Directors and Officers Liability Insurance, also known as D&O Insurance, (hereinafter referred to as “D&O Insurance”), constitutes a form of professional liability insurance which covers the civil liabilities incurred by directors, supervisors, and senior executives (hereinafter referred to as “Directors and Officers”) in defending against the claims brought by companies, shareholders or third parties. It serves as a crucial cornerstone of corporate governance for listed companies. Originating from the Common Law system, D&O Insurance provides coverage for directors and senior executives. Notably, within the civil law system and the Chinese corporate governance system, D&O Insurance coverage has expanded to encompass a company’s supervisors.

The enactment of the revised Securities Law (2019 revision) marked a significant milestone in China’s regulatory and restraint mechanism, continuously strengthening oversight and liability restraint mechanism on Directors and Officers. Consequently, there is a growing recognition among companies, both listed and non-listed, of the imperative nature of D&O Insurance as a safeguard against potential liabilities. Thus, the demand for D&O Insurance as a risk protection for Companies, including listed and non-listed ones, as well as Directors and Officers continues to intensify.

On December 29, 2023, the 7th Session of the Standing Committee of the 14th National People’s Congress voted to adopt the newly revised Company Law of the People’s Republic of China (hereinafter referred to as the “2023 PRC Company Law”), which came into effect on July 1, 2024. The 2023 PRC Company Law, for the first time, explicitly encourages companies to purchase D&O Insurance and requires the board of directors to report the relevant details regarding the D&O Policy purchased at the shareholders’ meeting.

The legislation pertaining to D&O Insurance represents a proactive response to market demands aimed at encouraging and promoting its adoption. It further underscores the importance of securing D&O Insurance for Chinese companies. In order to elevate the corporate governance standards, the 2023 PRC Company Law systematically clarifies the liabilities of Directors and Officers. From the application scope, coverage subjects and approval procedure, the 2023 PRC Company Law constantly expands and refines the liabilities of Directors and Officers while establishing the D&O Insurance system. Notable changes include the extension of the application scope to encompass non-listed companies, broadening coverage to include all directors rather than solely independent directors, and modifying the approval process from shareholder meeting approval to post-purchase reporting to shareholders. The evolving business environment has prompted the continuous enhancement of the D&O Insurance system.

Article 193 A company may, during the term of office of a director, purchase the liability insurance for the compensation liability to be borne by the director in performing the duties.

After the company purchases liability insurance or renews the insurance for the director, the board of directors shall report the insured amount, coverage and premium rate etc. of the liability insurance at the shareholders’ meeting.

It was first provided in the Guiding Opinions on the Establishment of Independent Director System by Listed Companies (hereinafter referred to as the “Guiding Opinions”) in 2001 that “listed companies may establish necessary Independent Director liability insurance systems in order to mitigate the risks that may arise in the normal performance by Independent Directors of their duties and responsibilities”. Subsequently, the Guidelines on Governance of Listed Companies (2018 Revision) (hereinafter referred to as the “Governance Code”) and the Several Opinions of the State Council concerning the Reform and Development of the Insurance Industry encouraged the establishment of the D&O Insurance system, but the aforementioned provisions were only reflected in policy documents and regulatory documents. The 2023 PRC Company Law, represents the first legislative endorsement of D&O Insurance, encouraging companies to purchase D&O Insurance to transfer directors’ management risks.

In accordance with Article 193 of the 2023 PRC Company Law, the coverage subjects of D&O Insurance have extended from independent directors to all directors, and the application scope of D&O Insurance has also extended from listed companies to non-listed companies. The approval procedures have shifted from “approval by a shareholders' meeting” prescribed in the Governance Code to “the board of directors shall report to the shareholders’ meeting”. The 2023 PRC Company Law further clarifies the insurer’s obligation to inform the shareholders’ meeting of the insured amount, coverage and premium rate of the insurance purchased.

In the past, listed companies were the major purchasers of D&O Insurance in China. With the enactment of the 2023 PRC Company Law and the Securities Law and growing recognition of the importance of D&O Insurance, broader uptake of D&O Insurance by non-listed companies is anticipated. This trend signals a positive outlook for insurance companies seeking to expand their presence in the D&O Insurance market.

