The duty of loyalty in China’s corporate law differs significantly from the law of other countries. As in other jurisdictions, the duty of loyalty in China requires directors to place the interests of shareholders before their personal and financial interests. But what counts as a prohibited conflict of interest uses extremely local definitions.
There are many common Chinese business practices that are now explicitly listed by the 2023 Company Act as unlawful, opening the door to litigation.[1] Moreover, the main rules were left deliberately vague in a way that could result in many other practices being arbitrarily declared illegal by individual local judges. The liability for a violation is for directors and officers to disgorge the illegal profit or be held personally liable for the company’s debts. Overall, managing risks related to the duty of loyalty in China is made difficult for both investors and executives due to how much authority is vested locally, and how the law is rapidly evolving in an effort to modernize the country’s corporate governance landscape.
In this CBL explainer, we will go over several competing theories of how to determine whether a breach occurred. We will look at a series of cases that identify what common business practices judges now find to constitute a breach, and introduce strategies to manage these risks.
Contents
- The Law is Highly Ambiguous
- Statutory Non-Exculpable Misconduct
- Exceptions to the Duty of Loyalty
- Conclusion
The Law is Highly Ambiguous
Different courts may apply different rules because the standard to determine the duty of loyalty breach is ambiguous in China. The 2023 Company Act § 180(a) identifies conflicts of interest and self-dealing as the two elements for duty of loyalty breach determination.[1] However, there is no doctrine that applies in specific cases. Chinese academic commentary has proposed three theories to apply these elements, any of which may be plausibly adopted by the courts:
- A two-factor test that looks for both conflict of interest and self-dealing. A breach of duty of loyalty requires both a failure to reasonably avoid conflicts of interest and the ultimate receipt of improper benefits.
- A personal financial benefit approach that turns on whether the director or officer obtained an improper personal benefit rather, not accounting for avoidance of conflicts of interest.
- An either-or approach that allows finding a breach for conflict of interest or self-dealing.
Attorneys in China expect courts to use the personal financial benefit test, because compared to other approaches, it’s more logical and easier to apply. By contrast, the two-factor approach requires both a conflict of interest and self-dealing, which conflicts with the legislative intent of § 181 and can make breach determinations complicated. § 181 expressly defines prohibited acts by directors and officers, which enacts a legislative intent to preclude separate analysis into whether a conflict existed.
Although the either-or test has received some academic support, it is often impractical to prove whether a director or officer took sufficient action to avoid conflicts of interest. Even if that can be shown, relying on the mere existence of a conflict in itself to determine a violation can make it hard to show liability. The personal financial benefit test is more persuasive because it centers on the damages; a harmless conflict with the company should not, by itself, amount to a duty of loyalty violation. The key consideration is whether the director or officer used their position to obtain an improper personal benefit at the company’s expense.
Drawing the line on when a director or officer crosses into abusing their authority for personal benefit can be complicated. Fortunately, CBL offers affordable managed legal services to help you navigate these issues.
Statutory Non-Exculpable Misconduct
Unexpected liability occurs under the duty of loyalty in China because some breaches cannot be disclaimed through governance documents. China’s 2023 Company Act § 181 provides the non-exculpable misconduct for directors and officers.[1] The following shows what the outlined misconduct is and how it can be presented in real life.
Misappropriation. Intentionally converting company assets for personal use is non-exculpable misconduct because it directly harms the company.
For example, in Yunnan Appeal 01-cv-1048 (2025), the Kunming appellate court held that Zhao, an officer, misappropriated company funds, breaching her duty of loyalty. Zhao deposited funds into the company’s account while labeling them as “investment,” “wealth management,” or “custody” funds, and later withdrew the money as “petty cash” to her personal account. Here, the court applied § 181(a), which provides a director or an officer owes a duty of loyalty to the company and must not misappropriate the company’s assets. Petty cash is intended for small, routine business expenses and is not appropriate for large expenses or non-business purposes. Therefore, Zhao caused loss to the company, misappropriating the company’s assets.
Commingling funds. This prohibition aims to keep company funds separate and prevent directors and officers from misappropriating funds by depositing them into personal accounts.
