ENFORCEMENT

Part TwoLIU ZhenzhenMay 30, 2014

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Content

Section 1 General IntroductionSection 2 Outside Director LiablitySection 3 Shareholder Derivative SuitsSection 4 Conclusion

Reference:

Outside Director Liability Across Countries (P140)

Why Do Shareholder Derivative Suits Remain Rare in Continental Europe? (P150)

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Section 1 General Introduction

Corporate Law: Encourage investment and protect shareholder

Agency: Shareholder v.s. Director

Enforcemet of Corporate Law: How to motivate the Director to act in the Shareholder's interest?

Director: Legal Liabilty

Shareholder: Shareholder Suits

ShareholderPrincipal

DirectorAgent

Agency

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Section 2 Outside Director Liablity

Director

Inside Director

Directors who are also executives.

Outside Director v.s. Independent Director

Outside Director: Directors who are not excutives.(Non-Executive Director)

Independent Director: Almost the same as Outsider Director, but not allowed to own shares of the company.

Outside Director Liability

Content: Fiduciary Duty

Consequence for Breach of Fiduciary Duty

A lawsuit could oblige outside directors to pay damages or legal fees out of their own pocket.

Aim: To make outside directors work hard and pay attention

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Empirical Study on Outside Director Liability

Scope of Research

Country Feature

U.K. The role of outside director is highly debated.

Germany

1. To explore how director liablities in a civil law country

2. To assess the impact of formalizing the role of outside directors through a two-tier board structure

Australia

CanadaCommon law jurisdiction

France

JapanCicil law jurisdiction

South Korea Emerging market country

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Empirical Study on Outside Director Liability

Findings In practice, the legal liability outside director faces rarely lead to personal payments.

Suits could pose the risk of an out-of-pocket payment. Shareholder Suits: Private Enforcement Public-minded Litigation: Public Enforcement

However, in most cases, D&O Insuranace is sufficient to cover legal expenses and damages.

Practical Outcome & Analysis "Functional Convergence"on low (but non-zero) risk Can the low liability risk motivate outside directors to be vigilant?

The reputational concern Public-minded litigation

When a governmental agency brings a civil lawsuit. A tiny risk of criminal prosecution for outside directors Procedural Consideration: The "American Rule"

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Theoretical Pros and Cons of Outside Director Liablity

Outside Director Liability

Substantial Risk

Prons Motivate the outside director to be more attentive

ConsDirectorship: decline

Decision-making: counterproductively cautious

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Section 3 Shareholder Suits: Private Enforcement

Shareholder Class Action

A lawsuit brought for personal claims of all shareholders.

Shareholder Derivative Suit

A lawsuit brought by a shareholder on behalf of a corporation against a third party.

Often, the third party is an insider of the corporation, such as an executive officer or director.

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The Scarcity of Shareholder Derivative Suits in Continental Europe

The small number of derivative suits in Continental Europe is often seen as a reason why corporate law is considered under-enforced in these jurisdictions.

But the author suggests that

There is a significant degree of enforcement through channels of corporate law, beyond enforcement derived from derivative suits.

If a legal system discourages derivative suits, disgruntled shareholders will take the "Path of Least Resistance" and resort to other enforcement mechanisms.

Scarcity of Derivative Suits Under-enforcement of Corporate Law?

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Explanations for the Absence of Derivative Suits

Four Necessary Criteria

1. Minimum Share Ownership Requirements

2. Costs and the Allocation of Litigation Risk

3. Access to Information

4. Limitations regarding Potential Defendants

Anna Karenina Principle

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1. Minimum Share Ownership Requirements

Assumption (Europe)

The incentive for a shareholder with a small amount of shares to bring a legitimate suit is very likely small.

Legitimate motives

The benefits of the lawsuit multiplied by the probability exceed the costs of litigation, including nonmonetary cost.

Percentage Limits (A major hurdle)

Particular percentage: 1%, 5%, 10%…

Pros: A screening mechanism against abusive lawsuits

Cons: Preclude some legitimate suits

USContinental E

urope

No ownership requirements

A qulified percentage of the company's share

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2. Costs and the Allocation of Litigation Risk

Law Firm Driven Litigation in the US

Rational Person: Benefit-Cost Analysis

Individual shareholders have little incentive to sue, because

The advantage is small.

The potential cost is substantial.

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2. Costs and the Allocation of Litigation Risk

Legal Rule controlling assessment of attorney's fees arising out of litigation

The "American Rule"

US: Each party pays its own cost regardless of the outcome.

The "English Rule"/The "Loser Pays" Principle

European Countries: The losing party has to reimburse the winning party for litigation costs.

Contingency Fees

US: Contingency fees.

European Countries: Contingency fees are uncommon and illegal.

Requirements to advance court fees

European Countries: High up-front fees

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3. Access to information

If meeting the burden of proof is extremely difficult for shareholder plaintiffs, the litigation cost rules may not be enough to encourage suits.

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4. Limitation Regarding Potential Defendants

European Countries

Possible Continental European derivative suits are limited to directors, corporate officers, auditors and the founders of the corporation.

The opportunity to engage with controlling shareholders is therefore limited.

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Do We Need Derivative Litigation?

Inquiry Proceedings

Shareholder

Derivative Suits

Path of Least Resistance

Nullification Suit

Criminal Investigation

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Why Do Shareholder Derivative Suits Remain Rare in Continental Europe?

A summary of reasons

The shareholder with a small amount of shares is not qualified to bring a lawsuit due to the percentage limit.

Since the losing party has to reimburse the winning party for litigation costs, shareholders are not willing to taking the risk of having to pay for the defendants' fees.

Meeting the burden of proof is extremely difficult for shareholder plaintiffs

The potential defendants are limited.

Shareholders take the "Path of Least Resistance" and resort to other enforcment mechanisms.

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Section 4 Conclusion

Outside Director Liability

It's a mechanism of public enforcement when a government agency brings a civil lawsuit against a director.

It's a mechanism of private enforcement when the shareholders bring a suit against a director.

"Functional Convergence" on low (but non-zero) risk is the order of the day for outside directors' personal liability.

Shareholder Derivative Suits

It's a mechanism of private enforcement.

It's arbitrary to conclude that corporate law is inadequately enforced in Continental Europe based on the sparse use of derivative suits.

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The End.

Thanks for Your Attention!