II. The Clarification and Elaboration of the Duties of Loyalty and Diligence of Directors and Officers

Under the modern corporate governance system, the Directors and Officers shall assume the duty of loyalty and duty of diligence. In practice, breach of such duties by Directors and Officers may result from either intentional acts, such as fraud and intentional concealment, or unintentional acts, such as mistakes, negligence or omissions. It is noteworthy that the D&O Insurance only covers losses arising out of the unintentional breach of duties of loyalty and diligence by Directors and Officers, namely the negligent violations. Typically, intentional acts such as fraudulent behavior, intentional illegal acts or crimes committed with intent are excluded from the coverage of D&O Insurance through the exclusion clauses.

Due to the absence of detailed and explicit standards regarding the duty of loyalty and diligence in the 2018 Company Law, judicial practice often involves assessing whether the actions of Directors and Officers violate laws, regulations, or company bylaws at a formal level. Some courts may additionally delve into a substantive examination to determine whether Directors and Officers have “exercised the reasonable care that a prudent person should exercise.” The inconsistency in examination standards, coupled with the lack of legal standards for the duty of loyalty and diligence, rendered D&O Insurance vulnerable to opportunistic behavior by management personnel.

Article 180 Directors, supervisors and senior executives shall assume the obligation of loyalty to the company and take measures to avoid the conflict between their own interests and those of the company and may not seek any improper interests by taking advantage of their powers.

The directors, supervisors and senior executives shall assume the duty of diligence to the company. When performing their duties, they shall, for the best interests of the company, exercise the reasonable care that shall be generally possessed by a manager.

The provisions of the preceding two paragraphs shall apply to the controlling shareholder or actual controller of a company who does not serve as a director but actually executes the affairs of the company.

Article 180 of the 2023 PRC Company Law has refined the core elements and defining criteria of the duties of loyalty and diligence over the 2018 Company Law, explicitly clarifying that the core of the duties of loyalty revolves around refraining from “seeking any improper interests by taking advantage of their powers”, and its essence is to avoid conflicts between personal interests and the those of the company. When conflicts arise between the interests of the company and those of Directors and Officers, the interests of the company shall prevail. Similarly, the core of the duties of diligence is defined as “when performing their duties, ..., for the best interests of the company, exercise the reasonable care that shall be generally possessed by a manager”. This duty primarily aims to define the standard of reasonable care in their performance of duties.

Article 181 to 184 of the 2023 PRC Company Law specifically sets forth restrictive or prohibitive provisions on normal behaviors by Directors and Officers that may harm the company’s interests, such as related-party transactions, corporate opportunities, and non-competition agreements. Theoretically, any acts by the Directors and Officers that breach the duties of loyalty and diligence as specified in Article 181 to 184 of the 2023 PRC Company Law may constitute the “intentional illegal acts” as exempted by the exclusion clauses in the D&O Insurance Policies. It is imperative for insurance companies to carefully tailor the Exclusion Clause according to market demand, avoiding the inclusion of intentional illegal acts within the coverage scope, while ensuring they do not indiscriminately exclude all risks associated with Directors’ and Officers’ breaches. Failure to do so may lead to a dysfunctional D&O Insurance market. In practice, a detailed analysis and differentiation should be applied to the provisions specified in the 2023 PRC Company Law. The specific provisions of the 2023 Company Law are referred to as follows:

Article 181 No director, supervisor or senior executive may have any of the following acts:

Article 182 Where any director, supervisor or senior executive directly or indirectly concludes a contract or conducts a transaction with his/her company, he/she shall report the matters relating to the conclusion of the contract or transaction to the board of directors or shareholders’ meeting, which shall be subject to the resolution of the board of directors or shareholders’ meeting according to the articles of association.

Where any of the near relatives of the directors, supervisors or senior executives, or any of the enterprises directly or indirectly controlled by the directors, supervisors or senior executives or any of their near relatives, or any of the related parties who has any other related-party relationship with the directors, supervisors or senior executives, concludes a contract or conducts a transaction with the company, the provisions of the preceding paragraph shall apply.

Article 183 No director, supervisor or senior executive may take advantage of his/her position to seek any business opportunity that belongs to the company for himself/herself or any other person except under any of the following circumstances:

(I) where he/she has reported to the board of directors or the shareholders’ meeting and has been approved by a resolution of the board of directors or the shareholders’ meeting according to the articles of association; or

(II) where the company cannot make use of the business opportunity as stipulated by laws, administrative regulations or the articles of association.

