Excluding frozen dividends and bonuses from debt enforcement

If dividends and bonuses due to, or expected by, shareholders in a company are under judicial freeze but the company has matured prior claims over shareholders, considerable controversy has arisen over whether the company may object to the enforcement to exclude frozen equity gains on the ground of statutory offset.

The Supreme People’s Court (SPC) has now clarified, in the Provisions on Several Issues Concerning the Enforcement of Equity Interests by People’s Courts, that frozen dividends, bonuses and other gains can potentially be excluded from debt enforcement.

Enforcement rules change

Many courts previously held that dividends and bonuses should be enforced pursuant to income enforcement rules.

The primary ground was that the Provisions of the Supreme People’s Court on Several Issues Concerning the Enforcement by People’s Courts (for Trial Implementation), which took effect in 1998, explicitly regarded the enforcement of dividends and bonuses as monetary payment enforcement, rather than enforcement of due claims of the person subject to enforcement.

The provisions further prescribed that the court may freeze dividends and bonuses regardless of their maturity. For dividends and bonuses that had fallen due, the court may order relevant companies to make payments directly to the applicant, or withdraw the amount from the company. This provision was, in fact, analogous to the enforcement of personal income.

However, since the equity enforcement provisions became effective, on 1 January 2022, the enforcement of dividends and bonuses became subject to the same enforcement rules as those for debt claims.

The SPC stated in its clarification and application of equity enforcement provisions that, given the complexity of dividend distribution claims, in reality even if the distribution plan passed by the resolution of a company’s shareholders’ meeting has expired, the company may still have a defence to non-payment, and directly drawing gains may impair the legitimate interests of the company as a third party.

Considering the complexity of dividends and bonuses and the protection of third-party objections, the equity enforcement provisions finally adopted the opinion that dividends, bonuses and other gains should be enforced as the debt claims of the person subject to execution.

At present, the enforcement rules for dividends and bonuses are mainly based on article 499 of the Interpretation of the SPC on Application of the Civil Procedure Law, and articles 45 to 53 of the enforcement provisions with respect to enforcement of debt claims.

Objection and limitations

Companies are entitled to object after dividends and bonuses become subject to the same enforcement rules as those for debt claims.

Given the fact that the company is an outsider – rather than a person subject to execution in the dividend and bonus enforcement proceedings – enforcing shareholders’ dividend claims against the company has its ground solely on the attachment-of-debt order and notice of performance issued by the enforcement agency.

Strictly speaking, this ground for enforcement may be less justified as it has not gone through legal procedures such as trial, arbitration and notarisation. Therefore, tradeoffs are required to protect the interests of companies by giving them the rights of procedural participation and objection.

According to article 499 of the Interpretation of the Civil Procedure Law and articles 47 to 49 of the enforcement provisions, if a company objects to the notice of performance within the specified time limit during gains enforcement to protect the company’s interests from impairment, the court cannot continue the enforcement and will not conduct a substantive examination of the company’s objection.

If an applicant for enforcement requests compulsory enforcement of the objected part, the court will not support such a request. The applicant can only bring an action of subrogation against the company pursuant to article 535 of the Civil Code.

In other words, enforcement can be successfully made only when the secondary obligor concerned raises no objection. Once the secondary obligor raises an objection, the applicant can no longer claim against the secondary obligor through enforcement procedures, but must resort to the action of subrogation.

Therefore, a company’s effective objection provides an opportunity to suspend enforcement and redirect the proceedings to the substantive proceedings for the action of subrogation.

However, a company’s objection still has limitations. If the company only alleges that it has no capacity to perform, has no direct legal relationship with the applicant, or does not materially deny the debts, it is not sufficient to block enforcement.

Offset right

In the authors’ opinion, if a company has matured debt claims over shareholders prior to the judicial freeze on dividends and bonuses, and raises an objection after the judicial freeze is imposed on the ground of statutory offset, such objection should be adequate to block the enforcement.

The reason is that all debt claims are equal. Therefore a judicial freeze does not necessarily warrant a priority of repayment for claims that enter the enforcement procedures first.

Moreover, the offset is functionally similar to guaranteeing and protecting the company’s claims over shareholders, which is also in line with the intention of introducing the right of objection. In the Chongqing branch of Harbin Bank v Chongqing Shenlongxia Travel Development (2017), the SPC believed that the secondary obligor remained entitled to statutory offset after the debts were frozen.

Considering changes in judicial attitude after the equity enforcement provisions took effect, the authors believe that a company can seek to suspend or exclude enforcement against frozen dividends and bonuses via an objection that the company enjoys prior claims over shareholders. This will partly ease the enforcement dilemma.

Chen Zhuo is a partner at Tian Yuan Law Firm. He can be contacted by +86 138 1041 7260 or by email at chenzhuo@tylaw.com.cn
Yin Yutong is an associate at Tian Yuan Law Firm. She can be contacted by +86 138 1139 4158 or by email at yinyutong@tylaw.com.cn