Board Directors' Duty of Loyalty, and Removal of the Non-competition Obligation

According to reports, the Taipei District Court recently ruled in a case where a corporate board's non-competition obligation was removed that, since the company in question – Union Insurance Company – had not provided shareholders the information necessary to make a judgment, and harm was done to both the company and shareholders' interests, the resolution by Union Insurance's shareholders' meeting for “removal of the board of directors non-competition prohibition" was invalid.

As stipulated in Article 209 of Taiwan's Company Law, "a director who engages in an activity within the scope of the company's business, on their own account or on behalf of another person, shall explain the significant contents of such activity to the shareholders' meeting and obtain its approval". Paragraph 5 of the same Article provides that, where a director violates the provision of the first paragraph, the shareholders' meeting may exercise its right to consider the earnings from such activity to be the earnings of the company (i.e., the shareholders' right to compel ‘disgorgement' of such earnings). As to "a director…shall explain the significant contents of such activity to the shareholders' meeting and obtain its approval", the Ministry of Finance's letter of interpretation maintains that this means directors must explain "before the fact" and "individually" the significant contents of their activities to the shareholders' meeting, and obtain approval, but does not include "after the fact" and "summary" removal of directors' responsibilities.

Directors' management of a company is something entrusted to them by the shareholders. In order to safeguard the interest of companies and their shareholders, legislation not only requires a duty of care. Directors are also bound by a duty of loyalty. Directors having a so-called duty of loyalty means that when directors carry out their professional functions, they must act with the best interest of the company in mind. They may not put their own interest above those of the company and its shareholders; they may not take the company's opportunities for their own advantage and engage in activities that harm the company's interests. Since directors' non-competition obligation prevents directors from using secrets learned through their professional duties in outside competing businesses, to the detriment of the company and its shareholders, it therefore falls within the perimeter defined by the duty of loyalty.

Accordingly, if a director wishes to obtain approval for competing business, via a resolution of the shareholders' meeting, the contents of the explanation given must be sufficient to clarify the potential competitive activity about to be undertaken, and in fact, to be legal, such action should not take advantage of opportunities exploitable by the company, so that there is no concern that it may harm the interests of the company and its shareholders. From a procedural perspective, however, in addition to thorough information disclosure, it is also necessary to keep shareholders with key personal stakes in the outcome from participating in the voting on such resolutions, so as to prevent conflicts of interest. If there are indeed concerns about a director's competing business activity damaging the company's interests, engaging in the activity would run counter to the directors duty of loyalty to the company, and directors may not rely solely on a majority resolution of the shareholders' meeting to avoid that responsibility. In practice, many have believed that you only needed to get agreement from the shareholders' meeting and then you could engage in competitive business at will, while in fact this is due to ignorance that the non-competition obligation puts such behavior within the confines of directors' duty of loyalty.

In actuality, the reason why directors' non-competition rules have not been clearly effective lies in the insufficient transparency of Taiwan's corporations and the poor quality of their information disclosures. Also, there are no clear standards on the extent of disclosures, although in the Union Insurance case the court again expressed the governing body's perspective and legislative intent, namely by requiring that before tabling a resolution to remove the prohibition against engaging in competing business, the board of directors must first provide shareholders the information necessary to make a judgment, and such information must constitute concrete facts that allow one to forecast the degree of impact the company will subsequently receive. The Ministry of Finance also has related letters of interpretation with requirements on the extent of disclosures, but the explanation of what it calls "before the fact" and "individually", and the standards for what kinds of information "constitute concrete facts that allow one to forecast the degree of impact the company will subsequently receive" all remain abstract. To find the path to compliance and gradually establish concrete standards, one must still rely on the practical measures taken in each case by the courts and the government units involved.

In addition, the practical feasibility of related channels for seeking relief after the fact is also an important link to be systematically exploited. In Taiwan now, shareholders' meetings are commonly manipulated by large shareholders, and large shareholders also frequently sit as directors, so whether the right of disgorgement can be executed smoothly is not without doubts. For shareholders to seek relief through litigation after the fact, on the other hand, the bar is set very high, with many restrictions, so that it is not usually in the interest of shareholders to pursue it. Hence, the non-competition rules in Taiwan's Company Law have very limited utility. There remains ample room for exploration and thought about how to adjust them to reflect reality.

Eric Tsai is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to: Eric.Tsai@tw.pwc.com