Related Party Transactions: Company Act Compliance

An advertising agency owned by the spouse of your company chairman is preparing to take on your company's annual marketing project, with a contract value of NT$5 million. These transactions are frequent in small and medium-sized enterprises (SMEs). In the legal sphere, this is not an internal family matter of moving money from the left hand to the right hand. It is a 'related party transaction' that triggers high-level regulation under the Company Act. If the procedure is slightly flawed, the validity of the contract may be disputed, and the directors participating in the resolution may face liability for damages under Article 23 of the Company Act. In our experience assisting companies in establishing compliance processes, most disputes do not arise from the unfairness of the transaction itself, but from procedures that do not comply with the mandatory provisions of Articles 206 and 223 of the Company Act.

Neglecting the Duty to Explain and Recuse from Voting

When a board of directors discusses a proposal involving the interests of a director or the legal person they represent, that director cannot simply sit and listen. According to Article 206, Paragraph 2 of the Company Act, a director who has a personal interest in the matter under discussion at a board meeting shall explain the essential content of such interest at the meeting. This 'duty to explain' is the first step of procedural justice. If the director conceals that they are a major shareholder of the counterparty, or that the counterparty is a company managed by a relative within the second degree of kinship, the board resolution contains a procedural defect.

The core restriction lies in 'recusal from voting.' Article 206, Paragraph 3 of the Company Act applies Article 178 mutatis mutandis, stating that a director who has a personal interest in a matter that may be detrimental to the company's interests shall not participate in the vote, nor shall they exercise the voting right on behalf of another director as a proxy. The standard for judgment here is whether there is a 'risk of harm to the company's interests.' To ensure the stability of resolutions, AgreeGold suggests that whenever a related party transaction is involved, the interested director should recuse themselves, and their voting rights should not be counted in the resolution. If this provision is violated and a vote is forced, the resolution may be considered illegal, affecting the subsequent execution of the contract.

This recusal requirement affects the calculation of the quorum and the majority. Under Article 206, Paragraph 1, resolutions of the board of directors shall be adopted by a majority of the directors at a meeting attended by a majority of the directors. However, if a director is recused under Article 178, their voting rights are not counted toward the total voting rights of the directors present at the meeting. This means the threshold for passing the resolution must be met by the remaining eligible directors. If a board has five directors and two must recuse themselves, the resolution must be passed by a majority of the remaining three directors present. Failure to account for this math often leads to resolutions that appear to pass on paper but are legally invalid due to a lack of a valid majority.

Example Clause: The signing of this Contract was approved by a resolution of the Board of Directors of Party A on [Date]. The interested director, [Name], explained the essential content of the interest in accordance with Article 206 of the Company Act and recused themselves from the vote according to the law.

Using the Wrong Representative Signature on the Contract

A common pitfall for SMEs involves the signature block. Usually, company contracts are signed by the chairman on behalf of the company. When the counterparty is the chairman themselves or another company where the chairman serves as the person in charge, the situation changes. Article 223 of the Company Act explicitly states: 'In case a director of a company conducts a sale, a loan, or any other legal act with the company on their own behalf or for another, the supervisor shall be the representative of the company.'

This law prevents conflicts of interest caused by 'self-dealing' or 'representing both sides.' If your company's chairman signs a contract on behalf of the company with another company they manage, without a supervisor signing as the representative, the contract faces a 'lack of representative power.' According to Article 71 of the Civil Code, a legal act that violates a mandatory or prohibitive provision of the law is void. While some cases may allow for subsequent ratification, during contract performance, this becomes a fatal flaw that counterparties or other shareholders can use to claim the contract is void. If the company has an audit committee, the independent director members of the audit committee exercise the powers of the supervisor mutatis mutandis.

The requirement for supervisor representation is not optional. It applies regardless of whether the board has approved the transaction. Even with a unanimous board resolution, the chairman still lacks the legal power to sign a contract where they are the counterparty or represent the counterparty. This is a common point of confusion. Many managers believe that board authorization overrides the need for a supervisor's signature. Article 223 is a mandatory rule of representation, not a rule of internal authorization. A contract signed by the chairman in violation of Article 223 is technically 'unauthorized representation' under Article 170 of the Civil Code, meaning it does not bind the company unless the company (through the supervisor) later ratifies it.

Example Clause: The representative signatory for Party A (the Company) shall be the Supervisor, [Name], representing Party A in signing this Contract with Party B (the interested party) pursuant to Article 223 of the Company Act.

Ignoring Personal Liability for Illegal Board Resolutions

If the procedure for a related party transaction is non-compliant, it is not just the contract's validity at risk; the directors' personal assets are also on the line. Article 193, Paragraph 1 of the Company Act stipulates that the board of directors shall carry out business in accordance with laws, regulations, the articles of incorporation, and resolutions of the shareholders' meeting. If a resolution of the board of directors violates the law and causes damage to the company, the directors who participated in the resolution are liable to the company for damages. This means if the company procures at a price higher than the market rate due to a failure to recuse, or if a contract is declared void and prepayments cannot be recovered, shareholders can file a lawsuit against these directors under Article 214 of the Company Act.