For example, in Shannxi 0113-cv-18448 (2024), the court found Yang, an officer, violated his duty of loyalty and held him personally liable for the company’s debts. As a statutory representative, Yang deposited funds belonging to the company into his personal account instead of the company’s account. The court applied § 181(b), which explicitly prohibits directors and officers from commingling company funds with personal funds, finding this was commingling that harmed creditor interests. Therefore, he was held personally liable for the company’s debts.
You can learn more about the risks of directors using personal accounts for company fund in our guide to preventing D&O theft and abuse of authority.
Kickbacks. Exploiting a position for kickbacks or other illegal gains is an abuse of corporate authority and therefore constitutes non‑exculpable misconduct that cannot be disclaimed by company governance documents.
Commissions. Collecting transaction commission without company authorization is non-exculpable misconduct because the loyalty of the officer representing the company may be compromised by their personal financial gain, harming the company. In China, transaction commissions often take the form of finder’s fees, secret profits, or kickbacks that should otherwise belong to the company.
In Hebei Appeal 06-cv-8642, the appellate court held Wang, an officer, breached his duty of loyalty by collecting unauthorized transaction commissions, failing to act in the company’s best interests. Wang, an executive, oversaw procurement for two projects. As the head of procurement, he was expected to do market research, select suppliers, and negotiate pricing to get a better deal.
Here, the court applied the China Company Act § 181(d), under which D&O may not personally collect unauthorized transaction commissions.[1] They must exercise their fiduciary duties with due diligence and in the best interests of the company when performing assigned responsibilities under § 180(b). Wang’s actions amounted to violation of his fiduciary duties because he omitted those steps and made both purchases through the same broker, resulting in inflated prices paid by the company and causing losses. Therefore, he failed to discharge the professional duties required of the head of procurement and did not act in the company’s best interests.
Confidentiality. Disclosing trade secrets without company authorization is non-exculpable because trade secrets are intangible company assets that derive independent economic value from not being known. D&Os who disclose them can thus undermine the company’s competitive advantage and directly or indirectly harm the company’s interests.
In Jiangsu Appeal 13-cv-3269 (2024), the Suqian appellate court held that officer Song disclosed Company A’s trade secrets. Unauthorized disclosure of trade secrets by a director or an officer constitutes a breach of the duty of loyalty under § 181(e). Song left his position as the Chief Operating Officer of Company A to form Company B in the same line of business as Company A. Company B later entered into a business agreement with another company on terms identical to a separate agreement between Company A and a Hunan company, following which Company A alleged that that Song breached the NDA he had signed with Company A. The court concluded that Song’s breach constituted disclosure of Company A’s trade secrets.
Exceptions to the Duty of Loyalty
Generally, the duty of loyalty isn’t breached if directors and officers don’t use the position for private gain. Even if some acts superficially resemble the non-exculpable misconduct outlined in § 181, the court will review whether the company’s interest was ultimately harmed. Below, we’ll go over what is excepted from the definition of non-exculpable misconduct, its specifics, and the applicable judicial precedents to help directors and officers identify what is not a breach of duty of loyalty.
Use of company funds in good faith. Directors and officers using company funds do not breach the duty of loyalty if they lack intent to misappropriate and the use does not harm the company’s interests.
In Guangdong case 0606-cv-5635 (2024), the court held that D&O conduct did not constitute a duty of loyalty breach by misappropriating company funds. D&O transferred company reserves to an investee company as a capital contribution. The court applied the China Company Act § 181(a), under which misappropriation of company assets is non-exculpable misconduct.[1] The court concluded this was not misappropriation or a breach of the duty of loyalty, reasoning the company owns an interest in the investment and there was no evidence it caused loss. Therefore, the transfer was not non-exculpable misconduct under § 181(a).
Authorized commingling. D&O use of a personal bank account payments for company business use does not constitute a breach of the duty of loyalty, assuming the company knew about it.
In Guangdong 0106-cv-26177 (2018), the court held that directors and officer did not violate their duty of loyalty by using personal accounts for business payment. § 181(b) prohibits D&O from commingling company funds with personal funds and treats it as a duty of loyalty breach. In this case, however, there was no evidence that the executive intended to misappropriate company funds, and such use of personal accounts was expressly authorized by the company. The court concluded such use of personal bank accounts for business payments was not non-exculpable misconduct under the China Company Act.[1]
Lawful commissions. Commissions earned under a lawful agent-principal contract are not commercial bribery.
