Abstract

The adoption of director's duty of care in the 2005 revision of the PRC Company Law made significant progress in holding directors accountable for their wrongdoings. However, certain defects still exist, most importantly the lack of a specific standard for the duty of care in the legislation. Therefore, this article adopts an empirical and comparative approach in reviewing Chinese duty of care cases in comparison with major jurisdictions such as the United Kingdom and the United States. The 86 sample cases hand-collected from the ten-year period from 2011 to 2020 reveal that the number of duty of care litigation in China is still far lower than other types of company disputes, despite an increasing trend. This article finds a divergence in judicial practice concerning at least two different standards of the duty of care, with an array of non-uniform factors considered in the judgments. Accordingly, this article adopts a selective approach concerning best practices in major jurisdictions globally and proposes several solutions specifically catered to China's legal and commercial context, including the unified adoption of the objective reasonable person standard, the suggestion that a wholesale transplant of the business judgment rule is undesirable while some of its elements could be borrowed for reference, the shifting of evidentiary burden to the defendants and the promotion of director's liability insurance. By incorporating these changes, China's company law stands to benefit from striking an appropriate balance between director's authority to manage the companies and shareholder's right to hold them accountable.

Introduction

It has been long recognized that directors are at the center of attention in corporate governance and their role is becoming increasingly significant following the financial crisis in 2008. As such, director's duties are adopted in many countries in order to make them accountable for breach of duties. However, the dilemma for legislating director's duties is that the potential liability may also deter talented and diligent people from taking directorships. This is particularly true when it comes to the duty of care, as there is a clear gap between the stringent standards of conduct (i.e., conduct rules) and the more lenient standards of review (i.e., decision rules) in laws and regulations. In this article, we focus on director's duty of care (qin mian yi wu, 勤勉义务) in the context of corporate law, where the director or officer of a company is required to manage the company with a certain standard of care so as to safeguard and promote the best interest of the company. The duty of care, together with the duty of loyalty, are generally recognized as two key components of the fiduciary duties owed by directors to their company. The duty of loyalty and the duty of care correspond broadly to two types of major risks imposed on shareholders when they delegate management to directors. While the duty of loyalty concerns conflict of interest situations where directors pursue their self-interests, the duty of care addresses situations where the directors are not pursuing self-interests but are nevertheless slack or incompetent with their actions, leading to losses to the company. Such a notion of the duty of care is the most developed in common law countries, while civil law countries like China, Japan and Germany have introduced similar concepts.

In the United Kingdom, director's duties were codified for the first time under section 172(1) of the UK Companies Act 2006, which requires a director to "act in good faith… to promote the success of the company". The goal of section 172(1) was to adopt an "enlightened self-interest" approach to UK corporate Law. Although this approach is regarded as an aspirational standard, it has been criticized by some commentators as "British Folly". It remains to be seen whether such legislation will achieve its goal. More specifically, section 174 further provides an objective reasonably diligent person standard for the duty of care, requiring a director to exercise "reasonable skill, care and diligence" that can be expected of a reasonably diligent person in his position. Therefore, section 174 represents a departure from the relatively relaxed subjective standard that UK courts historically subscribed to.

In the United States, although the duty of care appears to be a relatively strict requirement for directors, it is adjudicated in a generous way by the courts. The probable reason behind this is the effect of the court's combined application of both the objective standard and the business judgment rule. This means that while the US courts follow an objective reasonable person standard, a favorable presumption would shield the directors from liability if he or she made an unwise decision but nevertheless met the requirements of 1) absence of self-interest, 2) appropriate information gathered and 3) rational belief that the decision was in the best interest of the company. As such, instances entailing liability for the breach of the duty of care are relatively rare in the US and this trend is likely to continue.

Recent Australian case law exhibits a greater fluidity compared with the US. Meanwhile, it is more stringent from a liability perspective, as the primary tool of enforcing breach of director's duties is by way of Australian Securities and Investments Commission, rather than private litigation.

In Germany, section 43(1) of the Limited Private Companies Act ("GmbHG") and section 93(1) of the Stock Corporations Act ("AktG") require that a director must employ the diligence of a prudent businessman in all matters concerning the company. Since 2005, section 93(1) of the AktG further includes the business judgment rule with respect to entrepreneurial decisions, which, as acknowledged by the courts, applies to limited private companies as well.

Similarly, in Japan, section 330 of the Companies Act states that "the relationship between a stock company and its directors shall be governed by the provisions on mandate" In addition, the Civil Code provides that "a mandatary is obligated to manage the entrusted affairs with the care of a good manager in accordance with the tenor of the mandate". The Japanese court has also applied the business judgment rule with slight variations.

In China, the duty of care was introduced under Article 148 of the 2005 Revision of the PRC Company Law. In 2018, the Company Law was revised again, following which the duty of care is stipulated in Article 147. It provides that "directors, supervisors and senior officers of a company shall observe laws, administrative regulations and the company's article of association, and shall assume the duty of loyalty and duty of care to the company". Moreover, "directors, supervisors and senior officers of a company shall not take advantage of their functions and powers to accept bribes or collect other illicit earnings, and shall not take illegal possession of the property of the companies". Furthermore, Article 149 of the 2018 Revision stipulates that where a director, supervisor or senior officer violates laws, administrative regulations or the company's articles of association in performance of his duties, and thus causes losses to the company, he shall be liable for compensation. Lastly, Article 151 allows shareholders to bring derivative actions against wrongful directors if the company itself has failed to do so.

