The Supreme People’s Court Several Issues Concerning the Application of the PRC Company Law Provisions (3), which came into effect on 16 February, set forth detailed rules on the application of the law to such issues as the establishment of companies, capital contributions and the confirmation of shareholdings.
The Provisions provide the following with respect to how liabilities under contracts entered into with third parties, harm caused to third parties and other liabilities and expenses incurred during the establishment of a company are to be borne.
Where the company has been established
- If a subscriber entered into a contract in his own name, he, in principle, will bear the contractual liabilities himself, unless the company acknowledges the contract after its establishment, or has already actually enjoyed rights or performed obligations under the contract, in which case the contract counterparty may demand that the company bear the liabilities.
- If a subscriber entered into a contract in the name of the company being established, the company, in principle, will bear the contractual liabilities after its establishment, unless it has evidence showing that the subscriber executed the contract for his own benefit and that the contract counterparty did not act in good faith, in which case the subscriber will bear the contractual liabilities.
- If a subscriber causes harm to a third party in performing his duties relating to the establishment of the company, the damages in tort are to be borne by the company after its establishment.
Where no company has been established
- All or some of the subscribers are to bear joint and several liability for the expenses and liabilities incurred in connection with the establishment of the company. Those subscribers that have borne any liability may demand that the other subscribers share this liability proportionately.
- All of the subscribers are to bear joint and several liability for the harm caused to a third party by a subscriber in performing his duties relating to the establishment of the company.
Non-monetary capital contributions
The PRC Company Law does not specify the criteria for determining whether a capital contribution made in the form of non-monetary property has been paid in full (i.e. whether the capital contribution obligation has been performed in full). In this regard, the Provisions set forth the following criteria for determining this.
- If an investor makes his capital contribution in the form of non-monetary property that has not been appraised and valued, a court may appoint an appraisal firm to conduct an appraisal.
- If an investor makes his capital contribution in the form of non-monetary property that requires the carrying out of procedures for change in title, he is required to carry out the statutory procedures and actually to deliver the property to the company.
- If an investor makes his capital contribution in the form of allocated land use rights, or land use rights over which an encumbrance has been created, he is required to carry out the procedures for changing the nature of the land use rights or to remove the encumbrance within a reasonable period of time designated by a court.
- If an investor makes his capital contribution in the form of equity in another company, such equity must satisfy four conditions set forth in the Provisions.
Contribution of others’ property
- If an investor makes a capital contribution in the form of property over which he does not have a right of disposal, the matter will be handled with reference to the provisions on acquisition in good faith in article 106 of the PRC Property Law. In other words, if the company acted in good faith, it shall have ownership of the property.
- If an investor makes a capital contribution in the form of money derived from an illegal or criminal act, such as embezzlement, bribery, misappropriation or diversion, his equity interest should be disposed of by way of an auction or sale and the proceeds used to compensate the injured party, rather than directly recovering the capital contribution from the company.
Failure to contribute
With respect to the failure of a shareholder to perform his capital contribution obligation, the Provisions increase the number of parties that are required to bear liability, increase the number of rights holders that may make a claim, and limit the defence grounds that may be invoked by the liable party or parties.
Those liable and their liability
- Subscribers (bear joint and several liability with the shareholder that failed to make his capital contribution).
- Directors and senior officers (if the shareholder failed to pay his capital contribution in full as a result of a failure to perform his obligation of due diligence as specified in the PRC Company Law, he will be required to bear the attendant liability).
- The other shareholders, directors, senior officers or the actual controller that assisted the shareholder in illegally withdrawing his capital contribution (bear joint and several liability with the shareholder that illegally withdrew his capital contribution).
- A third party that advanced the capital contribution (if such party advanced funds to assist the investor in establishing the company, and, after capital verification and establishment of the company, the investor withdraws the funds to reimburse the third party but fails to make up the difference in his capital contribution, such third party and the investor are to bear joint and several liability).
- An equity transferee that acquires equity in bad faith (if an investor that has failed to perform his capital contribution obligation transfers his equity, and the transferee knew or ought to have known of this but nevertheless proceeded with the acquisition, he shall bear joint and several liability with the investor).
Rights holders and their rights
- The company and other shareholders have the right to demand that a shareholder that failed to make his capital contribution or the other subscribers fully perform the capital contribution obligation, or that a shareholder that illegally withdrew his capital contribution or the person(s) that assisted him in such illegal withdrawal return the principal of and interest on that capital contribution.
