shall be responsible for the damages to the company if their behaviors violate the laws, regulations, rules or the article of association of the company and bring about losses to the company in the process of their performance of their duties in the company.
According to the above stipulations, the directors, supervisors and senior officer of a company shall bear the liability of compensation when the following conditions are met:
1) The company must suffer a loss;
2) The alleged behavior of the directors, supervisors or senior officers in performing company duties violates laws, administrative regulations or the articles of association of the company. The Article 148 of the Company Law clearly stipulates that "a director, supervisor, or the general manager shall have the fiduciary and diligent duties to the company", therefore, if the aforesaid persons do not perform their duty of fiduciary and diligence, they may constitute a violation of law;
3) There must be a causal relationship between the alleged violation behavior and the loss of the company;
4) The alleged directors, supervisors or senior officer must have fault, i.e., being either negligent or intentional.
In the case "Wang Changsong v. Yidu City Hengyun Machinery & Equipment Company" [(2009)YiZhongMinErZhongZi No.00086], Mr. Wang Changsong was the executive deputy general manager of Yidu City Hengyun Machinery & Equipment Company ("Company"). During his term of office, the Company was fined by the local counterpart of the State Administration of Industry and Commerce because of fraudulent contents in the website of the Company. The appeal court held that:
"Wang Changsong, as the executive deputy general manager of the Company, should take certain responsibility of management and care to the overall administrations of the Company, including knowing the operation status of the website of the Company. The fine imposed upon the Company because of its website occurred during the term of office of Wang Changsong who was responsible for the overall administration of the Company. It was irrelevant with the original timing when such website was established, but was relevant with the operation status of the website when it was found to violate the laws and fined. Apparently, in respect of the violations that there were found fraudulent contents in the website of the Company, Wang Changsong, as the executive deputy general manager responsible for the overall administrations of the Company, should take reasonable duty of management and care. Wang Changsong claimed that he had no idea regarding the operations of the website, however, no corresponding evidences were provided, and it would also be not in line with the common sense. It was reasonable that Wang Changsong, as the high executive responsible for the overall administration of the Company, should know the general circumstances of the operations of the Company's website. Thus, the court would not uphold the appeal claims of Wang Changsong. In respect of the losses of the Company due to the fine upon its website, Wang Changsong should make damages corresponding to his fault. The court of first instance held that Wang Changsong should take 40% of damages to the losses of the Company (according to the causational extent between Wang Changsong's behaviors and the losses) which was considered by this court of appeal higher than the reasonable duty of management and care of Wang Changsong, thus this court of appeal made adjustment that Wang Changsong should take 20% of damages to the losses of the Company. "
In the above case, the conditions of Wang Changsong's liability as an officer of the company were satisfied:
1) The company was fined by the local counterpart of the State Administration of Industry and Commerce because of fraudulent contents in the website of the Company;
2) Wang Changsong, as the executive deputy general manager responsible for the overall administrations of the Company, should take reasonable duty of management and care, however, he failed to make sure that the operation status of the website of the Company complied with the laws;
3) But for Wang Changsong's violation of his duty of care, the fraudulent contents in the website of the company should have been found and corrected;
4) Although Wang Changsong claimed that he had no idea about the operation status of the website of the Company, however, as executive deputy general manager responsible for the overall administrations of the Company, he should know the general circumstances of the operations of the Company's website and thus had negligence to fail to know and correct the fraudulent contents in the website of the company.
2. D&O Liabilities under the Tort Law of the PRC
1) Article 12 of the Tort Law
Article 12 of the Tort Law of the People's Republic of China reads as follows：
"Article 12 Where two or more people respectively engage in tortious acts that cause the same damage and the extent to which each person is liable can be determined, the infringing parties shall respectively bear the corresponding liability; in the event that it is difficult to determine the extent to which each person is liable, the infringing parties shall be liable to pay an equal amount of compensation."
Article 12 of the Tort Law provides about torts by several persons respectively without communication of intentions, which means the coincident combination of the behaviors of two or more persons, without common communication of their intentions in advance, brings about the infringement of other persons. The nature of torts by several persons without communication of intentions is still separate tort behavior of different persons. In such case, each person will take liability attributed to the extent of his fault, i.e., they will not take joint and several liability, but separate liability of each other. For instance, Driver B run red light to across the road while Municipal Engineering Company A was repairing sewer pipes in the middle of the road without setting up warning signs. At the same time, passenger C crossed the road according to the traffic signal lights. In order to avoid B's car, C accidentally fell into the sewer pipe being repaired by A. Therefore, for C’s injury, A and B constituted coincident combination of torts by several persons without communication of intentions. In such case, A and B should take their share of liabilities respectively, but not joint and several liability.
