On December 29, 2023, the “Company Law of the People’s Republic of China (Revised in 2023)” (“New Company Law”) was passed by the Standing Committee of the Fourteenth National People’s Congress, formally coming into effect on July 1, 2024. The New Company Law represents the first major overhaul of the Company Law in the last two decades. The Company Law of the People’s Republic of China (PRC), initially established in 1993, has undergone six revisions. Throughout its creation and refinement, it has drawn extensively on rules from the western legal system, with regulations about self-dealing transactions being a prime example.
A. Self-dealing Regulations in China
Before this revision, China’s Company Law distinguished between direct self-dealing and indirect “affiliate transactions”. Article 148 prohibited directors and officers from directly trading with the company without approval from shareholders. Article 21 prohibits directors and officers from exploiting their control over affiliated entities to harm the company’s interests.
A significant transformation in the New Company Law is the elimination of the distinction above. The law now encompasses both under the umbrella term “self-dealing transactions,” which includes both direct and indirect dealings by directors and officers with the company. Additionally, the new law explicitly stipulates that the relatives of directors and officers are also subject to the rules.
Article 182 and 185 provides new sets of procedural requirements that govern all self-dealing transactions. Directors and officers, who intend to engage in self-dealing transactions either directly or through controlled entities, must report to the board or the shareholders. The transaction must be voted on by the board or during a shareholders’ meeting, where directors with a conflict of interest must avoid voting. Only after the resolution is passed can the transaction be considered compliant with the law.
B. Self-dealing Regulations in the United States
In the United States (U.S.), self-dealing or “conflicting interest transactions” often fall under the duty of loyalty. This duty, owed by directors and officers, restricts them from transactions that conflict with the company’s interests. The Model Business Corporation Act (MBCA) and Delaware General Corporation Law (DGCL) address this issue in similar ways.
MBCA states that conflicting interest transactions occur when a director or “related persons” – family members or other individuals with close relationships to the director – engage in company transactions that they have a significant financial interest in. MBCA specifies that when there’s a potential conflict of interest, directors have to disclose this information and abstain from voting at board meetings where such transactions should be decided.
Slightly different from the MBCA, which provides a compliance standard for making self-dealing transactions work, DGCL offers dispute-resolution-based guidelines for validating transactions. It creates a safe harbor for self-dealing transactions from automatic invalidity, as long as they have been approved by informed, disinterested directors or shareholders. Furthermore, if no prior approval is obtained, judicial review for fairness can justify the transaction.
The courts assess fairness based on several factors, including whether the corporation received full value in the commodities purchased; whether the transaction was at the market price, or below; whether there was a detriment to the corporation as a result of the transaction.
C. Comparison Between Rules in China and the United States
Comparing the rules of these two different jurisdictions, we can see that the New Company Law of the PRC has largely adopted the rules from the MBCA and DGCL, while there are also some differences between them.
- Definition of Self-dealing Transaction With the New Company Law of the PRC unifying the definition of self-dealing, both Chinese and U.S. rules define self-dealing transactions as those involving directors and officers trading with the company, either directly or indirectly through persons or entities over which they have control or significant influence.
- Approval Requirement Both Chinese and U.S. rules require the self-dealing transactions to be voted by informed and disinterested directors or shareholders. In this context, the New Company Law has largely incorporated the U.S. approval requirements for self-dealing transactions, thereby addressing the previous ambiguity in terms of procedural stipulations.
- Fairness Standard
DGCL validates self-dealing transactions lacking the approval procedure if the transaction meets the fairness standard. The New Company Law of the PRC does not explicitly provide for such an exception, but similar fairness principles have been incorporated in judicial practice.
In the “Provisions of the Supreme Court on Application of the Company Law of PRC (V),” the Chinese Supreme Court underscored that mere procedural approval is insufficient as a defense in self-dealing cases. It has also emphasized in the (2019) Civil Final No. 496 case the importance of reviewing the substantive content of the transaction, including whether the contractual terms and performance conform to normal business principles and whether the price is reasonable.
- Application of Business Judgment Rule
The Delaware Court maintains that once a transaction is approved by an informed and disinterested board, the business judgment rule (BJR) should be invoked. Under this rule, the court refrains from interfering with the board’s decision unless there is evidence of gross negligence or a clear act of mismanagement, such as gift or waste. This contrasts with the Chinese Supreme Court’s opinion: here, a self-dealing transaction, even if it satisfies approval requirements, is non-compliant if it deviates from the principles of fairness.
The reason for this difference is that boards in China are composed of shareholders or shadow directors (directors who can only follow the shareholders’ instructions), while boards of American companies are expected to either be independent or make decisions based on their fiduciary duties to the company. The shareholders sitting on Chinese company boards are usually not professional managers and may find it difficult to form professional business judgments. As a result, it is common for controlling shareholders to control the board of directors. Applying the BJR to their decisions without the extra protection of the fairness standard would lead to a huge increase in unfair, self-dealing transactions.
In conclusion, the New Company Law has drawn extensively from U.S. regulations to refine its rules on self-dealing transactions, thereby enhancing the self-dealing governance. This reform provides a stronger legal foundation for protecting the interests of companies, thus promoting corporate governance practices that align with international standards.