Exploring creditor protection paths under new Company Law

Behind debtor companies with no assets for execution often lie issues such as insufficient shareholder contributions, false contributions and withdrawal of capital contributions. Before the implementation of the new Company Law, judicial practice could regulate these issues but often required in-depth reasoning in judgments, the application of principle-based clauses and alignment with judicial documents’ value orientations to protect some lucky creditors.

Many creditors, however, were hindered by factors such as economic and time costs, as well as the complexity of investigation and evidence collection.

With the new Company Law, a company’s capital adequacy obligations and the duties of directors and supervisors are strengthened, moving from theory to practice. These changes enable a more efficient and uniform top-down approach to addressing these issues.

Shareholders’ compensation liabilities

The Judicial Interpretation (III) of the Company Law specifies that company creditors are eligible plaintiffs in disputes over capital adequacy. This aligns with the new Company Law, presents no conflicts and shall remain applicable.

Regarding the legal consequences for shareholders who fail to meet their capital contribution obligations, the new Company Law has added liabilities for damage to the company. In practice, it is essential to continually monitor the detailed composition and boundaries of such liabilities.

For example, beyond the delayed payment of contribution interest, the existence and extent of compensation liabilities can significantly affect the effectiveness of creditors’ rights to subrogation claims against shareholders.

Accelerated shareholder contributions

Regarding creditors’ requests to accelerate shareholder contributions before maturity, making shareholders supplementary judgment debtors requires them to assume company debt for unpaid portions within the scope of the shareholders’ unpaid contributions.

Under article 6 of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, creditors had to prove that the company had exhausted its execution measures and had valid reasons for bankruptcy. However, article 54 of the new Company Law simplifies this process by only requiring proof that the company cannot pay its due debts, thus lowering the application standard.

On the day the new Company Law took effect, the Xicheng District People’s Court in Beijing applied article 54, adding shareholders who had not fulfilled their contributions as judgment debtors.

Despite this, the debtor company had already been subject to enforcement in a previous case in which the court had issued a final ruling because of the company’s lack of executable assets. Therefore, this case did not actually break new ground beyond the objective standards set by article 6 of the minutes.

From the perspective of protecting creditors’ legitimate rights and improving case handling efficiency, the standard for a company being “unable to pay due debts” should be further expanded. For instance, in scenarios where a company facing repeated demands for payment from a creditor still cannot pay, or where a company admits its inability to pay, that company should be presumed to be “unable to pay due debts”.

Directors’ liabilities

Before the new Company Law, creditors could request that shareholders who had not fully met their capital contribution obligations bear a duty to pay supplementary compensation for the company’s unpaid debts within the scope of their unpaid capital contribution. However, the liability of directors in such cases and the conditions under which creditors could demand that directors and the debtor company jointly compensate is contentious.

The new Company Law explicitly stipulates directors’ duties to verify and urge capital contributions. If a company has only one director, all statutory duties fall on that director. If the director fails to diligently verify capital contributions and to issue timely written demands on discovering deficiencies, he or she can be deemed to have failed in his or her duties. Consequently, creditors can sue the director, requesting joint liability with the non-contributing shareholders.

For a debtor company with a board of directors, the responsibility should generally be considered to lie with each director. However, individual directors can provide evidence of having fulfilled their duties within their scope of authority, responsibility and capability to seek exemption from liability.

Additionally, the new Company Law’s article 52 stipulates the shareholder disqualification system. Under certain conditions, if directors fail to urge the payment of capital contributions, or to disqualify shareholders in a timely manner, thus causing creditors to suffer losses because of misplaced trust in the company’s capital adequacy, it can be argued that the directors bear some fault and might be held liable.

Liabilities of former shareholders

Creditors have the right under article 88 of the new Company Law to demand that former shareholders of the debtor company make up for unpaid contributions by new shareholders. If the same equity has been traded multiple times, can creditors request that all historical shareholders bear supplementary liability for unpaid contributions by the equity transferee?

The authors think the answer should be yes, but the supplementary liability should follow a sequential order. Specifically, creditors should start with the current shareholders and work backwards, with shareholders individually liable for the unpaid contributions of their transferees. This approach was endorsed by a ruling from the Haidian District People’s Court in Beijing in August 2024.

Conclusion

Overall, the new Company Law provides extensive protection paths for creditors. This article has highlighted a few aspects from the perspective of shareholder contributions. Creditors might broaden their approach and consider various angles to protect their legitimate rights and interests.

Zhang Zheng is a partner at Guantao Law Firm. He can be contacted by phone at +86 189 6462 2728 and by email at zhangz@guantao.com

Chu Wenqin is an associate at Guantao Law Firm. She can be contacted by phone at +86 158 0213 9198 and by email at chuwq@guantao.com