The new Company Law establishes a clear disgorgement mechanism in article 186, requiring directors, supervisors and senior executives to return illicit gains from certain breaches to the company as outlined in articles 181-184.
It expands liability to supervisors and specifies three triggers for this disgorgement – abuse of corporate assets, self-dealing transactions, and misuse of corporate opportunities.
However, what falls within the scope of income is decided on a case-by-case basis, with no unified approach. Drawing on landmark rulings, the authors of this article outline the judicial reasoning used to determine this scope.
Jiang Xuan
Partner
Zhong Lun Law Firm
The scope of liable parties extends beyond officially appointed directors, supervisors and senior executives. While article 186 of the Company Law textually restricts the subjects to these roles, judicial practice applies the disgorgement liability more broadly.
In Su 03 Min Zhong 6921 (2021), the court ruled that any person who manages a company and performs duties that are substantially identical to those of a director or senior executive is also subject to the company’s disgorgement rights.
The scope can also pierce the corporate veil in wholly owned structures. In Zui Gao Fa Min Shen 1686 (2021), the Supreme People’s Court found that the interests of a wholly owned subsidiary and its parent are aligned.
In other words, if a parent company’s directors or senior executives appropriate the subsidiary’s business opportunities, the disgorgement rule applies, and the gains must be surrendered to the subsidiary.
Liable income is not confined to indirect gains. In scenarios involving competition with a company – such as operating a competing business, or seizing a corporate opportunity – income gained by directors, supervisors or senior executives is often indirect.
Xin Xiangrong
Paralegal
Zhong Lun Law Firm
This makes proving the value of such indirect benefits a challenge, often leading courts to exercise discretion to determine the sum.
In Zui Gao Fa Min Shen 1686 (2021), where a director exploited a business opportunity through a third-party company he/she controlled, the plaintiff argued that the director’s income included capital increases in that third-party company, and profits from the sale of his indirect equity.
But the court did not adopt this view, instead setting the disgorgement amount by considering operational costs and the project’s development prospects.
Similarly, in Jing 0112 Min Chu 29206 (2023), concerning a director’s breach of non-compete duties, the court refused to award the competing entity’s entire annual profit, opting instead to calculate a sum based on the scale and growth of the respective companies’ operations.
There must be a causal link between income and breach of fiduciary duty. The Company Law’s disgorgement remedy targets income “obtained from violating articles 181-184”. A textual interpretation confirms that income disgorged must be causally connected to the wrongful act.
Critically, disgorgement liability differs from compensatory damages for harming company interests. It addresses gains the wrongdoer obtained from their breach of fiduciary duty, meaning a company loss is not a prerequisite, nor is the calculation based on that loss.
Therefore, in disgorgement cases, the focus must be on establishing causation between the income and the director’s, supervisor’s or senior executive’s specific breach of loyalty.
Calculating disgorgable income requires considering the specific gain in question. A key point of contention is whether “income” is net or gross of associated costs.
Among the 2024 Top 10 Commercial and Financial Cases selected by the Guangdong High Court – where the individual, Zhang, and an investment company were accused of damaging another company’s interest – the court ruled that the entire revenue a director gained from an improper connected-party transaction must be disgorged to the company without deducting operational costs.
In its reasoning, the court clarified that the statutory disgorgement remedy serves to punish and deter breaches of fiduciary duty by directors, supervisors and senior executives. However, in cases involving the misappropriation of corporate opportunities, or breaches of non-compete obligations, the causal link between a third party’s revenue and the fiduciary breach is often indirect, as this income is influenced by market conditions, management quality and policy factors. This makes it difficult for a claimant to prove the gains.
In such instances – such as Hu 01 Min Zhong 9247 (2020), Su 01 Min Zhong 3258 (2020) and Jing 01 Min Zhong 8039 (2021) – courts typically exercise discretion, considering factors such as the company’s loss, severity of the breach, the third party’s operations, and industry-average profit margins.
Conversely, where a third party’s revenue can be ascertained, and operational costs constitute a significant portion – as in Su 03 Min Zhong 6921 (2021) – the court may deduct these costs to avoid excessive punishment.
Key takeaway
The company disgorgement regime aims to strip wrongdoers of illicit profits from fiduciary breaches. Highlighting its role in “punishment and deterrence”, the above-mentioned Guangdong High Court ruling carries substantial weight.
A trend towards more refined adjudication is also evident, with courts analysing the specific nature of the breach. In practice, defining the scope of income demands a focus on causal links and demonstrable profits, requiring litigants to devise precise and effective evidence strategies.
Jiang Xuan is a partner and Xin Xiangrong is a paralegal at Zhong Lun Law Firm
Zhong Lun Law Firm
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Beijing 100020, China
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E-mail: jiangxuan@zhonglun.com | xinxiangrong@zhonglun.com
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