Mediation Abstract
After a listed company has discharged its civil liability for misrepresentation externally, an investor protection agency holding shares in the company can legally initiate a shareholder derivative action to seek reimbursement from the company’s liable directors, supervisors, and senior executives in subrogation of the company. The presiding court, on the basis of respecting the parties’ willingness to mediate, can encourage the investor protection agency to resolve the dispute conclusively through a single mediation process, upon defining the scope of liability of the directors, supervisors, senior executives, and intermediaries through measures such as litigation guidance and legal interpretation.
Basic Facts
A network technology company, listed on the A-share market, along with 14 of its then directors, supervisors, and senior executives including Zhang XX and Wang X, as well as the accounting firm responsible for auditing its annual report, received administrative punishments from the China Securities Regulatory Commission (CSRC) in July 2016 for reporting inflated profits and other information disclosure violations in its 2013 annual report. Subsequently, thousands of investors sued the company and related liable persons for securities misrepresentation liability, contending that these false statements had led to their investment losses. Following an effective civil judgment, the company paid RMB 335 million in compensation to the investors.
The plaintiff, the China Securities Investor Services Center Co., Ltd. (CSISC), established by the CSRC to protect investors, held 100 shares in the network technology company. On April 3, 2021, the CSISC sent the company a Shareholder Inquiry and Proposal Letter, urging it to recover losses from the liable persons; however, the company failed to take corresponding measures. Consequently, on September 8, 2021, the CSISC brought a shareholder derivative action on behalf of the company before the Shanghai Financial Court, under case (2021) Hu 74 Min Chu No. 3158, in accordance with Article 151 of the Company Law of the People’s Republic of China and the recently added Article 94 of the Securities Law of the People’s Republic of China.
On November 18, 2021, the network technology company, as plaintiff, filed a related lawsuit against Zhang XX, Wang X, Wang XX, Hong X, and Guo XX under Case (2021) Hu 74 Min Chu No. 4237. The case sought from the five defendants reimbursement of approximately RMB 325 million in civil compensation paid to investors in a series of securities misrepresentation disputes. This claim was later adjusted to RMB 335 million.
Given the facts and the grounds of the two cases were closely related to the said series of securities misrepresentation disputes and interconnected to the legal relationship of recourse for joint and several liability in securities fraud, the Court, ex officio, added other directors, supervisors, and senior executives penalized by the CSRC concerning the false statements as third parties in the case, in order to find the facts and define each defendant’s scope of liability.
Mediation Results
Since the defendant Zhang XX (controlling shareholder and then chairman and general manager of the company) had fully compensated the company for the claimed losses, the plaintiff CSISC applied to withdraw the lawsuit on the basis that all litigation demands had been met. The Court approved CSISC’s application to withdraw this case against the company’s directors, supervisors, and senior executives regarding dispute over liability for damaging the interests of the company, under case (2021) Hu 74 Minchu No. 3158. The Court then organized the mediation of the related lawsuit, involving the company versus its directors, supervisors, and senior executives for the same liability dispute, under case (2021) Hu 74 Min Chu No. 4237. Through the two cases, the company received full compensation of RMB 335 million from the controlling shareholder.
Mediation Guidelines
During the trial, the Court facilitated the substantial resolution of the dispute through a single action, avoiding procedural futility.
First, the Court established the principle of “resolving disputes through a single action.” Targeting the primary offenders, the CSISC initially sued only four defendants, including the controlling shareholder (who also served as the chairman and general manager) and the chief financial officer. However, a simple ruling requiring only these defendants to assume liability might spur ongoing litigations among the jointly and severally liable parties, each seeking reimbursement from the others. Therefore, the Court, ex officio, added over ten signing directors, supervisors, and senior executives as well as the auditing firm as third parties. After thoroughly assessing all stakeholders’ faults and causative potency, the Court conclusively determined the internal liability shares of those jointly and severally liable to prevent any protracted litigations among the involved parties.
Second, the Court delved into the fundamental conflict to facilitate mediation. After adding third parties ex officio, the Court clarified to all defendants and third parties that they needed to actively defend themselves regarding their faults and causative potency in this case. The Court also organized three pre-trial meetings, leveraging measures such as litigation guidance and legal interpretation to unearth the deep-seated contradictions. Upon defining the scope of liability of the directors, supervisors, senior executives, and intermediaries, the Court specified the legal principles. This allowed all parties to fully understand the litigation risks. Following several rounds of negotiations, a preliminary mediation agreement was reached for the controlling shareholder, Zhang XX, to fully compensate the company for its losses.
Third, the Court took strict precautions to prevent the emergence of secondary disputes during the performance of the mediation agreement. 1. The feasibility of mediation was assessed from a legal standpoint. Given that the network technology company had the right to seek reimbursement from its controlling shareholder, actual controller, directors, supervisors, and senior executives after making compensation for securities misrepresentation, it was legally justified for the parties to agree that Zhang XX would fully pay this compensation. 2. The mediation plan was scrutinized procedurally to ensure it had been approved by the company’s authorized body. The company had submitted a board resolution that consented to the mediation, which was confirmed lawful and valid. 3. The credibility of the company’s claims for external compensation was verified on the basis of fact. The Court reviewed over 3,000 effective civil judgments and actual payment receipts, concluding that the company’s claimed compensation to small and medium investors aligned with the objective facts.
Mediation Significance
This case was recognized among the 2023 Top Ten Nominated Cases Promoting the Rule of Law in the New Era, the CSRC Top Ten Typical Cases of Investor Protection, and the Top Ten Typical Cases of Financial Consumer Rights and Interests Protection. In recent years, the number of cases where listed companies have been held liable for civil compensation due to securities fraud has significantly increased. However, it remains rare for these companies to seek redress from their directors, supervisors, and senior executives after discharging their compensatory liability. This case is China’s first shareholder derivative action initiated by an investor protection agency under the newly added Article 94 of the Securities Law. It is also the first instance in the country where an investor protection agency has stepped in to recoup losses from a listed company’s directors, supervisors, and senior executives after the company was found liable for civil compensation due to securities fraud. Amid the full implementation of the registration system reform, this case serves as a vital model for enhancing the accountability of relevant parties. Through the Court’s diligent efforts, the controlling shareholder was urged to fully reimburse the company for its losses, setting a precedent in China’s capital market. This has effectively deterred the “critical minority” from misconduct and robustly safeguarded the legitimate rights and interests of small and medium investors.
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