Review standards for fiduciary duties of directors

Directors of a corporation are authorized to act on its behalf, ensuring proper management of corporate assets internally and having business dealings with outsiders externally. As fiduciaries, directors have duties of a fiduciary nature towards the corporation. However, when the corporation becomes the target of a proposed takeover, the decision made by its board of directors in response to the takeover offer may give rise to conflicts of interest between directors and the corporation.

If shareholders of the target disagree with the decision of the board of directors and take the case to a court, usually the court will examine whether the directors acted in contrary to their fiduciary duties by applying the business judgment rule, entire fairness standard, or enhanced scrutiny standard as appropriate to the circumstances.

Fiduciary duties of directors

Fiduciary duties of directors are specified in laws and regulations that include the Company Law, the Measures for the Administration of Takeover of Listed Companies, and the Measures for the Administration of Takeover of Non-Listed Public Companies. In a friendly takeover, conflicts of interest undoubtedly arise if the buyer reaches a secret deal with directors of the target with the purpose of getting the proposed M&A transaction done, or induces directors to agree to, and subsequently persuades shareholders into, accepting a lower bid price.

Even if directors of the target do not seek a secret deal, their motivation to keep the director position is likely to trigger conflicts of interest with shareholders of the target. In a hostile takeover, conflicts of interest are inevitable, because directors of the target might reject the offer, or take anti-takeover measures out of consideration for their own interest, given that the takeover is likely to deprive control and work opportunity of directors despite the possibility that it might provide material benefits to the target.

Being the entrusted operator of the target, and as part of their fiduciary duties, the target’s board of directors must make best efforts to ensure that their decision in response to the proposed takeover offer is in the best interest of the corporation and its shareholders under the prevailing circumstances.

Author: Wang Jianrui is a partner and Yang Bin is an associate at East & Concord Partners