‘Company debt’ and the acceleration of shareholders’ capital contribution

By Wang Li, Leaqual Law Firm
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On 8 November 2019, the Supreme People’s Court issued a notice of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, requesting courts at all levels to grasp and apply the minutes in an effort to unify trial criteria and regulate judges’ discretion.

Article 6 of the minutes set out a uniform judgment standard for accelerating shareholders’ capital contribution outside of bankruptcy, in which the protection of shareholders’ entitlement of a certain contribution period was upheld as a basic principle. “Where the creditor requests shareholders to make supplements or compensation beyond their duty of capital contribution, and before their contribution deadline, on the grounds that the company is unable to settle its matured debts, the court shall not support such requests.” Exception, however, can be made with “extension of shareholders’ contribution deadline by way of, among others, a resolution at the shareholders’ meeting or general meeting upon the incurrence of company debt”.

While these regulations under the minutes shed considerable light on the basic judgment criteria, judicial practice remains laden with a series of undetermined issues. When they say “the incurrence of company debt”, what type of debt does that entail? Does the debt need to be determined in amount, or due? Does it require confirmation by a court ruling? The author addresses these questions by illustrating a past case of his.

Case profile

‘Company debt’ and the acceleration of shareholders’ capital contribution Wang Li
Wang Li
Senior Associate
Leaqual Law Firm

Company A, established in April 2017, executed a construction project in July 2017, under which company B undertook to construct a senior care project for company A. In May 2020, the project was forcibly demolished by an administrative authority due to failure to secure a zoning permit, and company A failed to pay project funds to company B.

The original registered capital of company A was RMB30 million (USD4.7 million), its original shareholders were natural persons C and D, and the deadline for capital contribution was 31 December 2019. On 3 September 2018, company A held a shareholders’ meeting to extend the contribution deadline to 31 December 2020.

On 3 December 2018, C and D each transferred all of their equity in company A to natural person E. On the same day, current shareholder E rendered a shareholder’s decision to postpone the deadline for his capital contribution to company A to 31 December 2050. On 10 February 2020, the registered capital of company A was reduced from RMB30 million to RMB2 million, about which company B was not notified in writing.

In October 2019, company B filed a lawsuit in the court of first instance, demanding company A’s payment of project funds, and that C, D and E bear supplementary damages. In October 2021, the court of first instance rendered a judgment finding the construction contract invalid, and ordered company A to pay company B the RMB30 million project funds, but dismissed company B’s other claims.

Case analysis

As the project was forcibly demolished by the government authorities, company B could not obtain payment by exercising the priority right to repayment attached to a construction project. Additionally, company A was established specifically for this project, with a paid-in capital contribution totalling only RMB950,000 according to publicly available business information, and shareholder E had no actual capital contribution capacity. Even if the court had ruled in favour of company B, it had little chance of receiving payment.

The core issue of the case where company B was concerned was to have the original shareholders C and D, who did have payment capacity, to bear the attendant liability. To achieve this, they needed to substantiate that the transfer of equity by C and D before the expiration of the capital contribution deadline specified in the company’s articles of association (AOA) constituted “a transfer of equity without performance of capital contribution obligations”.

Pursuant to article 18 of the Provisions (III) of the Supreme People’s Court on Several Issues concerning the Application of the Company Law of the People’s Republic of China, creditors of a company have the right to demand shareholders who have not performed or fully performed their capital contribution obligations to do so.

In this case, the precondition to company B’s ability to demand C and D to bear their capital contribution liabilities is they failed to perform their capital contribution obligations before transferring their equity. Company A’s AOA specified that the deadline for C and D’s capital contributions was 31 December 2020, which at the time of the equity transfer had not yet expired.

Based on this fact alone, C and D were unlikely to be found liable for capital contribution before transferring their equity. The judgment at first instance held that the transfer by C and D of their equity before the expiration of the deadline was legal.

However, pursuant to the two circumstances specified in the above-mentioned article 6 of the minutes, the creditors of the company have the right to demand that shareholders whose capital contribution deadline has not expired to bear supplementary damages for the outstanding debt of the company to the extent of their amounts unpaid.

In this case, company A and company B executed the construction contract in July 2017, following which company B entered the construction site, which necessarily gave rise to a liability owed by company A to B. Accordingly, C and D extended the contribution deadline by amending the AOA on 3 September 2018, in line with the circumstance for accelerating the deadline for the payment of shareholder capital contributions, as specified in the minutes.

Accordingly, at the time of equity transfer, the capital contribution obligations of C and D had in fact matured, but they transferred their equity without performing their contribution obligations and should therefore bear supplementary damages to the extent of their unpaid amounts. The judgment of second instance upheld the above view of company B and ruled that C and D bear supplementary damages for the debts of company A to the extent of their outstanding capital contributions.

Through this case and in light of the views expressed in the book, Understanding and Application of the Minutes of the National Work Conference on Civil and Commercial Adjudication by Courts, compiled by the Second Civil Division of the Supreme People’s Court, it is clear that: (1) “company debts” include both active and passive debts as well as contingent debts; (2) “company debt” does not necessarily have to “have fallen due” or have a “determined amount”, as long as evidence exists to fully substantiate a claim-debt relationship between the parties; and (3) to rule for acceleration of the deadline for payment of shareholder capital contributions does not require confirmation of a “company debt” by an effective ruling or judgment, and the company’s creditors may simultaneously institute legal actions against the company and the shareholders that have not made the capital contributions, thereby saving judicial resources.

Wang Li is a senior associate at Leaqual Law Firm

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