D&O Liability Insurance in China | Chambers Expert Focus (2024)

Directors’ and officers’ (D&O) liability insurance is still new to mainland China.Although it was introduced to China in the late 1990s, it did not appear to be important to many Chinese companies and the uptake was rather slow.Now the D&O market is set to boom due to changes in the legal environment.

In a civil judgment rendered by Guangzhou Intermediate Court in 2021, Kangmei Pharmaceutical (a well-known listed company in the PRC) as the defendant was ruled to compensate a total amount of RMB2,458,928,544 to 52,037 investors for its serious violation of PRC securities-related laws by disclosing fraudulent financial information to the public.Relevant senior management officers of Kangmei Pharmaceutical, responsible for the security-related misrepresentation, were held jointly liable for a certain percentage of the huge amount of compensation.This was the first judicial precedent of special representative action, which was newly adopted in the amendment of the PRC Security Law in 2020.Since this case, there has been a substantial increase in public attention to and market demands for D&O liability insurance, given the risk exposure demonstrated by the serious consequences of the Kangmei judgment in this securities-related claim.

Securities-related claims covered by D&O insurance are normally defined as any demand or civil, criminal, administrative, regulatory or arbitration proceedings alleging a violation of any laws or regulations relating to securities, the purchase or sale or offer or solicitation of an offer to purchase or sell securities, or any registration relating to such securities, brought by any person or entity alleging a violation arising out of, based upon or attributable to the purchase or sale, or offer or solicitation, of an offer to purchase or sell any securities of an insured company.

Under PRC law, the possible proceedings that might be covered by D&O insurance include:

The type of losses covered by D&O insurance may include any award of damages (including punitive and exemplary damages); an award of costs or settlement in respect thereof (including claimants’ legal costs and expenses); and costs arising from dealing with the claim, such as defence costs, investigation costs, crisis management costs, etc.

Prior to 2021, it was controversial whether fines imposed by a competent authority would be covered by D&O insurance.Although there were no clear laws or regulations at that time preventing the coverage of penalties by D&O insurance, there was concern about the moral risks arising from insurance covering the penalties of illegal activities.

The Supervisory and Administrative Measures of Liability Insurance (《责任保险业务监管办法》银保监办发[2020]117号, the “Measures”) issued by the China Banking and Insurance Regulatory Commission (CBIRC), the administrative authority of the insurance industry in the PRC, which took effect on 1 January 2021, set forth a clear rule for this question.Article 6 of the Measures provides that liability insurance is applied to cover the liabilities that the insured must legally assume for the losses caused by the insured to a third party, and the insurance company will strictly determine the coverage liability and will not cover certain risks or losses, including:

Since what the insurers may cover is governed by the Measures, insurers are required to refrain from covering criminal fines and administrative fines in compliance with the Measures.

The Measures issued by the CBIRC govern the activities of the insurance industry through supervisory authority.So far, there have been no civil judicial disputes of insurance contracts relating to the application of Article 6 of the Measures, nor any interpretation from higher level laws or administrative practice of Article 6 of the Measures by the CBIRC. In the absence of similar precedents, there would still be uncertainty regarding the court’s opinion of insurer’s grounds in rejecting the coverage of fines based on the Measures when the existing policy term clearly provides the coverage of such.It will be interesting to observe relevant future cases.

It is common in D&O insurance to exclude liability arising out of a dishonest or fraudulent act which is established by final binding adjudication or acknowledgment by the insured.It is hotly debated whether the security-related misrepresentation found by a binding adjudication falls within the exclusion of D&O insurance.

Considering D&O covers the liabilities arising from wrongful acts in violation of relevant laws, regulations or any occupational duties, it is more reasonable to interpret such exclusion as applying to the acts or omissions of the insured, with intention rather than by negligence or fault. If there are no clear findings that the insured individual responsible for the security-related misrepresentation committed such act or omission with sufficient knowledge of the falseness of the statement and subjective malice, it could be argued that there might not be a strong basis to apply such exclusion.

For insured companies, this could be even more complicated to determine, as a legal person does not have the ability to express its intention by itself. The expression of intention could be manifested by the behaviour of its legal representative, the management of the company or its staff. In practice, if there are no clear findings by an administrative or judicial authority of the subject malice of a company, there would not be sufficient basis to conclude that a company being punished for violation of laws due to the fault of its management has the same subject malice, solely based on finding subject malice in certain persons at management level, unless the internal governing structure of the company is unable to function properly so that the company is completely controlled by offenders of the law.