Article 184 Where any director, supervisor or senior executive fails to report to the board of directors or the shareholders’ meeting and obtain an approval by resolution of the board of directors or the shareholders’ meeting according to the articles of association, he/she may not engage in any business that is similar to that of the company where he/she holds office for himself/herself or for any other person.

Following the amendment of the 2023 Company Law, considerable discrepancies exist among insurance companies with regard to the coverage remit of D&O Insurance. Further discussion is merited on whether the circumstances set forth in Articles 181 to 184 should be incorporated into the Exclusion Clause.

In light of this, we propose the following advice:

1) Intentional breaches of the duties of loyalty and diligence, especially those involving serious illegal acts and intentional crimes, shall undoubtedly be deemed as an exclusion term, such as embezzlement and misappropriation of company funds by Directors and Officers.

2) It is not advisable to directly include the miscellaneous provision such as “other acts in violation of the obligation of loyalty to the company” stipulated in Article 181 (VI), as an Exclusion Clause when concluding a D&O policy. Exclusion clauses shall be explicit and specific so as to avoid disputes; otherwise, the People’s Court and arbitral tribunals may apply the “contra proferentem” principle when interpreting such clauses, which is unfavorable to the insurer.

3) As stipulated in Article 183 of the 2023 PRC Company Law, Directors and Officers shall not take advantage of their position through seeking business opportunities, that belongs to the company, for themselves or any other person. In practice, related disputes often arise due to the lack of sophisticated corporate governance in China, especially when the directors, recommended by shareholders, seek business opportunities that belong to the company. If such circumstances are included in Exclusion Clauses, it may deviate from the expectation of the policyholders. This issue merits further discussion among insurance companies.

4) The “principle of insurable interest” shall be taken into account when designing the Coverage and Exclusion Clauses in accordance with the 2023 PRC Company Law. Unlawful interests shall not be covered to avoid regulatory concerns.

III. Controlling Shareholders and Actual Controllers as the “Shadow Directors” in D&O Insurance Policy

Article 180 Directors, supervisors and senior executives shall assume the obligation of loyalty to the company and take measures to avoid the conflict between their own interests and those of the company and may not seek any improper interests by taking advantage of their powers.

The directors, supervisors and senior executives shall assume the duty of diligence to the company. When performing their duties, they shall, for the best interests of the company, exercise the reasonable care that shall be generally possessed by a manager.

The provisions of the preceding two paragraphs shall apply to the controlling shareholder or actual controller of a company who does not serve as a director but actually executes the affairs of the company.

Article 180 Clause 3 of the 2023 PRC Company Law specifies that controlling shareholders and actual controllers who do not hold the position of director but execute the company’s affairs shall also assume the duty of loyalty and diligence to the company.

Currently, the D&O Insurance Policy typically defines the actual controllers and controlling shareholders as the “shadow directors”, included as the insured individuals. Under the 2023 PRC Company Law, losses incurred by the controlling shareholders or actual controllers due to a failure to perform their duties of loyalty and diligence may also fall within the coverage of a D&O Insurance Policy, thereby increasing the risk of triggering policy liabilities.

Notably, unlike their counterparts in Common Law jurisdictions, the PRC’s laws and regulations have not specified the definition and scope of “shadow directors”. It is usually necessary to determine whether controlling shareholders or actual controllers of an insured company constitute the shadow directors in the D&O Insurance Policy according to the specific policy definition. For example, the definition of shadow directors in the D&O Liability Insurance policy of an insurance company defines shadow directors as “individuals who, although not holding the position of directors, are accustomed to acting under their instructions or directions”. According to this policy, such controlling shareholders and actual controllers may fall within the scope of the aforesaid “shadow directors” due to their significant influence on the company’s resolutions or significant control of the company’s operations.

We recommend that insurance companies, when designing a D&O Insurance Policy, take into full consideration the definition of “shadow directors” and draft the policy terms in a more specific way so as to prevent potential disputes.

IV. Impact of Controlling Shareholders and Actual Controllers’ Joint and Several Liability on Insurers’ Subrogation Recourse

Article 192 Where any controlling shareholder or actual controller of a company instructs any director or senior executive to carry out any act damaging the interests of the company or the shareholders, it shall bear joint and several liability with the director or senior executive.

