Joint, several liability of shareholders in liquidation disputes

By Wang Qiang, Leaqual Law Firm
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A sales contract dispute between Shanghai Cunliang Trade and Jiang Zhidong et al was a case selected by the Supreme People’s Court (SPC), as Guiding Case No. 9, with the adjudication rules formed designed to protect the interests of creditors. However, in the process, determining causality between act and result is often neglected, leading to increased shareholders’ liability in liquidation disputes, damages to the rights of minority shareholders, and violation of the principle of fairness. On 29 December 2020, the SPC issued its Notice on Ceasing to Refer to Certain Guiding Cases, announcing that Guiding Case No. 9 would no longer be referred to after 1 January 2021.

The above-mentioned notice paves the way for the judicial application of the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, as well as understanding the connotation of “neglecting to perform liquidation obligations”, and unifying the rules for judging shareholders’ liquidation liability in disputes of limited liability companies.

ILLUSTRATIVE CASE

In the 2020 retrial review and trial supervision case involving Beijing Catch New Technical Development and Xi’an Hi-tech Industries Development Zone Venture Park Development, the SPC applied article 18.2 of the Judicial Interpretations of the Company Law (II) (interpretation II), that “if shareholders, in the case of a limited liability company, or directors and controlling shareholders, in the case of a joint-stock company, neglect to perform their obligations, resulting in the loss of material properties, account books or important documents of the company, rendering it impossible to carry out liquidation, where the creditors allege such personnel to bear joint and several liability for repayment of debts of the company, the court shall uphold that allegation according to laws”.

Wang Qiang, Leaqual Law Firm, Joint, several liability of shareholders in liquidation disputes
Wang Qiang
Associate
Leaqual Law Firm

Under article 18.2, two conditions must be satisfied for shareholders of a limited liability company to be jointly and severally liable for debts of the company arising from an inability to liquidate. First, shareholders must have neglected to perform liquidation obligations. That means after the statutory liquidation causes arise, even when able to perform liquidation obligations, the shareholders deliberately delay performing or refuse to perform their obligations, or are unable to do so due to negligence.

Second, there is a causality between the passive inaction of shareholders who neglect to perform liquidation obligations and the resulting loss of material properties, account books or important company documents, rendering it impossible to conduct a liquidation.

In the 2020 case, the defendant was a shareholder holding 5% of shares of the company. There was no evidence its appointed person sat on its board of directors or supervisors, or participated in its operation and management. On that ground, the first-instance judgment determined the shareholder was not at fault for refusing or delaying the liquidation, resulting in the loss of material properties, account books or important company documents. Therefore, the court’s rejection of the creditor’s request for the minority shareholders to bear joint and several liability for the company’s debts was the appropriate decision.

ASSUMING LIABILITY

Active element: neglecting to perform liquidation obligations. With the clarification that shareholders of a limited liability company cannot be exempted from liquidation obligations because they are not the actual controllers or have not participated in the company’s operation and management, as well as the scope of “neglecting to perform liquidation obligations”, the minutes have unified judgment criteria, standardised judges’ discretion, and enhanced the openness, transparency and predictability of civil and commercial trials, which significantly improves judicial credibility.

Article 14 of the minutes shed further light on passive inaction of shareholders and the burden of proof, which protects creditors’ interests and prevents improper expansion of shareholders’ liquidation liability. That lays a foundation for safeguarding legitimate rights and interests of minority shareholders and those who have not participated in actual operation of the company.

Passive element: no causality. Article 15 of the minutes clarifies that absence of causality between the passive inaction of shareholders of a limited liability company and “the company’s inability for liquidation” may be a defence for shareholders. If they establish there is no causality between their actions and the company’s inability to liquidate, and they therefore should not be jointly and severally liable for the company’s debts, the court should uphold the claim.

KEY TO DETERMINATION

First, failure to initiate liquidation procedures or form a liquidation group should not be the criteria for judging whether shareholders “neglected to perform their obligations”. Second, shareholders’ failure to apply to a court to designate a liquidation group to conduct a liquidation should not be deemed “neglecting to perform obligations” as provided in article 18.2 of interpretation II. Under article 7 of interpretation II, “applying to a people’s court to designate a liquidation group to carry out liquidation” is a right, not an obligation, of shareholders. Thus, there is no negligence.

Third, in judging whether shareholders “neglect to perform their obligations”, preferential protection in judicial policies should be given to minority shareholders as specified in article 18.2 of interpretation II. When a shareholder proves it has taken active measures to perform its liquidation obligations, or a minority shareholder proves it neither sits on the board of directors or supervisors of the company, nor has appointed any person to serve as a member of such bodies, and that it has never participated in the company’s operation and management, it should be determined that the shareholder has not “neglected to perform its obligations” and should not bear joint and several liabilities for the company’s debts.

Finally, avoid consequentialism. The defence that there is no causality between shareholders’ passive inaction of “neglecting to perform obligations” and the adverse result of “loss of material properties, account books or important documents of the company, rendering it impossible to carry out liquidation” should be carefully examined according to evidence rules. If such a defence is established, the shareholders should not be jointly and severally liable for debts of the company, even if there is an adverse result.

To sum up, to determine shareholders’ liability in liquidation disputes, pay attention to the impact of the action (or lack of it) on the company’s inability for liquidation, rather than pursuing liability solely based on shareholding.

Wang Qiang is an associate at Leaqual Law Firm. Wang Liufang and Shi Chenchen, associates at the firm, also contributed to this article

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