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It has been more than 40 days since the newly revised Company Law came into effect. The sixth revised Company Law has undergone major changes. The provisions on shareholder obligations and directors, supervisors and senior managers’ responsibilities have undergone tremendous changes. Among them, the newly added "directors are liable to third parties" clause has attracted much attention for "breaking the isolation of the company."

This system is stipulated in Article 191 of the Company Law, which requires that company directors not only have a duty of loyalty and diligence to the company, but also bear liability to third parties including the company's creditors under certain circumstances. This article has been included in the Company Law (Draft for Amendment) since its publication, and it has been reviewed four times before it finally came into effect.

The "director's liability to third parties" clause has always attracted much attention and controversy. Some people call it a lifeline for creditors of bankrupt companies, some worry about third parties abusing their rights, some say the legal effect should be judged "for a while", and some say Pandora's box has actually been opened.

At the second Sino-Japanese Company Law Forum recently organized by the Law School and the Institute of Humanities and Social Sciences of Beijing University of Aeronautics and Astronautics, a lively discussion was held on the system of directors' external liability. The "corporate personality denial system" that "pierces the company's veil" and the "director's external liability" system are similar in breaking through the restrictions on the company's independent personality. So will Article 191 of the Company Law, which has already come into effect, also become a sword to "pierce the directors' veil"?

The “critical few” in company operations

Directors play a dual role of supervision and management in a company, and their position in the company's operations is crucial. The personal temperament of directors can also be seen in the company's social image, such as Yu Minhong in New Oriental, Zhao Jiazhen in Pinduoduo, and Lei Jun in Xiaomi.

The company's operation and management, strategic investment, key decisions, and future development are all controlled by directors, the "key minority" in these companies. In addition to directors, the "key minority" also includes senior executives, supervisors, and the company's controlling shareholders and actual controllers who are regarded as "shadow directors." Article 191 of the Company Law includes directors, senior executives, and "shadow directors" in the sequence of assuming responsibility for third parties.

Lin Yiying, deputy director of the Economic Law Office of the NPC Legal Affairs Committee, said that in certain circumstances, especially when directors are intentional or grossly negligent, requiring directors to bear direct liability to external third parties is conducive to constraining the performance of directors' duties. At the same time, it is also conducive to protecting creditors when the company is insolvent.

Zhang Yang, executive director of the Center for Japanese Law Studies at the Law School of Beijing University of Aeronautics and Astronautics, believes that the regulation of directors’ liability to third parties may have an important impact on corporate governance in my country. Zhang Yang said that in the corporate governance system, directors actually have three types of civil liabilities, namely directors’ liability to shareholders, directors’ liability to the company, and directors’ liability to third parties. Since directors’ liability to shareholders is limited to specific circumstances, it has little impact on my country’s corporate governance system. Directors’ liability to the company is a reflection of directors’ fiduciary duties, but companies often fail to hold directors accountable. At this time, they can only rely on the shareholder representative litigation system, which is not active in my country due to many institutional restrictions. Therefore, directors’ liability to third parties will break through the isolation of legal persons, allowing directors, who were originally internal organs of the company, to directly bear liability to third parties, which may become a rule that has an important impact on corporate governance in my country.

In practice, directors often use their power to intentionally infringe upon the interests of creditors. Zhang Yang shared: "For example, during the real estate development process, the developer knew that the entire real estate group, including its affiliated companies, had no solvency, but still issued commercial acceptance bills payable by affiliated companies, and used the bills as a means of payment to purchase cement, steel bars, and construction engineering services required for real estate development, so that cement and steel bar suppliers, construction companies, etc. ultimately could not get paid. In this process, the directors were knowingly intentional, or grossly negligent in believing that the real estate group's cash flow would improve in the future. This is actually based on intentional or gross negligence to damage the interests of third parties."

Zhang Yang believes that in practice, there is a large room for interpretation of "gross negligence" in Article 191 of the Company Law, which is closely related to the directors' duty of diligence and the sub-obligations of this obligation, such as "compliance obligations" and "supervision obligations". It needs to be further clarified from the perspective of interpretation in the future.