Article 192 of the 2023 PRC Company Law adopts the logic of joint and several tortious liability in civil law jurisdictions, requiring the controlling shareholders and the actual controllers to be jointly and severally liable with the Directors and Officers for acts that damage the interests of the company or the shareholders through their manipulation or instructions. Such regulatory measures could prevent the interests of the company and minority shareholders from being infringed upon by the Directors and Officers in pursuit of their own interests.

There existed a few feasible ways and routes for insurers’ subrogation against a third party after making payouts pursuant to the D&O Insurance Policy in the past. The above-mentioned provision on the joint liability provides a legitimate premise for the insurer to seek subrogation after making compensation, against the company’s controlling shareholders and the actual controllers who are truly liable or bear a higher proportion of liability.

As part of an insurance company’s wider sales strategy, it chooses to accommodate a client’s specific requirements in the terms of the insurance policy. Thus, flexibility of an insurer is a highly valued attribute for clients.

V. Scope of the Insurance Applicant’s Duty of Truthful Disclosure

Article 182 Where any director, supervisor or senior executive directly or indirectly concludes a contract or conducts a transaction with his/her company, he/she shall report the matters relating to the conclusion of the contract or transaction to the board of directors or shareholders’ meeting, which shall be subject to the resolution of the board of directors or shareholders’ meeting according to the articles of association.

Where any of the near relatives of the directors, supervisors or senior executives, or any of the enterprises directly or indirectly controlled by the directors, supervisors or senior executives or any of their near relatives, or any of the related parties who has any other related-party relationship with the directors, supervisors or senior executives, concludes a contract or conducts a transaction with the company, the provisions of the preceding paragraph shall apply.

Article 182 of the 2023 PRC Company Law introduces the following modifications to the related-party transaction restriction system of the 2018 Law:

1)    Including Supervisors to be subjected to the related-party transaction system;

2)    Stipulating the duty of truthful disclosure for Directors and Officers;

3)    Allowing the company’s stipulation of approval process for related-party transactions through bylaws, and to be resolved by the board of directors or shareholders’ meeting;

4)    Providing illustrative provisions on related parties, including the near relatives of the Directors and Officers, or any of the enterprises directly or indirectly controlled by the Directors and Officers or any of their near relatives, or any of the related parties who has any other related-party relationship with them stipulated by the miscellaneous provision.

Insurance companies commonly include related-party transactions as a key inquiry when applicants seek to purchase D&O Insurance. Insurance applicants shall perform the duty of truthful disclosure pursuant to Article 16 of the Insurance Law. The expansion and detailing of related-party transactions in the 2023 PRC Company Law provides a clearer legal basis for insurance applicants and insurers to assess the performance of truthful disclosure obligations and the elements for exercising the right to rescind an insurance contract.

Based on our experience, the questionnaires designed for D&O Insurance by insurance companies are relatively deficient; in that, they lack coverage of key issues. It is advisable to further optimize the questionnaires in alignment with the 2023 PRC Company Law.

Article 140 A listed company shall disclose the information about its shareholders and actual controllers according to law, and the relevant information shall be authentic, accurate and complete.

It is prohibited to hold the stocks of any listed company on an agency basis in violation of laws and administrative regulations.

Article 140 Clause 1 of the 2023 PRC Company Law introduces a new provision on duty of disclosure which requires listed companies to truthfully disclose the information of its shareholders and actual controllers. This aims to prevent the actual controllers from harming the interests of the company, minority shareholders and creditors through improper related-party transactions, thereby undermining the transaction order.

The establishment of this provision legislates and specifies the duty of truthful disclosure prescribed in the Administrative Measures for the Registration of Initial Public Offerings of Stocks, the Administrative Measures for the Information Disclosure by Listed Companies, and the Securities Law, providing insurers with a clearer legal basis to determine whether the insured has performed the duty of truthful disclosure.

VI. Refinement and Expansion of the Compensation Liability of Directors and Officers under the 2023 PRC Company Law

The amendments of the 2023 PRC Company Law have gradually refined and expanded the obligations and liabilities of Directors and Officers. Compensation liability under the D&O Insurance Policy may be triggered where (1) the Directors’ or Officers’ failure to perform their obligations in accordance with the law incurs losses to the company, or (2) the gross negligence by the Directors or Officers results in damage to a third party.

