New SPC judicial policy makes restrictive interpretation on shareholder's liabilities - CWG
Vincent Xuekai Qian
Mena Yun Li
Shareholders’ liability for indolent performance of liquidation obligation under the judicial interpretation of the Supreme People’s Court (SPC) on application of company law
According to the Company Law of the People’s Republic of China (the 'Company Law'), a company can be voluntarily or compulsorily dissolved. Article 180 of the Company Law (2018 Revision) stipulates that a company shall be dissolved for the following reasons:
- expiry of the term of operation stipulated in the articles of association of the company or occurrence of an event which triggers the dissolution as provided in the company’s articles of association;
- a resolution on dissolution has been passed by the board of shareholders or a shareholders’ general meeting;
- where the dissolution is required by a merger or division;
- the business licence is revoked or the company is ordered to be wound up or annulled; or
- a dissolution of the company is ordered by a people’s court in accordance with the provisions of Article 182.
Dissolution under Article 182 means, where a company experiences serious difficulties in its business and shareholder benefits will suffer serious damages if the company continues its operation, a shareholder or a group of shareholders holding ten per cent or more of the voting rights of the company may, in the absence of any other means, filing for application for a compulsory dissolution of the company with the people’s court.
A timely liquidation shall be conducted after dissolution of the company. Article 183 of the Company Law (2018 Revision) regulates that where a company is dissolved in accordance with the provisions of item (1), (2), (4) or item (5) of Article 180, a liquidation group shall be established to commence liquidation within 15 days from the occurrence of the event which triggers the dissolution. The liquidation group of a limited liability company shall be formed by the shareholders; the liquidation group of a company limited by shares shall comprise members appointed by the directors or the board of shareholders. Where the liquidation group has not been established by the deadline to conduct liquidation, the creditors may apply to a people’s court to appoint related individuals to form a liquidation group to conduct liquidation. The people’s court shall accept the application and form a liquidation group to conduct liquidation promptly.
The above-mentioned provisions stipulate the circumstances under which a company should be liquidated and how to submit an application for liquidation of the company to the people’s court but they fail to stipulate the liquidation obligor’s liability for failure to commence liquidation promptly. According to the paragraph 1 of Article 189 of the Company Law, members of a liquidation group shall perform their duties diligently and perform liquidation obligations in accordance with the provisions of the law. Paragraph 3 of Article 189 further stipulates that members of a liquidation group shall compensate the company or its creditors for damages suffered by the company or its creditors out of intention or gross negligence of the member(s) of the liquidation group. However, there are no specific provisions on the liability for such specific intention or gross negligence.
In practice, many company shareholders do not liquidate the company promptly in order to evade debts, which will cause serious harm to creditors’ interests. To solve this issue, on 5 May 2008, the Supreme People’s Court released Provisions on Several Issues Relating to Application of Company Law of the People’s Republic of China (II) (Judicial Interpretation of the Company Law(II) or JICL II). Paragraph 2 of Article 18 of JICL II, for the first time, clearly stipulates that where the shareholders of a limited liability company or the directors and controlling shareholders of a company limited by shares are slow to perform liquidation liabilities resulting in extinguishment of the company’s key assets, account books, important documents and so on, and making liquidation impossible, the people’s court shall uphold the claims pursuant to the law if the creditors claim that such shareholders of the limited liability company or directors and controlling shareholders of the company limited by shares bear repayment liability jointly and severally for the company’s debts,.
The Supreme People’s Court in its Guiding Case No 9 on 18 September 2012, Shanghai Cunliang Trading Co, Ltd v Jiang Zhidong, Wang Weiming and Others Sales Contract Disputes (Guiding Case 9), holds that shareholders of limited liability companies, directors and controlling shareholders of companies limited by shares shall perform their liquidation duties after the company’s business licence is revoked in accordance with the law, and cannot be exempted from liquidation obligations on the grounds that they are not the actual controller or have not actually participated in the company’s business management. The Guiding case has become a normative document for resolving similar disputes. Since then, courts have often referred to this guiding case for judgment. The main point of view of the Guiding case is that minority shareholders cannot be exempted from liquidation obligations on the grounds that they have not participated in actual operation and management. The court focuses on protecting the interests of creditors. Such judicial point of view has played a role of urging a related party to liquidate the company promptly and protect the interests of common creditors.