Breaking through corporate isolation, directors face creditors and take responsibility

Before the new company law was enacted, my country has always adopted the "company external liability + internal compensation" model for third-party damages caused by directors in the performance of their duties. That is, when a director who holds the management and operation rights of a company abuses his rights and causes damage to others, the company shall bear the liability for compensation; after the company assumes the responsibility, it will seek compensation from the director at fault. However, in reality, after assuming the responsibility, the company rarely holds the directors accountable, which leads to the unreasonable situation of "poor temple and rich abbot".

Shen Zhaohui, a tenured professor at Tsinghua University Law School and a member of the company law revision team, explained from a legal perspective that Article 191 of the Company Law, which provides for general regulations on directors' liability to third parties, grants external third parties a right to claim damages. This statutory liability method breaks through the isolation of the company and exposes directors who have made mistakes in performing their duties to creditors.

When applying this article, two questions often need to be answered: To whom are directors responsible? And why are they responsible?

Liability for any victim other than the company. Li Jianwei, deputy director of the Commercial Law Institute of the Law School of China University of Political Science and Law, explained in his book: There is no dispute that the “others” in the law first include the company’s creditors; further, it also includes the company’s shareholders, especially minority shareholders (small and medium-sized investors in the securities market).

Liability for causing damage to a third party due to intentional or gross negligence in the performance of duties. In simple terms, it is "two conditions and one result". The "two conditions" are that the director performs his duties; the director performs his duties with intention or gross negligence. The "one result" is that damage is caused to others.

It should be noted that the conditions for directors to be held liable to external parties do not include general negligence or abstract minor negligence. When directors perform their obligations with the care that a normally prudent person should have in similar circumstances and work hard to achieve the best interests of the company, the law will not usually force them to do so or act in hindsight.

From the perspective of comparative law, the rules on directors' external liability are more common in East Asian countries and regions, such as Article 429, Paragraph 1 of the Japanese Companies Act, Article 23 of the Companies Act of Taiwan, China, and Article 401 of the Korean Commercial Code.

Hirotaka Naito, associate professor of the Faculty of Law at Tohoku Gakuin University, said at the conference that the external liability system of directors in Japanese law originated in 1899. In 1969, the ruling made by the Supreme Court of Japan had the greatest impact on the current system. It has been more than 50 years since then. Although there is still controversy in the Japanese academic community about the significance and necessity of the system, Hirotaka Naito believes that the system has practical significance for curbing directors from neglecting their obligations and effectively protects the interests of creditors in practice.

Shen Zhaohui also mentioned that in my country's intellectual property field, there are actually many cases where directors take advantage of company production to infringe on competitors' intellectual property rights. The system of directors bearing external responsibilities has positive significance for the protection of intellectual property rights.

There are no such precedents in the 21 cases applying the new law.

"The new Company Law has been officially implemented since July 1, 2024, and it has been more than 40 days. According to incomplete statistics, courts in various places have generated 21 judgments applying the new Company Law. There is no first case on 'directors' liability to third parties'." Chen Ying'e, a lawyer at Beijing Huizhong Law Firm, shared.

In the judgments applying the new provisions of the Company Law, there are provisions such as accelerated maturity of equity contributions, comprehensive protection of shareholders' right to know, and liability for unexpired equity transfers. Chen Ying'e analyzed: "This may be due to two reasons. One is that the new Company Law has been in effect for a short time, and the other is that Article 191 is a completely new provision in the Company Law. However, based on the strong creditor protection of Article 191, we can make a bold prediction that in future corporate litigation, this article will inevitably become a powerful tool for corporate creditors to safeguard their interests."

Japan's judicial practice has proved this point. Naito Yuki introduced that according to Japanese judicial case data, the directors' external liability clause is the most cited legal provision in Japan's existing commercial law cases.

As far as the indirect infringement of the interests of third parties by directors’ behavior is concerned, combined with the principles and standards of directors’ fiduciary and diligent obligations detailed in the Company Law, directors may be liable to third parties in at least the following circumstances: shareholders withdrawing capital contributions, illegally distributing profits, illegally reducing capital, failing to fulfill capital contribution obligations on schedule, lack of legitimate related transactions, neglecting to perform liquidation obligations and responsibilities, illegal liquidation, etc., which lead to the reduction of the company’s liability property and damage to others. This undoubtedly places higher demands on the performance of duties of directors, supervisors and senior managers, but excluding the general negligence of directors from the conditions for third-party accountability is in fact also a legal protection for directors’ performance of duties.