Consequently, the scope of claims made by the insured company has been broadened, increasing the underwriting risks of the insurers. The improvements of legislation and the changes in market demand impose higher standards on the insurers’ policy design and underwriting assessment.

Article 51 After a limited liability company is established, the board of directors shall verify the capital contributions of shareholders. If it finds that any shareholder has not made capital contributions on schedule and in full amount as provided for in the articles of association, the company shall send a written notice of call to the shareholder to call up capital contributions.

Where any loss is caused to the company due to failure to fulfill the obligations as prescribed in the preceding paragraph in a timely manner, the responsible director shall make compensation.

Article 53 After a company has been established, none of the shareholders may illicitly withdraw the capital contributions.

In the case of violation of the provisions of the preceding paragraph, the shareholder shall return the capital contributions withdrawn. If it causes any loss to the company, the responsible directors, supervisors and senior executives shall bear the joint and several liability with the shareholder.

Article 163 No company may provide gifts, loans, guarantees or other financial aids for others to obtain the shares of the company or the parent company thereof unless it carries out an employee stock ownership plan.

For the benefits of the company, the company may, upon a resolution by the shareholders’ meeting or by the board of directors under the articles of association or the authorization of the shareholders’ meeting, provide financial aids for others to obtain the shares of the company or the parent company thereof, provided that the total accumulative amount of the financial aids shall not exceed 10% of the total issued share capital. A resolution by the board of directors shall be adopted by two thirds of all the directors.

Any director, supervisor or senior executive who is liable for any loss to the company due to violation of the provisions of the preceding two paragraphs shall make compensations.

Article 211 Where a company distributes profits to shareholders in violation of the provisions of this Law, the shareholders shall refund the profits distributed to the company, and the shareholders and the liable directors, supervisors and senior executives shall be held liable for compensation if any loss is caused to the company.

Article 226 When a company reduces its registered capital in violation of the provisions of this Law, its shareholders shall refund the funds they have received, and if the capital contributions of the shareholders are reduced or exempted, such capital contributions shall be restored to the original status; if any loss is caused to the company, the shareholders and the liable directors, supervisors and senior executives shall bear the liability for compensation.

Article 232 Where a company is dissolved according to the provisions of Item (I) (II) (IV) or (V) of Paragraph 1 of Article 229 hereof, it shall be liquidated. The directors, who are the liquidation obligors of the company, shall form a liquidation group to carry out liquidation within 15 days from the date of occurrence of the cause of dissolution.

The liquidation group shall be composed of the directors, unless it is otherwise provided for in the company’s articles of association or it is otherwise elected by the shareholders’ meeting.

The liquidation obligors shall be liable for compensation if they fail to fulfill their obligations of liquidation in a timely manner, and thus any loss is caused to the company or the creditors.

The 2023 PRC Company Law further clarifies the scope of compensation liability of the Directors and Officers through Article 51, Article 53, Article 163, Article 211, Article 226 and Article 232.

Article 51 stipulates the capital adequacy responsibility of the board of directors revealing the directors’ fiduciary duty to creditors and granting the board of directors the right to call up capital contributions. The board of directors are required to verify the details of and call up shareholders’ capital contributions. Failing to perform such obligation would results in liability for compensation.

Article 53 underlines the system of illicitly withdrawing capital contributions, extending a single shareholder's liability for compensation to Directors and Officers. It also provides that the liability shall be jointly and severally borne by the Directors and Officers and the shareholders.

Directors’ and Officers’ liability could also be seen in Article 163, Article 211, Article 226, and Article 232 which respectively refer to the circumstance in which the Directors and Officers are responsible for (1) providing financial aid for any person obtaining the company shares, (2) illicitly distributing profits, (3) illicit capital reduction and (4) failure to fulfill the obligations of liquidation in a timely manner. The 2023 PRC Company Law, through reinforcing the obligations and liabilities of Directors and Officers, promotes the alignment between their management rights and duties.

Article 191 Where any director or senior executive causes any damage to any other person in the performance of duties, the company shall be liable for compensation. If any director or senior executive is intentional or grossly negligent, he/she shall also be liable for compensation.

Whilst the 2018 Company Law only stipulates compensation liability to the company for damages caused by Directors and Officers in their performance of duties, it lacks remedy provisions for third parties whose interests were infringed upon by the Directors and/or Officers. According to Article 191 of the 2023 PRC Company Law, Directors and Officers shall be liable for damages caused to third parties by intentional or gross negligence when performing their duties, which provides a remedy for harms caused to third parties.

