Shareholder strategies defending neglected liquidation duty claims

By Yang Liqun, Zhilin Law Firm
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A recurring issue in recent years has been debtor companies having their business licences revoked before settling their debts. In such cases, creditors seek to hold shareholders responsible for neglecting their liquidation obligations. So, how should a company shareholder effectively mount a defence in such a situation?

In provisions of the Company Law and relevant judicial interpretations, the legal basis for holding shareholders liable for liquidation responsibilities is their failure to fulfil liquidation duties, resulting in the company’s inability to liquidate its assets and repay debts.

The elements required to establish this liability include: (1) the existence of shareholder negligence in fulfilling liquidation obligations; (2) the loss of key company assets, records or vital documents, preventing effective conduct of the liquidation process; and (3) an established causal link between shareholder neglect of their liquidation obligations and the company’s failure to liquidate assets or repay creditors.

Defence strategies for shareholders of limited liability companies (LLCs) can therefore revolve around these elements of liability.

Defence strategies

Yang Liqun, Zhilin Law Firm
Yang Liqun
Senior counsel
Zhilin Law Firm

Actively fulfil obligations. Specific measures for shareholders include but are not limited to becoming aware of reasons for the company liquidation; proactively communicating with fellow shareholders and submitting a formal liquidation request; organising and maintaining financial books; devising a comprehensive liquidation plan; and preserving all pertinent written correspondence and communication records.

Minority shareholder responsibilities. Minority shareholders who neither serve on the board of directors or supervisory board – nor have designated representatives within these, and have not been involved in the company’s day-to-day operations – do not have the capacity or obligation to fulfil liquidation duties. Therefore, they are not held jointly and severally liable.

Minority shareholders can present the following points of defence:

  • Minority shareholders typically hold an insignificantly small percentage of company shares and do not hold any official positions within the company. As such, they bear no responsibility for liquidation.
  • Even if a shareholder’s official position is registered with the company, if this registration contradicts their actual involvement in company management, they may obtain company resolutions and articles of association to confirm their lack of participation in decision-making or signing. If indeed they have not been involved in such activities, they cannot be deemed to have managed the company.
  • In cases where minority shareholders previously held positions within the company they can submit evidence – such as termination certificates, social security records and internal company documents – to demonstrate they have left the company for several years and were absent from actual management, lacking access to financial books and the ability and conditions to liquidate the company.

Nominee shareholding. Registered shareholders can provide evidence to prove they are not the actual shareholders, but holding shares on behalf of those who should be liable for failure to liquidate the company.

Additionally, registered shareholders can present evidence demonstrating their active efforts to contact the actual shareholders and request they fulfil their liquidation obligations.

But, importantly, note that nominee shareholding between actual shareholders and registered shareholders is considered an internal arrangement. Business registration carries external disclosure effects.

Regardless of whether registered shareholders are actively involved in company operations or are nominee shareholders, they cannot use the internal arrangement against external third parties. Therefore, this defence may not receive court support.

Capable of liquidation. During the liquidation phase, shareholders can provide relevant documentation – such as account books, vouchers, financial statements, subsidiary ledgers, general ledgers, cash journals, bank deposit records, inventory material details and other evidence – to demonstrate that their failure to fulfil liquidation obligations did not lead to loss of the financial books, and the company remained capable of liquidation.

If the court determines the company is still possible to liquidate, it should initiate compulsory liquidation proceedings and preclude shareholders from bearing liabilities.

Absence of executable assets. Shareholders can substantiate their position by presenting previous effective judgments and final rulings where the company, as debtor, had no assets available for court-ordered enforcement at the time of liquidation.

This evidence demonstrates the lack of a causal link between shareholder failure to fulfil their liquidation duties and the company’s inability to repay creditors.

However, different courts may hold varying opinions regarding whether the absence of assets available for enforcement within the company is indeed unrelated to the debtor’s inability to repay. Consequently, this defence risks not being supported by the court.

Expired statute of limitations on debt. According to article 16(1) of the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases, when company creditors seek joint liability from shareholders for company debts, shareholders can present evidence that the creditor’s rights on the debt has exceeded the statute of limitations. In such cases, the company is not obliged to repay the debt, and shareholders bear no joint liability.

Expired statute of limitations on liability. Under article 16(2) of the minutes, if LLC shareholders are asked to assume joint liability for company debts, the statute of limitations begins from the date the company creditor knew, or should have known, the company could not be liquidated.

Therefore, shareholders can provide evidence of the point in time when the creditor knew or should have known about the company’s inability to liquidate. This may demonstrate that the statute of limitations for the creditor’s claim has expired.

Latest development

The latest Third Review Draft of the Company Law has clarified current provisions concerning the party responsible for fulfilling liquidation obligations, clearly designating directors as the obligated party. This aligns with existing provisions in the Civil Code.

If this provision is implemented in future revisions to the Company Law, it implies that shareholders will no longer face stringent liquidation responsibilities.

In terms of the liquidation process, the principle of “those who operate, liquidate” aligns more closely with fundamental principles of corporate governance than the principle of “those who invest, liquidate”.

Yang Liqun is a senior counsel at Zhilin Law Firm

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