In Liaoning Appeal 02-cv-4588 (2020), the court found the contract was valid, rejecting the appellant’s arguments that the defendant lacked a brokerage business license and commission exceeded statutory limits. China’s Contract Act recognizes agent-principal contracts, and commission payments are not conditioned on licensing.[2] The court considered a contract under which the agent would refer or broker contracting opportunities for the principal, for a commission on success. It held that the China Antitrust Act and the Commercial Bribery Temporary Procedures cited by the appellant regulate commissions in those contexts and do not apply to agency commissions under contract law. It further concluded that the Business Income Tax Deduction Rules cited are administrative tax regulations and therefore irrelevant to the enforceability of the commission in the appeal.[3][4][5] Therefore, the contract and commission earned were both legal.
Commissions consented. Commissions accepted with the company’s informed consent are treated as employee compensation and a lawful disposition of company assets.
In Anhui 0303-cv-2545 (2018), the court held that directors and officers receiving commission pay did not equal receiving undisclosed commissions obtained by exploiting a corporate position. China Company Act § 181(d) prohibits directors and officers from receiving secret transaction commissions.[1] The court found that companies commonly use compensation structures consisting of base salary plus incentives, and that incentives are additional compensation paid on top of base salary, typically tied to specific sales targets. Therefore, it held that such D&O receipt of incentive compensation was not non-exculpable misconduct under § 181(d).
Unprovable trade secret misappropriation. A former D&O working for a competitor is only deemed to have misappropriated trade secrets if the company’s Articles had a non-compete, or they exploited them.
In Shanghai Appeal 2212 (2015), the court held that a former director joining a competitor did not misappropriate the former employer’s trade secrets. Directors and officers disclosing company trade secrets without authorization is prohibited as a duty of loyalty breach under § 181(e). In this case, however, the former employer could not prove the director used the company’s trade secrets or IP after departure, nor did it have non-complete obligations in its governance document. China also does not apply the inevitable disclosure doctrine, which permits the plaintiff to establish threatened misappropriation by showing that the former employee’s new employment will inevitably lead the defendant to rely on the plaintiff’s trade secrets for trade misappropriation claims.
Therefore, the former director’s joining a competitor did not breach any non-complete obligation or constitute misappropriation of the former employer’s trade secrets.
Conclusion
Duty of loyalty breaches under the China Company Act revolve around conflicts of interest and self-dealing. Given the realities of D&O misconduct and the legislative intent of the Act, its reasonable interpretation is that the duty of loyalty is violated when corporate authority is used to obtain an improper personal benefit. Consequently, avoiding non-exculpable D&O misconduct liability requires observing the prohibitions in § 181, including avoiding misappropriation of company assets, channeling cash flows legitimately, separating company and personal bank accounts, not taking secret profits from company transactions, and not misappropriating company trade secrets to support competing businesses.
In general, directors and officers must not commit any of the non-exculpable misconduct as outlined under § 181 for personal gain. In China’s daily business practices, some D&O acts might resemble the outlined misconduct, and they might thus be involved in a breach of fiduciary duty claim. To prevent this, directors and officers must always act in good faith and prioritize the company’s interests over personal gain.
If you have possible duty of loyalty related legal issues, you should consult a CBL legal expert to ensure they are handled appropriately.
FURTHER READING
Learn how to strategically prevent D&O theft and abuse of authority in China.
FOOTNOTES
[1] China Company Act (中华人民共和国公司法), (China National Congress, Dec. 29, 2023) (in Mandarin)
[2] China Contract Act (中华人民共和国合同法), (China National Congress, Mar. 15, 1999) (in Mandarin)
[3] China Antitrust Act (中华人民共和国反不正当竞争法), (China National Congress, Jun. 27, 2025) (in Mandarin)
[4] Commercial Bribery Temporary Procedures (关于禁止商业贿赂行为的暂行规定), (China National Administration for Industry and Commerce, Nov. 15, 1996) (in Mandarin)
[5] Business Income Tax Deduction Rules (企业所得税税前扣除办法), (China National Tax Administration, Sep. 27, 2006) (in Mandarin)