D&O Insurance Policy usually excludes intentional acts of the insured individual through the “confirmed illegal acts” clause. However, acts with gross negligence are not included in the Exclusion Clause, i.e., where the insured acts with gross negligence, that commonly triggers compensation liability under the policy.

The promulgation of the 2023 PRC Company Law has significantly increased the duty of diligence of Directors and Officers and, consequently, the probability of D&O Insurance claims. It is advisable for insurance companies to conduct further investigations on related issues arising accordingly.

Additionally, insurance companies require more considerations when designing D&O Insurance Policies in light of the obligations borne by the Directors and Officers. For instance, the board of directors’ capital adequacy responsibility stipulated in Article 51 of the 2023 PRC Company Law reflects directors’ fiduciary duty to creditors and grants the board of directors the right to call up capital contributions. Failure to perform this duty, to verify and call up the capital contributions, will result in compensation liability.

Whether the insured is obliged to promptly inform the insurer of any significant increases in underwriting risks is to be considered when the Insurance companies are designing D&O Insurance Clauses in accordance with the 2023 PRC Company Law; a case in point would be a shareholder delaying payment after the board of directors calls up capital contributions.

Article 189 Where any director or senior executive is under the circumstance as mentioned in the preceding Article, the shareholders of a limited liability company or the shareholders of a joint stock limited company separately or aggregately holding 1% or more of the total shares of the company for 180 consecutive days or more may request the board of supervisors in writing to initiate a lawsuit in the People’s court. If any supervisor is under the circumstance in the preceding Article, the aforesaid shareholders may request the board of directors in writing to file a lawsuit with the People’s court.

Where the board of supervisors or the board of directors refuses to initiate a lawsuit after it receives a written request of the shareholders as mentioned in the preceding paragraph, or fails to file a lawsuit within 30 days upon receipt of the request, or in an emergency, the failure to initiate a lawsuit immediately will cause irreparable damage to the interests of the company, the shareholders in the preceding paragraph shall have the right to directly initiate a lawsuit in the people’s court in their own name for the interests of the company.

If others infringe upon the legitimate rights and interests of a company and cause losses to the company, the shareholders stipulated in the first paragraph of this Article may initiate a lawsuit in the people’s court in accordance with the provisions of the preceding two paragraphs.

If a director, supervisor or senior executive of a wholly-owned subsidiary of the company is under the circumstance specified in the preceding Article, or if the legitimate rights and interests of a wholly-owned subsidiary of the company are impaired by any other person, thus causing any losses, the shareholders of a limited liability company or shareholders of a joint stock limited company separately or aggregately holding 1% or more of the total shares of the company for 180 consecutive days or more may request the board of supervisors or the board of directors of the wholly-owned subsidiary in written form to initiate a lawsuit in the people’s court or directly files a lawsuit with the people’s court in their own name.

Article 189 Clause 4 of the 2023 PRC Company Law establishes the dual Derivative Action system, expanding the scope of the defendants in the derivative action to the directors and senior executives of the company’s wholly-owned subsidiaries.

In view of the common practices of D&O Insurance policies, the parties included within a subsidiary relationship are usually companies wholly controlled by the insured company. In the prevailing D&O Insurance policies, the definition of “Insured Company” comprises any subsidiaries of the insurance applicant, and accordingly, the “Insured Individual” also comprises the Directors and Officers of any subsidiary of the insurance applicant. In accordance with the dual Derivative Action system, Directors and Officers of a wholly-owned subsidiary may also serve as the defendants in a claim, which may trigger insurance liability under the policy and expose the insurer to higher underwriting risks.

VII. Cross-claims between Insureds

As mentioned above, in accordance with Article 51, Article 53, Article 163, Article 211, Article 226 and Article 232 of the 2023 PRC Company Law, the insured Directors and Officers will be liable for the losses caused to the company due to their breach of duties. Disputes concerning compensation between a company and its Directors and Officers constitute “a cross-claim between the insured”, typically considered an “exclusion” under the D&O Insurance in the common law system. It usually refers to the lawsuit brought by a company against its Directors and Officers, or that between directors and senior executives, who are the insured individuals. The foregoing claims can be excluded from the policy coverage so as to prevent malicious collusion between the insured parties to harm the interests of the insurer.

