November 2022
Yanting Pei and Teresa Huang
In the course of dispute resolution, a creditor may be confronted with a situation where the corporate debtor is unable to repay its debts. In this case, can the creditor hold the shareholders of the company liable as well? This still depends on whether there is any contractual or legal basis for holding the shareholders liable.
From the contractual point of view, this depends on the agreement between both parties, such as whether the shareholders are required to provide a guarantee when the contract is signed or whether they are also a party to the contract. In the absence of a relevant agreement, this can only depend on the legal basis.
From the legal perspective, this mainly depends on two scenarios. Firstly, if the company shareholders have not yet completed the capital contributions, if the creditor can hold the shareholders liable for the capital they are yet to contribute can be considered. Secondly, it is possible to consider if the corporate personality can be denied.
1. Requesting the shareholders who have not completed the capital contribution to assume part of the liability
Pursuant to Article 22 of the Provisions of the Supreme People’s Court on Specific Issues Concerning Application of the Company Law of the People’s Republic of China (II) (hereinafter, “Judicial Interpretation II”), Articles 13 and 14 of the Provisions of the Supreme People’s Court on Specific Issues Concerning the Application of the Company Law of the People’s Republic of China (III) (hereinafter, “Judicial Interpretation III”), and Article 35 of the Enterprise Bankruptcy Law, a creditor may request the shareholders of the debtor to assume joint and several liability or supplementary liability for the unsatisfied portion of the company’s debts within the principal and interest of the capital the shareholders have not contributed under the following circumstances:
(1) The shareholders have not paid up their capital contributions (including those that have and have not expired) at the time of liquidation for the company’s dissolution or bankruptcy.
(2) The shareholders have not fulfilled or have failed to fully fulfill their capital contribution obligations.
(3) The shareholders have withdrawn their contributed capital (only with respect to the principal and interest of the withdrawn contributed capital).
According to the explanation in the Several Specific Issues of the Supreme People’s Court on the Current Trial of Commercial Cases, if a shareholder fails to pay the capital contribution because the capital contribution payment period has not expired, this is not covered by the scenario under Judicial Interpretation III where the shareholders have not performed or have failed to fully perform their capital contribution obligation. Therefore, the Minutes of the National Courts’ Civil and Commercial Trial Work Conference (Fa [2019] No. 254) (hereinafter, the “Minutes”) also further clarified that in a case where the shareholders’ capital contribution period has not expired, a creditor cannot request the shareholders to assume supplementary liability within the scope of the capital contribution they have failed to paid on the ground that the company cannot settle its debts as they fall due, except for the following circumstances:
(1) In a case in which the company has satisfied the criteria for bankruptcy but fails to file for bankruptcy, the company is the object of enforcement and the people’s court has exhausted the execution measures with no property available for enforcement.
(2) After the company’s debt is incurred, the (general) shareholders’ meeting of the company adopts a resolution or follows another approach to extend the capital contribution period of the shareholders.
Therefore, in the case of shareholders who have not contributed to the capital, this depends on whether the capital contribution period has expired, and if it has indeed expired and the shareholders have failed to perform or fully perform the capital contribution obligation or have withdrawn their contributed capital, they can be required to assume supplementary liability within the scope of their required capital contribution[1]. In the case where the shareholders’ capital contribution period has not yet expired, the shareholders may be requested to assume the supplementary liability within the scope of their required capital contribution under the circumstances where the debtor company entered dissolution or bankruptcy or under the above-mentioned two exceptional circumstances stipulated by the Minutes.[2]
It is worth noting that the Company Law is currently under revision, and Article 48 of the released draft amendments provides that if the company cannot settle its debts as they fall due and there is an obvious lack of solvency, the company or the creditor has the right to require the shareholders who have subscribed to the capital but the subscription period has not expired to pay their capital contributions in advance. Although the provisions on the apparent lack of solvency are somewhat vague, and the provisions of Article 89 of the draft are also somewhat controversial, still this shows that the conditions for applying the accelerated expiration of shareholders’ capital contributions have been relaxed. If Article 48 of the released draft has been ultimately amended to this article, as for the company’s debts the shareholders are required to assume, the terms of application will be changed and will need to be reconsidered based on the new provisions.
2. Denying corporate personality
The independence of corporate personality and the limited liabilities of shareholders are the basic principles of the Company Law. Therefore, the conditions for denying independent corporate personality and requiring shareholders to assume joint and several liability are particularly strict since they are extreme exceptions to the principle of limited liability of company.