Yue Wanbing, assistant researcher at Tsinghua University Law School, believes that the behavior of directors infringing the interests of third parties as restricted by Article 191 of the Company Law is not "point-like, intermittent, direct" infringement, but "linear, continuous, indirect" infringement. "In practice, there is a situation that clearly exceeds the scope of regulation by tort law and debt law, that is, the "continuous, long-term, linear" indirect infringement by directors has caused damage to the interests of third parties. For example, directors use their information advantages and positions to squander the company's property for a long time, pay themselves high salaries, and even transfer the company's assets, so that the company cannot eventually repay its due debts." Yue Wanbing further explained.

Zou Xuegeng, a lecturer at the School of Civil, Commercial and Economic Law of China University of Political Science and Law, explained from the legislative purpose that the system is to prevent directors from carrying out major illegal acts that damage the public interest. With the application of Article 191 of the Company Law, directors of companies that seriously infringe on the public interest, such as the Kangmei Pharmaceutical financial fraud case, the Changsheng Bio-technology toxic vaccine case, and the Sanlu milk powder toxic milk powder incident, will no longer be able to escape responsibility.

The exercise of rights also requires boundaries

The exercise of rights cannot violate the original purpose of the rights, nor exceed the necessary boundaries of the rights. The system of directors' external liability is of great significance to the creditors of small and medium-sized enterprises and the protection of the interests of creditors when the company is insufficiently funded. However, the issues such as what kind of responsibilities the directors bear, the scope of directors' responsibilities, and the sharing of responsibilities between the company and directors have not been clarified. Many scholars say that the exercise of creditors' rights needs boundaries.

Shen Zhaohui expressed his concern about "directors may bear excessive obligations" due to abuse of rights. "Directors bear direct external responsibilities, which means that they bear fiduciary obligations to seek benefits for the company and shareholders and social obligations to third parties. In some cases, these two are in conflict with each other. Companies, especially large companies, will bear huge compensation liabilities in the course of operations, such as tort liability, product liability, environmental pollution liability, and asset management liability. If rights are abused, the directors will bear joint and several liability with their limited personal property and the company's huge debts, which will cause the directors to bear excessive compensation liabilities."

Li You, associate professor at the School of Law of Beijing University of Aeronautics and Astronautics, called for "limiting the application" of directors' external responsibilities. He said that the law has endowed companies with independent legal personality, and the relationship between directors and companies is a commissioned relationship. Whether from the perspective of the company's independent personality or the allocation of commissioned responsibilities, the traditional legal person theory states that directors' performance of their duties generates corresponding responsibilities, which should be borne by the legal person.

Wang Xiangchun, associate professor at the School of Law of the Central University of Finance and Economics, also pointed out that in addition to the "limited application" of this article, the constituent elements of directors' external liability should also be clarified, including whether the responsible parties include independent directors and other supervisors, the definition of directors' illegal acts and damages, and whether there is a causal relationship between directors' behavior and damages.

In addition, the identification of directors' external infringement and the estimation of the scope of damage are also difficult problems. A scholar joked that if a company chairman drinks expensive mineral water with a unit price of more than ten yuan per bottle every day, which is paid by the company, and the chairman believes that drinking the mineral water makes him feel good, and then he can keep a clearer mind when making business decisions at the board meeting, which is beneficial to the long-term interests of the company, then is this considered a serious infringement on the company's property? In this regard, Yue Wanbing suggested that in future judicial interpretations and guiding cases, the directors' external infringement behavior can be limited by using the characteristics of "linear, continuous, and indirect".

Scholars have expressed recognition and affirmation that Article 191 of the Company Law has fulfilled the mission of protecting creditors. Compared with the right of subrogation and the right of revocation in the field of civil law and debt law, the system of directors' external liability stipulated in the Company Law has natural advantages, but "limiting the application" of this system to balance the interests of directors and creditors should be the focus of future attention to prevent this article from becoming a sword of Damocles hanging over the heads of directors.