Disregard of corporate personality, also known as “lifting the corporate veil”, a legal concept relative to the independence of corporate personality, refers to the disregard of the independent personality of a company and the limited liability of shareholders in specific circumstances, directly ordering the company’s shareholders and others to bear joint and several liability for the company’s debts.
Independence of corporate personality and limited liability of shareholders, two cornerstones of the modern corporate system, can diversify and reduce the investment risks of shareholders, stimulate social investment and promote growth of social wealth. On the other hand, they are prone to redistribute the investment risks originally concentrated in the shareholders to the creditors of the company, thus potentially affecting the security and order of commercial transactions.
To better protect the interests of shareholders and creditors of the company, the system of disregard of corporate personality came into being.
China’s current system to disregard corporate personality is specified in article 20.3 of the Company Law, which provides that, “where shareholders of a company take advantage of the company’s independent status or the limited liability of shareholders to disregard debts and seriously harm the interests of the company’s creditors, such shareholders shall bear joint and several liability for the debts of the company”.
However, the article only provides for the typical situation. In both practice and doctrine, disregard of corporate personality is further divided into “horizontal” and “reverse” disregard, with horizontal personality confusion characterised by improper transfer of property between parent-subsidiary companies and sister companies.
In the 2013 Supreme People’s Court Guiding Case No. 15, the court held that affiliated companies controlled by the same shareholder constituted personality confusion, could seriously damage the interests of creditors, and should be jointly and severally liable to creditors. This is considered an exemplary case of the expansive application of article 20.3 of the Company Law between affiliated companies, and has had a demonstrative effect on subsequent judicial practice.
In 2019, the Supreme People’s Court made clear, in the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, how to apply the system of disregard of corporate personality, specifically listed some common situations such as personality confusion, excessive domination and control, and significant under-capitalisation, and in the “excessive domination and control” situation, listed interest transfer between parent-subsidiary companies or subsidiaries.
However, neither a law nor a judicial interpretation, the above-mentioned minutes cannot be directly cited in the main text of a judgment. Therefore, there is still no clear legal basis for horizontal disregard of personality.
Reverse disregard of personality, on the other hand, mainly refers to the transfer of assets to the company by its shareholders for the purpose of avoiding debts, resulting in the shareholders’ inability to pay their debts, thus damaging the interests of their creditors.
These creditors then claim that the company is jointly and severally liable for the debts incurred by shareholders. The Company Law also has no clear provisions on reverse disregard of personality.
Updates and advice
Article 23.3 of the new Company Law (Draft Revision) (Third Revision) provides that, “if a shareholder utilises two or more companies under his/her control to commit the acts provided in the preceding paragraph, the companies shall be jointly and severally liable for the debts of any one of the companies”. This article incorporates part of the “excessive domination and control” provisions of the minutes, and clearly establishes a horizontal disregard of personality system.
Compared with the horizontal counterpart, reverse disregard of personality lacks sufficient trial practice and is regularly debated in the academic community, its development depending on research and summarisation of judicial practice. However, the current draft amendment to the Company Law does not explicitly introduce the system of reverse disregard of personality. The question of whether China should establish a system, and how to design it, still needs to be explored.
The release of the new draft is not only intended to legally address the limitations in the application of the traditional disregard of personality, but will also positive impact judicial practice.
At present, there are many cases where the court is unable to enforce payment and judgment, with debtors restricted of high consumption and included in the list of dishonest persons. In many such cases, independence of corporate personality and limited liability of shareholders are abused to the detriment of creditors.
In similar circumstances, the party may consider including the shareholder who abuses independence of corporate personality and limited liability of shareholders, or the third-party company, to be held jointly and severally liable for being involved as a defendant in litigation. Alternatively, the party may also hold the shareholder or the third party jointly and severally liable in a separate lawsuit.
Despite legal guarantees, the creditor should still pay attention to retaining complete materials of commercial transactions to ensure sufficient evidence, and familiarise themselves with the above debtor’s illegal behaviour so as to legally exercise the rights of a creditor.
From the perspective of risk avoidance, companies need to strictly abide by the Accounting Law and other laws and regulations, and establish strict, standardised and independent transaction procedures to avoid ambiguity in terms of personnel, business and, in particular, finance that may lead to litigation risks.
Alex Sun is a senior partner at Ronly & Tenwen Partners. He can be contacted at +86 139 1743 4785 or by e-mail at firstname.lastname@example.org.
Guo Qingqing is a paralegal at Ronly & Tenwen Partners. She can be contacted at +86 191 0165 0617 or by e-mail at email@example.com.