Neglect of liquidation duties by limited company shareholders

By Zhu Qimin and Yin Shi, Han Kun Law Offices
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Limited liability of shareholders is an important feature of modern companies. Article 3.1 of the Company Law provides that the liability of a shareholder shall be limited to the amount of their capital contribution/the number of their subscribed shares. However, under special circumstances, such as when a shareholder neglects to fulfil liquidation obligations, resulting in a failure to liquidate the company due to the loss of company property, the limited liability system may not suffice.

In the past decade, many changes have been made to the judicial practice of determining the neglect to fulfil liquidation obligations and responsibilities by shareholders in limited liability companies.

Early attitudes

Zhu Qimin, Han Kun Law Offices
Zhu Qimin
Partner
Han Kun Law Offices
Tel: +86 8516 4149
Email: qimin.zhu@hankunlaw.com

The negligence of shareholders of limited liability companies in fulfilling liquidation obligations was first directly stated in the Provisions of the Supreme People’s Court on Certain Issues Concerning the Application of the Company Law of the People’s Republic of China (II) promulgated in 2008. To protect the interests of creditors and establish a healthy corporation withdrawal mechanism, after the promulgation of the above-mentioned interpretation (II), the court strictly requires shareholders who neglect their liquidation obligations to assume liability for the company’s debts.

It is worth noting that in September 2012, the Supreme People’s Court (SPC) issued Guiding Case No. 9, indicating that whatever the shareholding ratio in the company, or whether they actually participate in operation and management, they are obliged to liquidate the company within a time limit after any statutory liquidation circumstance occurs.

As long as they neglect to fulfil the liquidation obligations, there will be a causal relationship between them and the loss of a company’s main property and account books, and they should bear joint and several liability for the company’s debts. Since then, local courts have dealt with similar cases with reference to Guiding Case No. 9, and gradually formed a unified adjudication rule.

Over time, this gave rise to so-called professional creditors. They buy idle creditors’ rights from companies that meet the liquidation conditions at a low price, and then require the shareholders of limited liability companies to bear joint and several liability for paying off the company’s debts, taking advantage of the provision on shareholders’ negligence in fulfilling the liquidation obligations.

As a result, minority shareholders can be liable for the company’s enormous debts, causing an obvious imbalance between rights and obligations. The phenomenon drew the attention of the Filing Office of Legislative Affairs Committee of the Standing Committee of the National People’s Congress and the United Front Work Department, both of which have written to require the SPC to investigate.

Recent recalibrations

Yin Shi, Han Kun Law Offices
Yin Shi
Senior Associate
Han Kun Law Offices
Tel: +86 8525 5540
Email: shi.yin@hankunlaw.com

On 8 November 2019, the SPC issued the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, which fundamentally altered the adjudication rules of strict liability fixation in Guiding Case No. 9.

Article 14 of the above-mentioned minutes defines “neglecting to fulfil liquidation obligations” as passive behaviour failing to fulfil the obligations intentionally or negligently when the liquidation obligation can be fulfilled after the occurrence of liquidation causes.

Article 14 also lists valid defences for shareholders claiming non-constitution of negligence in fulfilling their obligations:

    1. Shareholders have taken active measures to fulfill their liquidation obligations, such as requesting the controlling shareholder or other shareholders to liquidate the company, but the latter has not initiated the process;
    2. Minority shareholders prove that they are not, and have not appointed any person to serve as directors or supervisors of the company, and have never participated in its operation and management.

Article 15 of the minutes changes the previous “consequentialist” judgment tendency, and provides a causal relationship between “negligence in fulfilling liquidation obligations” and “failure to liquidate due to the loss of the company’s main property, account books or important documents” as a necessary condition for shareholders to assume joint and several liability for the company’s debts.

For example, if a shareholder can prove that the company’s main property or account books were lost before the occurrence of the cause of liquidation, then it has no fault in the loss, and the causal relationship cannot be established. Even if there is the “result” of the company’s inability to liquidate, the shareholders should not be jointly and severally liable for the company’s debts due to “negligence in fulfilling the liquidation obligations”.

After the adjustment of the minutes, the unfair situations where minority shareholders were required to bear the company’s debts far exceeding their capital contribution have been significantly improved.

Looking ahead

Who is the liquidation obligor of a limited liability company? This is a fundamental question when determining if shareholders have neglected their liquidation obligations.

According to article 18 of interpretation (II), the liquidation obligor of a limited liability company appears to be the company’s shareholders. Some believe the liquidation obligor should be the company’s directors, not the shareholders, and the shareholders’ “liquidation obligations” do not exist at all, so the shareholders should not be held responsible for “neglecting to fulfil the liquidation obligations”. In this regard, the SPC made no provision in the minutes, indicating that the issue would be solved by the revised Company Law.

It is worth noting that the Draft for Comments on the Company Law (Revised Draft) published in December 2021 provides in article 228 that the directors are the liquidation obligor of the company, and should bear the compensation liability for the company’s failure to liquidate in time, a clear break from the relevant provisions of the current Company Law and the interpretation (II).

However, it remains uncertain whether the above-mentioned contents of the draft for comment will be retained in the official version of the new Company Law as is. Will the exemption of shareholders’ liquidation obligations aggravate the phenomenon that shareholders use “zombie enterprises” to evade debts in practice? Will the official new Company Law make special provisions for shareholders that actually participate in or even control the company’s operations without serving as directors? The authors will continue to keep an eye on the issue.


Zhu Qimin is a partner at Han Kun Law Offices. She can be contacted on +86 8516 4149 or by email at qimin.zhu@hankunlaw.com

Yin Shi is a senior associate at Han Kun Law Offices. He can be contacted on +86 8525 5540 or by email at shi.yin@hankunlaw.com