- Creditors have the right to demand that a shareholder that failed fully to perform his capital contribution obligation or a shareholder that illegally withdrew his capital contribution bear, to the extent of the principal of and interest on the capital contribution he failed to make or to the extent of the capital contribution that he illegally withdrew, supplementary damages in respect of the portion of the company’s debts that the company is unable to discharge and demand that the subscribers of the company bear joint and several liability for this.
- Such supplementary damages are a non-recurring liability, that is to say, once the shareholder that failed fully to perform his capital contribution obligation or illegally withdrew his capital contribution has borne such liability, other creditors may not make an identical claim.
- Limitation on the defence of limitation of actions: a shareholder that has failed fully to perform his capital contribution obligation or illegally withdrew his capital contribution may not mount a defence against the claim of a rights holder on the grounds that the limitation of actions in respect of such obligation has expired.
- Limitation on the defence of status: a shareholder may not refuse to perform his capital contribution obligation on the grounds that he is only a nominal shareholder.
Illegal withdrawal of contributions
The Provisions set forth several circumstances that constitute illegal withdrawal by a shareholder of his capital contribution, filling a void in the PRC Company Law:
- once his capital contribution is transferred into the company’s account and verified, he transfers it out again;
- he transfers his capital contribution out by fabricating a false creditor-debtor relationship;
- he prepares fraudulent financial accounting statements to fraudulently increase profits that are then distributed;
- he makes use of a connected transaction to transfer his capital contribution out; or
- he otherwise withdraws his capital contribution without carrying out the statutory procedure.
Shareholders failing to contribute
- In the case of a joint stock limited company, if a subscriber fails to pay his capital contribution on schedule and still fails to do so after a reminder from the subscribers, the subscribers may put such shares up for offer to others.
- In the case of a limited liability company, if a shareholder fails fully to perform his capital contribution obligation or illegally withdraws all of his capital contribution, his qualifications as a shareholder may be terminated by way of a shareholders’ resolution. With respect to the capital contribution not made by such shareholder, the company may carry out a reduction of capital, or the capital contribution may be made up by the other shareholders or by a third party.
- The company may, by way of its articles of association or of a shareholders’ resolution, place reasonable restrictions on the rights of a shareholder that has failed fully to perform his capital contribution obligation or has illegally withdrawn his capital contribution, such as the right to claim a profit distribution, the pre-emptive right to subscribe for new shares and the right to a distribution of remaining property.
Pursuant to the PRC Company Law, when a shareholder makes his capital contribution in accordance with the law or acquires equity by way of succession, the company is required to issue him an investment certificate, record his name in the register of shareholders and carry out business registration procedures. However, in practice, many companies fail strictly to perform these obligations. The Provisions provide that such a shareholder may institute a legal action, demanding that the company perform these obligations.
Nominal and actual investors
In practice, based on the provisions of a contract or for other reasons, the nominal shareholder and actual investor may be different persons. The Provisions address this issue:
- if the contract executed by the actual investor and the nominal shareholder is valid, the investment benefits may be claimed against the nominal shareholder in accordance with the contract and the nominal shareholder may not mount a defence on the grounds that he is the shareholder recorded in the register of shareholders;
- if the actual investor is to request that the company change shareholders, issue him an investment certificate, record his name in the register of shareholders, record his name in the articles of association of the company and carry out registration with the company registry, he requires the consent of at least half of the other shareholders;
- if the nominal shareholder transfers, pledges or otherwise disposes of the equity registered under his name to a third party, or if a shareholder that has transferred his equity again transfers the same equity before registration of the change in the equity is carried out with the company registry, matters, in both cases, will be handled with reference to the system governing acquisitions in good faith in article 106 of the PRC Property Law;
- if someone fraudulently uses another’s name to make a capital contribution and registers such third party as a shareholder with the company registry, the person whose name was fraudulently used and registered as the shareholder shall not bear any liability.
In addition to the above, the Provisions set forth rules on substantive and procedural issues relating to the parties in cases for the confirmation of shareholder qualifications, requirements in respect of the adduction of evidence in equity title disputes, and other relevant matters.
Business Law Digest is compiled with the assistance of Haiwen & Partners. The authors can be emailed at firstname.lastname@example.org. Readers should not act on this information without seeking professional legal advice.