Compensation liability for directors’ neglect of liquidation duties

By Li Zhingyong, Grandway Law Offices
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The second draft of the revised Company Law stipulates, in article 228, that directors are the liquidation obligors of limited liability companies. Based on this, creditors have the right to claim compensation from directors who fail to fulfil their liquidation obligations. This article explores the legal basis for this provision.

EVOLUTION OF LEGAL PROVISIONS

The Company Law does not provide for the liquidation obligor, but only stipulates in article 183 that when a limited liability company is dissolved due to reasons other than merger or separation, the liquidation team of the company is composed of its shareholders. Article 18(1) of the Judicial Interpretation II of the Company Law specifies the compensation liability of shareholders who fail to carry out the liquidation.

Compensation liability liquidation duties
Li Zhingyong
Partner
Grandway Law Offices

Article 70(2) of the Civil Code, for the first time, stipulates that the liquidation obligor is a member of the executive or decision-making body, such as the directors or a council member, who are legal persons. Article 70(3) specifies the compensation liability for negligence in liquidation. However, due to the existence of the exception clause in article 70(2), article 183 of the Company Law excludes the application of article 70(2) of the Civil Code in limited liability companies.

Article 228 of the revised Company Law stipulates that directors are the liquidation obligors of limited liability companies when the company is dissolved due to reasons other than merger or separation, and it also specifies the compensation liability for liquidation obligors who fail to carry out their duties. This achieves consistency between the Company Law and the Civil Code.

LEGAL BASIS

(1) The logic behind the compensation liability for neglect of liquidation duties of shareholders is not reasonable. In the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, the Supreme People’s Court clarified that the compensation liability for neglect of liquidation duties is a tort liability.

Whether it is classified as individual liability or vicarious liability, the compensation liability for neglect of liquidation of shareholders is difficult to logically justify. According to article 37 of the Company Law, the resolution on liquidation is a shareholder meeting’s authority, and the shareholder meeting’s decision-making process requires two active steps: convening and submitting resolutions.

Unless the articles of association of the company stipulate otherwise, shareholders cannot generally make a resolution to initiate liquidation on their own. Therefore, it is illogical to regard the neglect of liquidation as shareholders’ own liability, and to require them to compensate for it.

At the same time, the Company Law does not recognise directors as perpetrators of tort liability for failing to liquidate, and when there are no other perpetrators, asking shareholders to bear the vicarious liability of failure of liquidation is not justified.

(2) The compensation liability for neglect of liquidation duties is more conducive to the preventive function of tort liability law. The academic community believes that the preventive function of tort liability law in China is aimed at forming an effective economic mechanism through compensation for tort damages, forcing the perpetrator to take preventive measures and avoiding bearing tort compensation liability.

Under the mechanism where shareholders are unable to bypass the board of directors or execute directors to make a resolution to dissolve the company and establish a liquidation team, it is not feasible to urge shareholders to take preventive measures by holding them accountable for compensation if they cannot initiate liquidation.

It is more appropriate for the directors, who hold the first key to initiate liquidation, to bear the compensation liability for neglect of liquidation duties, better exerting the preventive function.

(3) The Supreme People’s Court hopes to resolve the relevant contradictions through interpretation. In the above-mentioned minutes, the Supreme People’s Court limited the compensation liability of shareholders for neglect of liquidation duties in two dimensions.

First, it stated that the compensation liability of shareholders should be based on their capability of fulfilling the liquidation obligation and, second, it excluded the liability of small shareholders who are neither members of the board of directors nor the supervisory board, nor appointed personnel in those positions, and who have not participated in the management of the company.

The interpretation’s intention to return the liquidation obligation to the directors is evident. However, to avoid judicial power overstepping legislative power, relevant issues urgently need to be thoroughly resolved through a revision of the Company Law.

THE PRINCIPLE OF ATTRIBUTION

According to the third paragraph of article 228 of the revised draft of the Company Law, the compensation liability of the liquidation obligor should be a special tort liability, and the principle of attribution is that accountability is based on a breach of statutory obligations without considering the intention of fault. Article 1166 of the Civil Code also shares this point.

Even if a director actively fulfils the liquidation obligation, it is still possible that the liquidation group cannot be established in a timely manner due to the obstruction of other directors, and according to the revised draft the director cannot be directly exempted from liability.

The legal basis for this is that the director has the obligation and the right to take action to prevent torts. According to article 229 of the revised draft, a director who actively fulfils his or her obligation may apply to the people’s court as an interested party to designate relevant personnel to form a liquidation group, and the principle of individual liability under tort law can still be implemented.

Li Zhiyong is a partner at Grandway Law Offices

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Grandway Law Offices
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Beijing, 100005, China

Tel: +86 10 8800 4488
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E-mail: lizhiyong@grandwaylaw.com

www.grandwaylaw.com

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