Although such provisions have made much progress from a historical perspective, certain defects still exist. Most importantly, there is an imbalance between the duty of loyalty and the duty of care. While the content of the duty of loyalty is stipulated in detail in Article 148, none of the articles in the Company Law, nor in any other laws, provide a general standard for the duty of care. While some regulations do provide further details, they are nevertheless soft law that is non-binding on the Chinese courts. For example, Articles 4 and 21 through 26 of the Code of Corporate Governance for Listed Companies issued by the China Securities Regulatory Commission ("CSRC") indicate that director's duty of care means that directors should invest sufficient time and energy in performing their duties; possess necessary knowledge, competence and qualities to perform their duties; and also ensure that the company complies with laws, regulations and its articles of association.

Similarly, in the Guidelines for Articles of Association of Listed Companies issued by CSRC, Article 98 stipulates that the duty of care requires directors to "1) ensure that the commercial activities of the company comply with laws and administrative regulations and the requirements of various economic policies of the State, and that the commercial activities do not exceed the scope of business stipulated in the business license; 2) treat all shareholders equally; 3) get a timely grasp of the company's business and management; 4) issue a written confirmation opinion for the company's regular reports, and ensure the veracity, accuracy and integrity of information disclosure by the company; 5) provide the relevant information and materials to the board of supervisors truthfully, and refrain from hindering the exercise of official powers by the board of supervisors or the supervisors; 6) and observe any other diligence obligations stipulated by laws, administrative regulations, ministry rules and these Guidelines." In addition, "Companies can provide further requirements regarding the duty of care in the articles of association pursuant to specific needs".

In addition to the above regulations, the Guidance on Appointment and Activities of Directors of Listed Companies of the Shanghai Stock Exchange and the Guidance on the Shenzhen Stock Exchange Small and Medium Enterprise Director Conduct also mention directors' duty of care without providing a specific standard. Although these soft law instruments help in delineating the specific actions directors should undertake to ensure their fulfillment of the duty, they still fall short of providing a general standard that would enable judges to adjudicate cases with factual scenarios that do not fall squarely within these provisions. Additionally, these provisions themselves contain a certain level of vagueness in expressions such as "timely report".

This absence of a general standard for the duty of care in the Company Law deprives judges of proper guidance in judicial practice, resulting in inconsistency and confusion as judges apply different standards to fill the lacuna. The existing literature either has a disproportionate focus on the duty of loyalty under PRC law and relatively thin discussion on the duty of care, or conflated the two duties. Moreover, most of the empirical studies are outdated and therefore do not reflect the most current trend of judgments in this topic. This is particularly so since it is only in recent years that duty of care related litigation has been increasing. It is against this backdrop that we have written this article to fill the literature gap in examining the duty of care in China from empirical and comparative perspectives, and to discuss the enforcement of the duty of care in practice by empirical research, with a view to obtaining a theoretical reflection on the potential institutional disadvantages and problems and offering corresponding solutions.

In this article, we surveyed the duty of care cases from 2011 to 2020. It is only about a decade ago that PRC courts at various levels started to gradually make their judgments accessible online, pursuant to the Six Regulations on Transparency of the Judiciary, effective from December 12, 2009. All of the relevant cases dating from the issuance of the Regulation to December 31, 2020 have been collected and examined in this paper, constituting the most updated set of cases under this topic. The judgment database used is China Judgments Online, which is the most comprehensive database on Chinese judgments and has archived 73,419,189 civil cases adjudicated by various levels of courts at the end of our search period. We used "duty of care (qin mian yi wu)" as the keyword in the database, selected "judgment" for the type of documents, "civil cases" for the type of cases and narrowed down the areas to disputes related to "companies", "securities, bonds, insurance, bills, etc", or "liability arising from damaging company's interests" and litigated under Article 147 of the PRC Company Law. We excluded the cases that are irrelevant to the duty of care, the cases that do not involve directors or senior executives, as well as the administrative cases and repeated ones. A total of 86 cases were found on the duty of care of directors and senior executives. They are examined in detail in this article.

This article is thus structured as follows. The second part performs quantitative and qualitative analysis on the 86 hand-collected cases in order to examine the collective trends in terms of their chronological and geographical spread, the characteristics of the plaintiffs and defendants, including factors such as the shareholding of the plaintiffs and the types of wrongdoings. The third part reviews the reasoning in these cases and focuses on a theoretical discussion about the standards Chinese judges use in deciding duty of care cases and their underlying rationales, while engaging in a comparative analysis with the standards used in UK and US courts. The fourth part offers several recommendations that the authors believe would help to improve and clarify the duty of care in China. Most importantly, the authors recommend that the objective reasonable person standard should be uniformly applied by Chinese judges in adjudicating duty of care cases, whereas a wholesale transplant of the business judgment rule is undesirable. It is also suggested that the burden of proof should be shifted to the defendant directors once the plaintiff could establish a prima facie case. The last part concludes.