Article 23, Paragraph 1 of the Company Act states that the responsible person of a company shall conduct business faithfully and exercise the due care of a good administrator. If they violate this and cause damage to the company, they are liable for compensation. In related party transactions, if a director sacrifices the company's interests for private gain, they violate this 'fiduciary duty.' This liability is personal and unlimited, not limited to the amount of their capital contribution. Therefore, during the contract review stage, ensuring that the minutes of the meeting fully record the process of explanation and recusal is a necessary means to protect directors from legal prosecution.

We observe that many directors assume they are protected if they follow the majority. However, Article 193, Paragraph 2 provides that directors who express their dissent, as proven by the minutes or a written statement, are exempted from liability. Silence is not dissent. If a director is present and does not object to a procedurally flawed related party transaction, they are legally deemed to have participated in the illegal resolution. The burden of proof shifts to the director to show they either dissented or were not present. For the directors who are interested parties, the burden is even higher; they must prove they fulfilled the disclosure requirements of Article 206. If the minutes are silent on the 'essential content' of the interest disclosed, the disclosure is legally insufficient.

FAQ

Do transactions with a director's spouse or children count as related party transactions

While Article 206 of the Company Act primarily regulates the 'personal' interests of directors, if a director's spouse, a blood relative within the second degree of kinship, or a legal person controlled by the director enters into a transaction with the company, it is generally identified as a 'personal interest.' This is because the interests of these parties overlap significantly with the director's personal interests. If explanation and recusal are not performed, it easily constitutes an infringement on the company's interests. We suggest clearly defining the scope of related parties in internal regulations, including the director's spouse and minor children, to comply with the spirit of information disclosure in Article 206, Paragraph 4 of the Company Act.

What if the company has only one director and no supervisor

According to Article 128-1 of the Company Act, a business corporation organized by a single institutional shareholder may elect not to have a board of directors or a supervisor. In this case, the powers of the board are exercised by the director, and the recusal provisions for board meetings do not apply. However, if a standard SME has only one director but has a supervisor, the supervisor must still represent the company when that director transacts with the company. If no supervisor is appointed (as in some closed corporations), the matter should be referred to a shareholders' meeting resolution or handled according to the articles of incorporation to ensure the fairness of the transaction procedure.

Is the supervisor's representation a right or an obligation

This is a mandatory representative power stipulated by law. The legislative intent of Article 223 of the Company Act is to prevent fraud. Therefore, as long as the elements of 'a director performing a legal act with the company for themselves or others' are met, the supervisor 'must' come forward to represent the company. This is not something the chairman can authorize or assign to someone else. If the contract is stamped with the company's official seal and the chairman's personal seal instead of the supervisor's personal seal, the contract contains a procedural flaw that cannot be waived by board authorization.

Can a later board resolution fix a procedural defect

If a related party transaction is conducted without a prior board resolution or supervisor representation, the legal act is 'pending effectiveness.' According to Article 170 of the Civil Code, a legal act performed by a person without the power of representation in the name of a principal is not effective against the principal unless ratified by the principal. The company can rectify this by holding a board meeting and having the supervisor ratify the signature. It must be noted that before ratification, the contract is not legally binding on the company. If the ratification process still fails to comply with recusal rules, the ratification resolution itself faces the risk of being illegal.

Does the price of a related party transaction have to be exactly the market price

The law does not mandate that the price must be identical to the market price, but it requires that it be 'fair and in the company's interest.' The duty of care of a good administrator required by Article 23 of the Company Act means that directors must have a reasonable business reason to explain why this counterparty was chosen. If the price is higher than the market price, they must explain if there is other added value, such as technical uniqueness or delivery guarantees. If there is no justification and it is clearly unfair, the directors participating in the resolution face risks of breach of trust under Article 342 of the Criminal Code or liability for damages.

Related Party Transaction Compliance Checklist

• Verification of Counterparty Identity: Confirm whether the contract counterparty is a company director, a director's spouse, a blood relative within the second degree of kinship, or a legal person substantially controlled by the aforementioned persons. If any of these apply, immediately initiate the related party transaction review process.
• Completeness of Board Disclosure Records: Check whether the board minutes clearly state that the interested director has explained the 'essential content' of their interest, such as shareholding percentage, transaction consideration, and the necessity of the transaction, rather than just recording 'recused according to law.'
• Verification of Voting Count Deduction: Verify the number of attendees and the number of voters in the board resolution. Confirm that the interested director was not included in the count of voting rights and that the remaining attending directors still meet the statutory quorum and majority requirements of Article 206 of the Company Act.
• Confirmation of Supervisor Representation: Check the representative signatory of the company on the last page of the contract. Ensure it is signed and sealed by the supervisor (or an independent director designated by the audit committee), rather than the chairman or a manager who has a conflict of interest.
• Retention of Fairness Evidence: Ensure the contract attachments include market price comparison sheets, independent expert valuation reports, or internal evaluation reports to prove that the transaction complies with the duty of care of a good administrator under Article 23 of the Company Act.