With the implementation of the new Company Law, state-owned capital funds are playing an increasingly significant role in economic activities. Appointing directors to investee companies for governance is a common practice, but it entails various legal risks. To safeguard the interests and the stable development of state-owned capital funds, it is crucial to analyse these risks from a litigation perspective and explore preventive measures.

Legal risks

Duties of loyalty and diligence. The new Company Law explicitly outlines directors’ duties of loyalty and diligence. Directors appointed by state-owned capital funds who fail to meet these obligations, such as by showing negligence in reviewing related-party transactions, risk causing losses to investee companies. Shareholders or other stakeholders may pursue litigation, seeking compensation for directors’ breaches of these duties.

In major strategic or investment decisions, directors who fail to conduct thorough research, or who rely on inaccurate information, may face litigation and claims for compensation if their decisions result in corporate losses.

Information disclosure. The new Company Law highlights the critical role of information disclosure. Failure by directors appointed by state-owned capital funds to ensure proper oversight, leading to concealment or misleading statements in financial reports or major announcements, could result in securities fraud litigation.

When state-owned capital funds, as shareholders, seek internal corporate information, failure by directors to promptly and accurately share the information may result in misinformed decisions due to information asymmetry, potentially leading to internal dispute litigation.

Compliance. The new Company Law introduces updated requirements for corporate governance and shareholder rights protection. Directors appointed by state-owned capital funds who fail to fully understand or properly implement these regulations may expose investee companies to legal violations. Issues such as illegitimate procedures in shareholder meetings or board decisions could trigger penalties from regulatory bodies and lawsuits from shareholders.

Directors appointed by state-owned capital funds, if failing to fulfil oversight duties on corporate compliance as required by state asset management regulations, particularly the mandate to preserve and enhance asset value, risk administrative accountability and legal action from regulators.

Countermeasures

Proper selection and training. A stringent selection process should be established to evaluate candidates’ professional expertise in areas such as law, finance and corporate management, along with their governance experience and ethical standards. Appointing highly qualified individuals as directors helps mitigate risks stemming from skill gaps at the outset.

Training programmes should also be conducted regularly on the new Company Law, state asset management regulations, and industry developments. Topics should cover the duties of loyalty and diligence, information disclosure requirements, and compliance management, aiming to enhance directors’ legal awareness and professional competence.

Robust supervision and evaluation. Internally, a supervision mechanism should be established with dedicated roles or committees overseeing directors’ performance. Externally, auditors and legal advisers can be engaged to conduct an independent review of directors’ decisions and actions.

Evaluation should be based on well-designed metrics such as decision accuracy, business performance improvement, and compliance execution. A tailored reward and penalty system linked to evaluation results can encourage diligence, accountability and risk prevention while mitigating risks and misconduct.

Enhanced communication and collaboration. Actively engage in the governance of investee companies, maintaining close communication with the management and other shareholders. Prior to decision making, consider diverse opinions to ensure decisions are well informed and rational.

Establish an information-sharing mechanism to promptly access and relay operational and financial data of investee companies. Collaborate with investee companies on accurate and complete information disclosure to mitigate litigation risks.

Risk detection and response framework. A dedicated legal risk monitoring system should be implemented to track potential risks in real time, focusing on key indicators such as regulatory changes, abnormal business data fluctuations, and shifts in shareholder relations for early assessment.

Comprehensive response plans should also be developed and tailored to various risks, such as shareholder litigation and regulatory penalties. For instance, in shareholder disputes, promptly gather evidence and engage professional legal counsel for swift action.

Takeaways

Under the new Company Law, directors appointed by state-owned capital funds face multiple legal risks, which, if they lead to litigation, could severely harm the interests of the funds and investee companies alike. To mitigate these risks, it is essential to optimise director selection and training mechanisms, establish a robust supervision and evaluation system, enhance communication and collaboration, and refine risk monitoring and response processes.

These measures safeguard the rights and interests of state-owned capital funds, promote the healthy development of the funds and investee companies, preserve and grow state assets, and contribute to the orderly functioning of the market economy.