Article 171, Paragraph 1, Subparagraph 2 of the Securities and Exchange Act stipulates the offense of irregular transactions. Due to the inherently dynamic and unpredictable nature of commercial activities, the standard for determining what constitutes “irregular transactions” has long been a complex issue in both the academy and judicial practice. This article uses a well-known domestic medical device group’s share acquisition case as an example to illustrate how the courts assess whether a transaction is irregular.
Case Facts
In March 2017, Company A intended to acquire all shares of Company C held by Company B. At that time, the chairman of Company A instructed his staff to draft an equity investment analysis report for Company A's potential investment in Company C, and directed the company's accountant to assess the value of Company C based on the emerging stock market price. However, the report failed to disclose that Company C had overdue accounts receivable that had not been recovered.
Subsequently, Chairman X of Company A proposed two resolutions at the board meeting: amendments to the procedures for the acquisition or disposal of assets, and an increase in Company A's shareholding in Company C. Two independent directors of Company A raised concerns about the reasonableness of the acquisition price of Company C's shares, arguing that the transaction would harm shareholders' interests, and therefore opposed the resolutions. Nevertheless, both resolutions were ultimately approved by a majority vote of the board.
Meanwhile, the board of Company C, in violation of its articles of incorporation, passed a resolution allowing Company C's funds to be used as a guarantee for Company A, enabling Company A to secure a bank loan to finance the acquisition of Company C's shares. Following this, Company A successfully completed the acquisition. However, at the end of March 2017, Company C released a material announcement correcting its reported revenue figures. As a result, the market price of Company C's shares plummeted, causing Company A to suffer losses exceeding NT$300 million.
Court Opinions
The Criminal Judgement by Taiwan Taipei District Court No. 109-Jing-Zhong-Su-Zi-35, the Criminal Judgement by Taiwan High Court No.112-Jing-Shang-Zhong-Su-Zi-43 indicate that, in determining whether a transaction constitutes an irregular transaction, the following criteria should be applied:
- Whether the decision-making process complies with the laws and the internal corporate regulations: to protect the interests of shareholders and the company, Taiwan Company Act and Securities and Exchange Act impose numerous prohibitions and procedural requirements. These obligations—whether acts required or prohibited—are primarily imposed on directors and managers in the performance of their duties. Many of these requirements are explicitly set forth in statutes, administrative regulations issued by competent authorities, and internal corporate rules and procedures. The purpose of such legal and procedural norms is to prevent the company from entering into transactions with excessively unreasonable terms that could expose it to significant risks. Therefore, the first step is to assess whether the decision-making process undertaken by the company’s directors and managers complies with applicable laws and internal corporate governance standards.
- Whether the parties to the transaction engaged in fair and equal negotiations: if both parties act independently and in pursuit of their own interests, and engage in fair and equal negotiations over the terms of the transaction, then regardless of the final terms, the transaction should be considered as regular transaction. Conversely, if the terms are unilaterally dictated by one party, and the other party merely complies without meaningful input—effectively becoming a passive or subordinate participant in the transaction—then even if the final terms are not obviously unfavorable when compared to similar transactions, the lack of fair and reciprocal negotiation renders the transaction irregular.
Here, although both Company A and Company C formally amended relevant internal regulations through board resolutions in order to facilitate the acquisition of Company C's shares, these resolutions were in fact based solely on information unilaterally provided by Chairman X of Company A and Chairman Y of Company C (who concurrently served as a director of Company A). The other directors were not provided with sufficient information to conduct any substantive evaluation or due diligence. As a result, the amendments to the articles of incorporation and internal control procedures were made without a proper decision-making process. Moreover, because Chairman Y of Company C concurrently held a directorship in Company A, he was required to recuse himself during discussions of the relevant resolutions at Company C's board meeting but failed to do so. This procedural violation led to a monetary penalty imposed by the Financial Supervisory Commission, further indicating that the process deviated from standard practices.
Furthermore, despite being aware of concerns regarding Company C's overdue accounts receivable and the potential unreliability of market prices in reflecting the company's true value, Company A's board of directors nonetheless approved the acquisition. Such a transaction is inconsistent with regular business practices and is detrimental to the company's interests. Therefore, it should be concluded that Chairman X, Chairman Y, and certain other directors of Company A violated the applicable rules and procedures governing such transactions and have thereby committed the offense of irregular transaction under Article 171, Paragraph 1, Subparagraph 2 of the Securities and Exchange Act.
As illustrated above, in determining whether a transaction constitutes an irregular transaction under Article 171, Paragraph 1, Subparagraph 2 of the Securities and Exchange Act, the court in this case proposed relatively clear criteria—namely, the compliance of the decision-making process and whether the parties to the transaction engaged in fair and equal negotiations. Since irregular transactions frequently involve related-party transactions and special breaches of trust, it is essential that corporate management pay close attention to ensuring transparency and openness in the decision-making process, including the disclosure and avoidance of conflicts of interest. Furthermore, all actions should be in strict compliance with applicable laws and internal corporate regulations to mitigate legal and financial risks.
(The article is originally in Chinese which can be found here.)