Exceptions to the bearing of limited liability by shareholders

Q: Do the shareholders of a limited liability company always only bear limited liability for the debts of the company?

A: Pursuant to the Company Law, a company is an enterprise with legal personality that has independent legal person property and the property rights of a legal person. A company bears liability for its debts to the extent of all of its property.

The shareholders of a limited liability company bear liability for the company to the extent of the capital contributions subscribed for by them, while the shareholders of a joint stock limited company bear liability to the company to extent of the shares subscribed for by them. These are the principles regarding the way that shareholders bear liability for the company’s debts. However, the Company Law and the judicial interpretations additionally provide that, under certain special circumstances, shareholders are required to bear joint and several liability for the company’s debts, namely, what is called the “system of lifting the corporate veil” or the “system of disregard of corporate personality”. From this it can be seen that the bearing of limited liability by shareholders is the principle while the bearing of joint and several liability is the exception.

Q: When are shareholders required to bear joint and several liability for the company’s debts?

A: Pursuant to the Company Law and the judicial interpretations, the circumstances in judicial practice mainly included the following:

A flaw or defect in the shareholder’s capital contribution. For example, a fraudulent capital contribution, incomplete payment of capital contribution, illegal withdrawal of capital contribution, etc. Common cases in judicial practice include: an investor makes his capital contribution in the form of property, such as premises, land use rights or intellectual property for which the carrying out of registration of title is required, but fails to carry out the procedures for registering the change in title; a shareholder fails to timely make his capital contribution by the deadline specified in the company’s articles of association; the company illegally withdraws a capital contribution by way of a connected transaction, makes allocations to a reserve, makes a loan to a connected party without collecting on the same, etc.

A shareholder abusing his rights to harm the interests of creditors. Common practices include: mixing and not differentiating the assets/funds/business/personnel of the company and its shareholders, and unclear financial accounts; a shareholder uses a connected transaction to divert company profits or harm the company’s interests; the company and a shareholder mix their operations, using the same people but operating under two names, and mixes their finances, personnel, assets and business; when the operations of the company run into difficulty, a shareholder transfers the company’s main business, profits, personnel, etc. to a newly established company, harming the interests of the original company’s creditors; etc.

Mixing of the property of a one-person limited liability company and the shareholder. A one-person limited liability company only has a single natural-person shareholder or legal-person shareholder. The Company Law specifies that if the shareholder of this type of company cannot show that the company’s property is separate from that of the shareholder, he or it bears joint and several liability for the debts of the company. In judicial practice, the shareholder of this type of company bears the burden of proving that the property of the company is separate from that of the shareholder, failing which he or it is jointly and severally liable for the debts of the company.

A defect in the company’s liquidation procedure. This mainly includes the shareholders failing to perform under the Company Law, their notification and announcement obligations in the course of the company liquidation procedure, resulting in creditors being unable to timely file their claims; the shareholders implementing a liquidation plan that has not been confirmed by the shareholders’ meeting/shareholders’ general meeting/People’s Court, causing the company or creditors to incur losses; the shareholders failing, after a reason for dissolution arises, to promptly establish a liquidation committee to liquidate the company, resulting in the impairment, erosion, or loss of, or damage to, company property; the shareholders failing to promptly perform their obligations, resulting in the loss of major property, accounting books, major documents, etc. of the company, making liquidation impossible; after dissolution of the company, the shareholders disposing of company property in bad faith, causing creditors to incur losses; after dissolution of the company but without liquidating it in accordance with the law, the shareholders using a fraudulent liquidation report to fraudulently secure deregistration of the legal person by the company registrar; the shareholders undertaking to bear liability for the debts of the company when the company registrar is carrying out the deregistration procedures; etc.

Sponsors required to bear joint and several liability when establishment of the company proves unsuccessful. Pursuant to the Judicial Interpretations of the Company Law (3), if a company is not established for any reason, the sponsors are required to bear joint and several liability for discharging the expenses/debts incurred when attempting to establish the company; if a sponsor causes a third party to incur a loss when performing its duties for establishing the company, all of the sponsors are jointly and severally liable for compensating the injured party if the company is not established.

Q: In judicial practice, how can an investor/shareholder avoid bearing joint and several liability for the company’s debts?

A: First, a shareholder should timely pay in its capital contribution according to the company’s articles of association. Although the company registrar no longer requires companies to have their paid-in registered capital verified, it is recommended that a shareholder have a capital verification done after making a capital contribution and carry out recordal of its paid-in capital contribution with the administration for industry and commerce. Second, in an investment, financing or acquisition deal, the investor or acquirer should have due diligence done on the payment of their capital contributions by the shareholders of the target company to avoid a situation where the new shareholder is required to bear joint and several liability due to a defect in the capital contribution of an original shareholder. Third, in operations, avoiding a situation where there is a mixing of the personalities of legal persons, with the company, its shareholders and affiliates keeping their finances, accounts, business and personnel separate, and avoiding, to the extent possible, the establishment of one-person limited companies. Finally, if a reason for dissolution of the company arises, company liquidation procedures should be promptly carried out and the company liquidated and de-registered in accordance with laws and regulations.

Pan Xiang is a partner and Liu Yujia is an associate at AnJie Law Firm