As for D&O's liabilities, if directors and officers of the company have wrongful acts separately which lead to the losses of the company, however, they have no communication of intentions on the torts against the company, then there will be no meeting of minds between directors and officers on the infringement of interests of the company. Such case should constitute torts by several persons respectively without communication of intentions and the directors and officers should take liability of each other attributed to the extent of their fault respectively, but not joint and several liability.
2) Article 11 of the Tort Law
It shall be noted that it is possible that the infringing directors and officers could take joint and several liabilities with respect to torts by several persons respectively without communication of intentions, which is provided by Article 11 of the Tort Law, reading as follows:
"Article 11 Where two or more people respectively carry out tortious acts that cause the same damage and the tortious acts of each person are capable of causing the entire damage sustained, all persons involved shall be jointly and severally liable.
Under Article 11 of the Tort Law, we can see, the infringing directors and officers may take joint liabilities when the following three conditions are met:
(1) two or more people respectively carry out tortious acts;
(2) their tortious acts cause the same damage;
(3) tortious acts of each person are capable of causing the entire damage sustained."
However, if the directors/officers respectively carried out tortious acts that cause the same damage to the company, but neither of them may cause the entire damage without the other's assistance, then they shall not take joint liabilities under this Article 11 of the Tort Law.
3) Article 8 of the Tort Law
The other type of tort is joint infringement which is provided by Article 8 of the Tort Law, reading as follows:
"Article 8 Two or more parties whose joint infringement causes damage to another party shall be jointly and severally liable."
Joint infringement means the tort behaviors of two or more persons who should take joint and several liability since their joint fault brings about infringement to other's valid interest, e.g., inciting or assisting another party to carry out tortious conducts where the inciting person and the behaving person constitute joint infringement. For instance, two persons A and B jointly threw out a television from the fifth floor, which hit C, a passenger. In such case, A and B constituted joint infringement against C.
However, if the directors and officers have no joint intention to infringe upon the interests of the company, then they should not take joint and several liability under Article 8 of the Tort Law.
3. Whether the Knowledge of the Directors and Officers of Their Duties Affected Their Liabilities
The answer is no. In the case of Ding Liye v. the Administrative Punishment of China Securities Regulatory Commission [(2008)YiZhongXingChuZi No.553], Mr. Ding Liye failed to fulfill his fiduciary duty as a director in the Illegal Information Disclosure Event of Shenzhen Shenxin Taifeng (Group) Co. Ltd (hereinafter referred to as "Shenxin Taifeng"), a listed company in China, therefore, was given a warning and an fine penalty of RMB 30,000. During 2003-2004, Shenxin Taifeng was found conducted the following illegal activities:
1) making a false report of the Annual Report 2003;
2) making a false inventory of RMB 20 million;
3) making a false prepayments of RMB 6.51 million; and
4) failing to disclose several major events of the company.
According to Article 177 of the then-prevailing Securities Law of People's Republic of China, CSRC imposed a fine of RMB 300,000 on Shenxin Taifeng. For those directors, including Mr. Ding Liye, who failed to fulfill their fiduciary duty, fines of RMB 50,000 and 30,000 were imposed respectively.
Mr. Ding Liye refused to accept the punishment decision from CSRC and initiated an administrative lawsuit to Beijing First Intermediate People's Court (hereinafter referred to as "the Court"). Mr. Ding argued that he was not involved in the actual management of Shenxin Taifeng and was totally unaware of the alleged activities of the company, because he had entrusted other directors to attend the Board on behalf of himself and the actual controller of the company intentionally concealed the illegal facts from him.
The Court held that, as a director of a listing company, Mr. Ding failed to fulfill his fiduciary duty, such as attending the Board meeting and supervising the company to disclose information timely and accurately. In this regard, no matter Mr. Ding was aware of his duty or not, he should bear responsibilities for his fault. Considering evidence that Mr. Ding had attended several Board meetings in respect of information disclosure, the Court believed it is impossible that Mr. Ding was totally unaware of his duty. Therefore, he should bear corresponding responsibilities for his own part. At last, the Court supported CSRC's punishment of imposing a warning and a fine of RMB 30,000 on Mr. Ding Liye.
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About the Author:
Mr. Jia Hui, a partner lawyer of DeHeng Law Offices, with his main practice area on insurance and M&A, has a great deal of experiences on insurance area, among which including: providing legal consultancy services to a Zurich Insurance company on a director-liability insurance dispute with a Sino-foreign contractual enterprise, providing legal consultancy services to Taikoo for its third-party liability insurance claims and disputes with Chubb Insurance Company of the USA, providing legal consultancy services to China Life Reinsurance Company for its reinsurance contracts, providing legal opinions on Union Life Insurance's major disease insurance claims and disputes，drafting an insurance manual for a foreign company to guide its treatment of insurance disputes in China, and providing legal consultancy services to a Chinese insurance company for its compliance management. Mr. Jia has lawyer licenses of both the New York State of the USA and of China.