However, there is usually no explicit term excluding cross-claims between the insureds in domestic D&O Insurance policies.

In view of the potential risks posed by “cross-claims between the insureds” to the insurer, it is advisable to draw on the experience of the Common Law system when drafting the policies, and to negotiate with the insurance applicant to include such exclusions in the insurance contract. It is noteworthy that, with respect to the potential risk of malicious collusion and conspiracy between the insured parties, Article 154 of the Civil Code prescribes that where a person colludes with his counterparty to perform an act impairing another’s legitimate rights and interests, such act shall be null and void. Therefore, even without explicitly excluding such risk, the insurer may contend that there is malicious collusion between the insurance applicant and the insureds to impair the insurer’s interests and thereby such act shall be deemed invalid.

VIII. Development and Solutions of D&O Insurance Terms under 2023 PRC Company Law

With the adoption and implementation of the 2023 PRC Company Law, Directors and Officers are held to a higher standard of liability. As the first law of its kind, the D&O Insurance system has actively responded to market demands through providing a protective mechanism for companies and their Directors and Officers, facilitating modern corporate as well as governance standards. The domestic market is increasingly cognizant of the significance of D&O Insurance.

The 2023 PRC Company Law clearly defines the duty of loyalty and diligence of Directors and Officers and enumerates the related parties’ transactions, affording insurance companies up-to-date knowledge on the duties and obligations of their Directors and Officers. Consequently, it tenders more prudent coverage advice and reasonable assessments during the process of underwriting, policy issuance, and claims handling.

The expanding insurance coverage and increasing underwriting risks arise coupled with the amendments on Directors’ and Officers’ duties and obligations, such as (1) the underlining duty of performance, (2) the refinement and expansion of Directors’ and Officers’ liabilities, (3) the establishment of the dual Derivative Action System, and (4) the breakthrough legislation of the D&O Insurance System. Therefore, insurers shall be equipped with higher professional capabilities and risk awareness in the process of negotiation, assessment, verification, underwriting, claim settling, and pursuing subrogation. Faced with an evolving D&O Insurance market, insurers are encouraged to make flexible adjustment on underwriting conditions, develop insights in accordance with commercial changes, reasonably balance risks and interests, and be better positioned to recognize and seize business opportunities.

In terms of policy design, insurance companies can employ several approaches to enhance their risk assessment capacity:

1)    Multi-dimension assessment, as well as quantification of policy terms.

2)    Explicit definitions and detailed expressions.

3)    Related experience leveraging from international insurers.

Meanwhile, exclusion clauses shall be utilized to balance the interests and risks between the insurers and the insureds. Namely, an insurance company may consider the drafting of clauses from the following perspectives:

1)    The coverage of the insureds.

2)    The definition of shadow directors or de facto director.

3)    The standards for related-parties transactions.

4)    The standards for identifying intentional acts.

5)    Adjustment regarding exclusion clauses and limitation of liability clauses.

6)    Inclusion of acts with gross negligence in the exclusion clauses.

7)    Inclusion of cross-claims between the insureds in the exclusion clauses.

8)    Distinctive protection methods for D&O.

The promulgation of the 2023 PRC Company Law creates a great opportunity for D&O Liability Insurance, by virtue of the extension of the coverage to include non-listed companies. Currently, the domestic insurance market predominantly offers D&O Liability Insurance tailored for listed companies, with a limited range of specialized products available for non-listed companies. The revision of the 2023 PRC Company Law, particularly its enhancement and clarification of directors’ liability for both listed and non-listed companies, fosters a conducive environment for the growth and success of insurance companies offering D&O Liability Insurance in China.

In response to the evolving business landscape and market demand, the legislation governing D&O Liability Insurance, as a special risk mechanism, provides comprehensive risk protection for companies, their directors, supervisors and senior executives. Furthermore, it incentivises transfer of management risks and consolidates sound corporate governance standards, and stabilises the market.

Given the existing legal framework and socioeconomic conditions, the adaptations and innovations of the D&O Liability Insurance system are expected to amplify its relevance and impact in the Chinese market. We eagerly anticipate the timely introduction of market-adapted D&O Liability Insurance products that align with domestic conditions and laws.

Authors : Hao Zhan, Jia WAN, Guangrui Cheng