Conditions for holding shareholders liable for a company’s debts

By Yan Lantao and Zhu Nandi, Tiantai Law Firm 
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Under Chinese law, a company is an independent legal person, enjoying property independently and bearing debts independently. The existence of the company system separates the property of the company from that of the shareholders. Therefore, after a company’s debt becomes due, the creditors usually cannot directly claim that the shareholders should bear liability for paying off the company’s debt. However, in the case of mixed corporate personality or under the following special circumstances, creditors may add shareholders as defendants or persons subject to execution in relevant litigation or execution procedures.

严澜涛, Yan Lantao, Associate, Tiantai Law Firm
Yan Lantao
Associate
Tiantai Law Firm

Failure to fulfill obligations

In accordance with the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of the Company Law of the People’s Republic of China (III), known as Interpretation III, creditors have the right to request shareholders who fail to fulfill or fully fulfill their capital contribution obligations to bear supplementary compensation liability for the unpaid part of the company’s debts within the scope of the principal and interest of unpaid capital contributions.

However, it should be noted that in the context of China’s corporate capital subscription system, the subscription period also belongs to the legitimate rights and interests of shareholders, and “failure to fulfill or fully fulfill” should be understood as failure to fulfill or fully fulfill upon the expiration of the payment or subscription of capital that shareholders have promised. This view has been widely used in judicial practice.

The minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts also clearly state that “under the system of subscription of registered capital, shareholders shall enjoy term benefits according to law”. In this case, creditors can rely on the company’s industrial and commercial registration information to prove the subscription period of the shareholders of the debtor, and require shareholders whose subscription period has expired but who have failed to fulfill the capital contribution obligation to bear corresponding liabilities.

Withdrawal of contributions

Interpretation III provides that for shareholders who withdraw their capital contribution, the creditors of the company have the right to request them to bear supplementary compensation liability for the unpaid part of the company’s debts within the scope of the principal and interest of the withdrawn capital contribution. However, creditors often need to pay more in litigation costs if they claim compensation liability this way.

First, it is more difficult to provide proof. Although due to the particularity of capital withdrawal cases, creditors are often just required to give preliminary evidence, this kind of “preliminary evidence” still hinders them. Second, case analysis is more complicated. The capital exchange between shareholders and the company is likely to be complicated. Thus, it is necessary to make a comparative analysis based on lots of data of capital flows, the actual use and other factors in order to identify the withdrawal behavior. Some shareholders may also seek to hide how they withdraw their capital contributions.

祝南頔, Zhu Nandi, Trainee, Tiantai Law Firm
Zhu Nandi
Trainee
Tiantai Law Firm

Transferral of equity

Interpretation III provides that if the shareholders of a limited liability company transfer their equity when they fail to fully fulfill their capital contribution obligations, and the transferee knows or should know about the situation, the creditors may require the shareholders of the company to bear supplementary compensation liability for the unpaid debts of the company within the scope of the principal and interest of the unpaid capital contribution, and the transferee shall bear joint and several liability.

However, in practice, there are different opinions on whether shareholders still enjoy the term benefits brought by the subscription period. For example, in Zui Gao Fa Min Zhong Case No. 230 [2019], the court held that failure to fulfill or fully fulfill the capital contribution obligation should be understood as failure to pay or fully pay the capital contribution, that is, it still recognized the shareholders’ term benefits. However, some courts have held the opposite opinion. In Su 02 Min Zhong Case No. 2487 [2020], the court held that the obligation to subscribe for capital contribution includes the obligation to undertake future credit, which has credibility after being publicised by the industrial and commercial registration, and will also become a consideration for creditors to assess the transaction risk. Therefore, the transfer of equity without the consent of existing creditors or the implementation of the settlement plan for existing creditors’ rights cannot exempt shareholders from their original credit obligation.

Accelerated obligations

The circumstances and conditions for applying the acceleration of shareholders’ capital contribution obligations have always been controversial in judicial practice. At present, the Bankruptcy Law only provides that the acceleration of shareholders’ capital contribution obligations can be applied “after the people’s court accepts the bankruptcy application”, which does not involve companies in normal operation.

However, the minutes of the national working conference make a ground-breaking provision which is that creditors can claim acceleration of shareholders’ capital contribution obligations under the following circumstances: In the case where the company is subject to execution, the people’s court exhausts the execution measures and has no property to execute, and there are bankruptcy reasons, but the company does not apply for bankruptcy; and, after the company’s debts are incurred, the resolution of a shareholders’ meeting of the company or otherwise extends the capital contribution period.

If the acceleration of shareholders’ capital contribution obligations is realised, creditors will have the right to require shareholders who fail to fully fulfill their capital contribution obligations to bear corresponding liabilities in relevant litigation or execution procedures.

As mentioned above, although the Company Law separates the property of the company from the property of shareholders in principle, in some legal cases, this separation can be broken, so that creditors can require the debtor’s shareholders to bear part of the liabilities. However, this way of claiming compensation exposes creditors to higher legal risks and burden of proof. Under normal circumstances, we always suggest that companies pay more attention to the negotiation of contract terms and the performance of contract obligations in the process of dealing with transaction risks. If necessary, third-party security or other safeguard measures such as property mortgages and pledges can be added to the process.

Yan Lantao is an associate and Zhu Nandi is a trainee at Tiantai Law Firm

Frank Liu Jerry Huang Tiantai Law Firm domain nameTiantai Law Firm
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E-mail:

yanlantao@tiantailaw.com

zhunandi@tiantailaw.com

 

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