The SPC’s new judicial policy on restrictive interpretation on shareholders’ liability for indolent liquidation
The problems arising from JICL II have become increasingly prominent. In the Minutes of the National Court Work Conference for Civil and Commercial Trials (the Ninth Civil Minutes) released on 8 November 2019, the Second Civil Tribunal of the Supreme People’s Court held that, with respect to the assertion of the shareholders’ liability for the liquidation of a limited liability company, the results of some case adjudications have inappropriately amplified the shareholders’ liability for the liquidation. In particular, in practice, some professional creditors file lawsuits for compulsory liquidation against a large number of zombie enterprises after acquiring a large number of zombie enterprises from other creditors at unreasonably low prices and in large quantity. On receipt of the confirmation by the People’s Court that the company’s main assets, account books, important documents, etc were extinguished, the limited liability company’s shareholders will be requested to assume the joint and several liability for the repayment of the company's debts according to paragraph 2 of Article 18 of JICLII. Some people’s courts did not accurately comprehend the conditions for application of the previously mentioned provisions and ruled that the minority shareholders liable for the company’s debts where such minority shareholders not ‘indolent to perform their obligations’ or though ‘indolent to perform their obligations’ but no causal relationship was established between indolent acts and the extinguishment of the company’s main assets, account books, important documents and so on, making the liability of the shareholders exceed the amount of their capital contribution substantially and resulting in obvious imbalance of interests. It should be clarified that the nature of the previously mentioned judicial interpretation on shareholder liquidation liability of a limited liability company is the tort liability that shall be borne by a company that is unable to carry out liquidation due to the shareholder’s delay in fulfilling their liquidation obligations. To make a ruling whether the shareholders of a limited liability company shall assume the liability for compensation to the creditors, the following factors shall be taken into consideration:
Ruling of indolent performance of liquidation obligation
The ‘indolent performance of liquidation obligation’ as stipulated in the second paragraph of Article 18 of JICLII shall mean that a shareholder of a limited liability company, when it is able to perform liquidation obligation after occurrences of liquidation events as regulated by law, intentionally delays or refuses to perform liquidation obligation, or any passive acts which made it unable to carry out liquidation due to negligence. Where a shareholder presents evidence to prove that it has taken positive measures to perform liquidation obligations, or a minority shareholder has presented evidence to prove that it is neither a member of the company’s board of directors or board of supervisors nor did it appoint personnel to act as a member of the said authorities and has never participated in the company’s business management and claim that it shall not bear joint and several liability for repayment for the company’s debts by citing that ‘failure to perform obligations’ is not constituted, the people’s court shall support the defence pursuant to the law.
Defence of causation
Where a shareholder of a limited liability company furnishes evidence to prove that its inaction of ‘indolent to perform its obligations’ has no causation with the consequence that ‘the company’s major assets, account books or important documents were extinguished, making it impossible to conduct liquidation’ and therefore claims that it shall not bear the joint and several liability for the company’s debts, the people’s court shall uphold such claim.
Defence of statutory time limit for litigation
Where any creditor of a company claims against any shareholder of the company to bear joint and several liabilities for repaying the company’s debts and such shareholder defends themselves on the grounds that the statutory time limit for any creditor of the company to claim against the company has expired, the relevant people’s court shall uphold the defence on verification after investigation.
Where a creditor of a limited liability company requests a shareholder of the company to bear joint and several liability for repayment of the company's debts based on the second paragraph of Article 18 of the JICLII, the statutory time limit for litigation shall commence from the date on which the creditor of the company knew or should know that the company was unable to be liquidated.
Further interpretations and comments
According to the Comprehension and Application of the Minutes of the National Court Work Conference for Civil and Commercial Trials compiled by the Second Civil Tribunal of the Supreme People’s Court, ‘Performance of Obligations’ shall not mean series of liquidation obligations to initiate liquidation. Such would include establishing a liquidation group, conducting liquidation services, completing liquidation and applying to the people’s court for declaration of insolvency after discovering that the company’s assets are insufficient to pay off its debts. Instead, it shall only refer to failure to initiate the liquidation procedure by establishing a liquidation group or failure to collect the company’s main assets and maintain account books, important documents and other obligations after the establishment of the liquidation group.
‘Indolence’ shall mean a type of inaction which may include both intention and negligence in terms of its default forms. ‘Intention’ shall mean that the shareholders of a limited liability company deliberately fail to perform their obligations of initiating the liquidation process, establishing a liquidation group to liquidate the company, collecting the company main assets, maintaining the company’s account books and important documents after the statutory liquidation procedures occurred and also shall mean refusal of performance and liquidation obligations after being requested by other shareholders. ‘Negligence’ shall refer to the shareholders who do not know about undertaking their liquidation obligations, initiating liquidation procedures, establishing a liquidation group, collecting the company’s main assets, and maintaining the company’s account books and important documents after the statutory liquidation procedures occurred due to lack of knowledge of laws.
Under each specific case, shareholders shall provide evidence that positive actions have been taken, such as requesting the controlling shareholder or other shareholders to liquidate the company but no response was obtained from the latter, or prove that, as the members of the liquidation group, the shareholders have requested other members of the group to collect the company’s main assets and maintain the company’s account books and important documents but no active actions were taken by other members of the liquidation group.
We believe the Ninth Civil Minutes provides a method of ruling for the courts at all levels in the trial of liquidation liability cases and will play a positive role in the correct application of the JICLII. However, according to the rationale of tort law, causation is one of the essential constituent elements of tort liability and statutory time limit for litigation is also a key factor which should be considered while the creditors initiate a lawsuit. The interpretation of causation and statutory time limit for litigation shall not be deemed as substantive judicial provisions created by the Ninth Civil Minutes; rather, these provisions merely manifest an attitude of the Supreme Court. The substantive provisions of the Ninth Civil Minutes on the shareholders’ liquidation liabilities shall be regarded as restrictive interpretations on the ruling of the liabilities for shareholders indolent in performing their obligations of liquidation aiming at preventing creditors from inappropriately overburdening the shareholders’ liability by abuse of the relevant JICLII provisions. The Ninth Civil Minutes actually tries to seek a reasonable balance between the shareholders’ liability for the liquidation of a limited liability company and protecting creditors’ interests. However, this judicial policy may also release negative policy signals, resulting in company shareholders not undertaking their liquidation obligations, and therefore harming the interests of creditors, which is not conducive to building a credible market credit system.