Identification of community debts in family corporate governance

The criteria for “community debt” as negative property of a family have been legislatively revised many times. Eventually, the doctrine that “the community debt must be jointly signed by both spouses” was established under article 1064 of the Civil Code, which provides that the debt used for the daily life or joint business of both spouses is a community debt. When a company is run by one spouse or both spouses, the criteria for “joint business” and the debt obligations of a “husband-and-wife company” become key risks in corporate governance.

Judicial criteria

There are no consistent criteria for “joint business of the spouses”, but local courts have given guiding opinions. For example, article 4 of the Notice of Zhejiang Higher People’s Court on Properly Hearing Disputes Over Debts of Married Couples pointed out that the common circumstances of “joint business of the spouses” include the business jointly decided on by the spouses, and the business authorised by one spouse and decided on by the other.

Article 48 of the Guide of Jiangsu Higher People’s Court to the Trial of Family Disputes (for Married Couples) pointed out that “joint business of the spouses” refers to the situation in which the spouses jointly decide on business, or one spouse authorises the other to decide on business matters or the other spouse benefits from the business.

Article 17 of the Guide of Tianjin Higher People’s to the Trial of Private Lending Cases in Tianjin Courts (Trial) pointed out that, to determine whether the loan to one spouse is used for joint business of the spouses, the examination should focus on the following:

1. The debt of one spouse is used for the operation of a sole proprietorship or a rural contracted business;
2. One spouse conducts operating or investing activity, while the other, though not directly participating, shares in the income from such activities; or
3. Other circumstances of joint business of the spouses.

When considering the joint business of the spouses in relevant cases, the Supreme People’s Court would also examine whether one spouse holds shares, holds a position, participates in the management of the company, engages in economic ties with the company, is aware of the incurrence of debt, and whether the debt arises during the marriage.

It is obvious that in judicial practice, the criteria for “joint business of the spouses” focus on whether the:

1. Debt is dedicated to the business;
2. Business is based on the common will of the spouses, which is manifested in joint decision-making, investment and operation, split of duties and co-operation, as well as other common expressions of intent. The spouse who agrees to have the community property managed by the other is deemed to accept and bear all the consequences of operating the property; and
3. Operating income is the main income of the family or is mainly used for the common life, that is, whether the income from the debt is used for the common life of the spouses.

Joint and several liabilities

A limited liability company established by a married couple for joint business is called a “husband-and-wife company”. According to article 57 of the Company Law, a “one-person limited liability company” refers to a limited liability company that has only one natural person or legal person shareholder.

However, based on the Civil Code provisions on “community property,” and the viewpoint established in judicial practice that “when a married couple establishes a company, the capital contributions originate from the same property rights, resulting in singular equity interests”, it is not uncommon to identify the husband-and-wife company as a one-person business.

In judicial practice, a husband-and-wife company is identified as a one-person business based on the following viewpoint: all the shares in a husband-and-wife company are essentially derived from the common property and controlled under common ownership. The shareholders demonstrate consistency of interests and singularity of substance, often preventing the mutual constraints typical among shareholders in a standard limited liability company, easily commingling community assets with company assets to the detriment of creditors.

Therefore, the husband-and-wife company is highly similar to a one-person company in membership and normative application, and thus essentially constitutes a one-person business. If it cannot be proved that the community property is independent of the company property, the spouses, as shareholders, shall be jointly and severally liable for company debts.

Denial of corporate personality

An opposite viewpoint holds that a husband-and-wife company cannot be equated with a one-person company. A one-person company is determined by the number of shareholders rather than the source of registered capital or ownership of shares, nor can a one-person company be identified simply on the grounds of family membership, one spouse’s non-participation in the company’s major decisions or operations, and the inclusion of company profit in community property.

There are two shareholders in a husband-and-wife company, which does not meet the formal criteria of a one-person company. Thus, there is no legal basis for determining a husband-and-wife company as a one-person business.

When determining whether shareholders of a husband-and-wife company should be jointly and severally liable for company debts with their personal assets, it is not appropriate to evaluate whether the company essentially functions as a one-person company.

Instead, under article 20(3) of the Company Law, which states, “If shareholders abuse the company’s independent corporate personality and limited liability status to evade debts, thereby severely harming the interests of the company’s creditors, they should bear joint liability for the company’s debts,” one should review whether a husband-and-wife’s company meets the criteria for disregarding corporate personality and thus determine if shareholders are responsible for jointly settling the company’s debts.

To sum up, the author opines that a husband-and-wife company should ensure proper risk isolation between the company and the family in its day-to-day operation to prevent the risk of commingled company and family assets in the course of business.

Yuwen Hongyan is a partner at Anli Partners