Pursuant to Article 20 of the Company Law, the shareholders of a company that abuse the independent status of the corporate legal person and the limited liability of shareholders to evade debts and seriously undermine the interests of the company’s creditors shall assume joint and several liability for the debts of the company. Pursuant to the Minutes and the judicial opinions of the courts in different jurisdictions,[3] the application of this article must at least meet the following criteria:
(1) The company’s shareholders have engaged in an act that abuses the company’s status as an independent legal person and the limited liability of shareholders (“abusive act”).
(2) The shareholders of the company have the subjective fault of evading debts (“subjective fault”).
(3) The results of undermining the creditors’ interests should reach a serious degree (“serious results”).
(4) There is a causation between the abusive act and the serious results, which means the creditor’s interests would not be severely impaired without the abusive act (“causation”).
For the determination of an abusive act, the Minutes and the judicial opinions of the courts suggest that the courts mainly look at whether there is personality confusion, excessive domination and control, significant undercapitalization, etc.
In terms of personality confusion, the Minutes pointed out that the most fundamental determination criterion is whether the company has an independent will and independent property, which is primarily reflected by the mixture and inseparability of the company’s and the shareholders’ property. To wit, the courts generally make a determination based on the following circumstances:
(1) The shareholders use the company’s funds or property without compensation and without financial records.
(2) The shareholders use the company’s funds to repay the shareholder’s debts or provide the company’s funds for use by affiliated companies free of charge and without financial records.
(3) The company’s and the shareholders’ books are not separated, making the company’s property indistinguishable from the shareholders’.
(4) The shareholders’ own earnings are not distinguished from the company’s, resulting in a lack of clarity concerning the interests of both parties.
(5) The company’s property is recorded in the name of the shareholders and is possessed and used by the shareholders.
In addition, the existence of confusion about business, personnel, residences, and other circumstances are also considered by the court.
For excessive domination and control, the court will mainly look for the existence of shareholders using related transactions to illegally conceal or transfer the company’s property, which may specifically include:
(1) Benefits transferred between the parent company and a subsidiary or between subsidiaries
(2) A transaction between the parent company and a subsidiary or between subsidiaries with the gains going to one party but the losses borne by the other party
(3) Funds withdrawn from the original company before another company with identical or similar business objectives is established to evade the debts of the original company
(4) Dissolution of the company first before another company is established with the premises, equipment, or personnel of the original company and with the same or similar business objectives to evade the debts of the original company
(5) Any other circumstances of excessive domination and control
And significant undercapitalization means that in the course of a company’s operation after its establishment, the capital amounts actually contributed by the shareholders to the company are obviously incommensurate with the risks embedded in the company’s business operation. If there is a shareholder who has not paid or has not paid in full the capital contribution, or if the shareholder has withdrawn the contributed capital after the establishment of the company, resulting in the company’s capital falling short of the minimum legal capital of such a type of company, the court will find that the company is significantly undercapitalized.
Therefore, if it is hoped to achieve the purpose of requiring shareholders to assume joint and several liability by denying the corporate personality, it is necessary to prove that the debtor’s shareholders have at least engaged in one of the abusive acts mentioned above.
According to the practical cases, a creditor’s burden of proof is quite heavy[4] (in the case of a one-person limited liability company, the company is certainly required to prove on its own that its shareholder’s property is independent of the company’s though), and it is still relatively difficult to pursue the liability of shareholders through the two above-mentioned approaches. Of course, if there is truly no better way, an application may be filed to declare the bankruptcy of the debtor. The released draft amendments to the Company Law also added a paragraph in Article 21 that provides that if a company’s shareholders use more than two companies under their control to commit abusive acts, each company shall be jointly and severally liable for the debts of any one of the companies. If this article is amended, there is still a better prospect of success in pursuing liability.
To avoid the circumstances where shareholders’ liability cannot be pursued in the future, it is advisable to conduct more background investigation on the performance ability of the counterparty, require the shareholders to provide a guarantee, or make more arrangements on the payment terms when entering into a contract to stay on the safe side.
[1] For example, in the case ([2020] Fu 0109 Min Chu No. 9642) involving disputes arising from the liability of Xiamen Greating Logistics Co., Ltd., Shanghai Pingxiu Trading Co., Ltd., Suping Ma, and others for undermining the interests of company creditors, the court held that the defendant shareholders should assume the supplementary liability for their behavior to transfer the capital away after capital verification, which constitutes a failure to perform their capital contribution obligation. In addition, it is worth noting that the capital contribution period expired during the trial of this case. Although the court did not comment on this, nevertheless it was no longer possible, from the defendants’ perspective, to assert the defense that the capital contribution period has not expired.
[2] For example, in the case ((2022) Xiang 06 Min Zhong No. 372) involving disputes arising from the capital contributions by shareholders such as Shenzhen Dark Energy Power Co., Ltd., Shaohua Liu, and other shareholders, the court held that since the capital contribution period had not expired, and that the creditor could not prove that the company has exhausted all execution measures without any property available for execution, the shareholders’ supplementary liability was not supported. In the case ([(2022) Lu 01 Min Zhong No. 1342] involving the objection to the addition and change of the enforcement object by Na Dong, Yuanyuan Wang, and others, the court also held that since the capital contribution period of the original shareholders had not expired and the creditor could not prove the bad intent in the failure to perform the capital contribution obligation and the transfer of shares, it is not appropriate to apply accelerated capital contribution. Therefore, the original shareholders should not be added as the object of enforcement.
[3] See the arguments on the denial of corporate personality in the Minutes; the Several Opinions of the Second Civil Trial Division of the Shanghai High People’s Court on the Trial of Cases Involving the Denial of Corporate Personality; and the Adjudication Guidelines of the Second Civil Division of the Higher People’s Court of Guangxi Zhuang Autonomous Region on Several Issues Concerning the Trial of Corporate Dispute Cases (Gui Gao Fa Min II [2020] No. 19)
[4] For example, in a series of cases ([2021] Fu 02 Min Zhong No. 1253 and other cases) involving the education and training contract disputes between several people and Shanghai Langen Education Technology Co., Ltd., Shanghai Enmai Education Technology Co., Ltd., and others, the court pointed out that although there were financial irregularities in the debtor company, still this is not sufficient to prove personality confusion between the company and the shareholder, nor can it prove that the purpose of establishing the companies was to evade debts. Therefore, the shareholders’ joint and several liability was not supported. In the first instance civil judgment in the case ([2017] Fu 0118 Min Chu No. 5014) involving the contract disputes between Shanghai Joint Supply Chain Management Ltd. and Lesports Flying Pigeon Technology(Tianjin) Co., Ltd. and Letv Sports Culture Develop (Beijing) Co., Ltd., the court held that the evidence produced by the plaintiff could only prove that Letv Sports handled relevant matters in the course of performing the contract at issue but could not prove that Lesports Flying Pigeon lost its independent personality with its finance, business, personnel, and premises confused with those of Letv Sports. Therefore, defendant Letv Sports should not assume joint and several liability for the repayment of Lesports Flying Pigeon’s debts. In the appeal case ([2018] Fu 02 Min Zhong No. 10656) involving the joint operation contract disputes between Hubei Trustan Apiculture Co., Ltd., and Shanghai Sasu Import & Export Trade Co., Ltd and Yuanfei Jiao, the court held that although the defendant Sasu and the shareholder Yuanfei Jao had the same office address and the defendant shareholder promised to help the company repay part of its debts, it should not be concluded merely on such a basis that personality confusion was established. In the case ([2019] Fu 0115 Min Chu No. 55219) involving the service contract disputes between Yen Liu and Shanghai Fanli Business Consulting Co., Ltd. and Quan Zhong, the court held that although defendant Quan Zhong was a shareholder of Fanli, his and the company’s funds and finance management could not be clearly distinguished, and the personality confusion between the shareholder and the company should be concluded, still the current finance status of Fanli is still unclear, it is still possible to repay the debts, and this has not yet constituted serious impairment to the creditor’s interests. Therefore, the shareholder’s joint and several liability was not supported. In the case ([2020] Fu 01 Min Zhong No. 2076) involving the objection to the application of Shanghai Aviation Tianfu Enterprise Co., Ltd. and Shanghai Hengyang International Trade Co., Ltd. for an executor’s execution, the court of second instance held that since the first instance judgment lacked a legal basis for finding that the property of the two companies was confused merely based on the existence of the payments at issue between Tianfu Enterprise and Tianfu Trade, the judgment was ultimately corrected.
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