China: New Judicial Interpretation Introduces Stricter Shareholder Liability

Last Updated: 30 June 2011
Article by Ulrike Glueck, Amy Chen and Ada Tong

On 6 December 2010 the Supreme People's Court of the People's Republic of China (the "PRC") promulgated Interpretation (III) of Several Issues relating to the Application of the PRC Company Law ("Interpretation III"), which came into force on 16 February 2011.

Interpretation III specifies the application of the PRC Company Law in disputes arising from company establishment, capital contributions and transfer of equity interests. Although procedural in nature, Interpretation III modifies the corporate legal framework in the PRC. Foreign investors should also consider it when drafting or amending corporate documents of foreign invested enterprises ("FIEs").

The main relevance of Interpretation III is likely to be the direct liability of a shareholder to its subsidiary's creditors for its own failure and that of other shareholders to provide capital contributions (see item 3 below for details).

Interpretation III covers the following main issues:

1. The parties' liabilities prior to the establishment of a company;

2. Validity of capital contributed in the form of property not owned by the contributor;

3. Stricter rules to support timely and complete capital contributions;

4. Unlawful capital withdrawal; and

5. Acknowledgement of the concept of nominal shareholder.

1. The parties' liabilities prior to the establishment of a company

It is common practice for investors in a company to conclude contracts (either in their own name or in the name of the company to be established) prior to the forming of the company. In practice, leases for premises are often signed before the company is established. In certain cases, supply contracts are also signed before the company has acquired its business licence. Legally speaking, a company is not established as a legal entity until its business licence has been issued, and only then does it have the civil capacity to conclude contracts in its own name.

In order to protect the other contract partner, according to Interpretation III investors must bear the related liability arising in connection with a contract concluded in their own name if the other party makes a corresponding claim. However, if the company approves or has actually performed such a contract, the company bears the related liability after its establishment in the event of a claim by the contract partner. As a consequence, if a lease is signed between landlord and investor in the name of the investor for the benefit of an FIE before its establishment, it is advisable to clearly stipulate in the lease that the landlord forfeits any claims against the investor once the rights and obligations under the contract have been assigned to the FIE. This will prevent the landlord from using Interpretation III to try to hold the investor liable for the lease of the FIE originally signed in the investor's name but later assigned to the FIE.

If the company fails to be established, the court may order all or some of the investors to bear joint liability towards the creditors if they make a corresponding claim.

2. Validity of capital contributed in the form of property not owned by the contributor

Contributions in kind to the registered capital of a company via property which the contributor concerned (the "Contributor") does not own and is not entitled to dispose of will not be automatically regarded as invalid. Contributions are deemed to be valid if:

(i) the other shareholders and the company are bona fide when the Contributor makes such contribution;

(ii) the appraisal value of the property was reasonable; and

(iii) the property has been actually delivered to the company and such ownership change has been properly registered if registration is required by law.

The actual owner of the contributed property may claim for damages against the Contributor. This means that it is possible for a company to acquire ownership of property contributed in kind which was not previously owned by the Contributor. In this respect, Interpretation III constitutes a significant improvement of a company's legal standing after receipt of such contribution in kind.

3. Stricter rules to support timely and complete contributions by investors

Interpretation III provides for stricter rules to encourage investors to duly perform their basic capital contribution obligations. Particular attention needs to be drawn to the following aspects:

(i) Who can be sued?

a) Promoters of a limited liability company bear joint liability with a shareholder who fails to duly perform its capital contribution obligation at the time of establishment of the company. The concept of promoter as defined in the PRC Company Law was originally intended for companies limited by shares only and has been extended by Interpretation III to include the shareholders of a limited liability company. Before Interpretation III, only shareholders who failed to duly perform their capital contribution obligations were liable to the company and to other shareholders who had duly performed their capital contribution obligations. The circumstances under which non-defaulting shareholders can be held jointly liable for another shareholder's failure to contribute capital are strictly limited to dissolution of the company or cases where the actual value of the capital contributions in non-monetary properties is found to be significantly lower than set out in the company's Articles of Association. The new rule has expanded the scenarios in which non-defaulting shareholders may be held liable. It also poses a considerable risk for foreign investors involved in Sino-foreign joint venture companies, should their Chinese joint venture partners refuse to fulfil their capital contribution obligation. In such cases, the foreign investors may be liable to the company's creditors for performance within the scope of the defaulting Chinese joint venture partner's unpaid capital contribution and the relevant accrued interest. They may only subsequently claim for compensation from their Chinese partners.

b) Directors and/or senior management personnel who breach their duty of loyalty and/or duty of diligence bear liability if a shareholder fails to perform its capital contribution obligation during a capital increase.

(ii) Who can sue?

The company, shareholders who have properly fulfilled their contribution obligations and the company's creditors are all entitled to sue. This is an important change to the legal concept of the limited liability company under Chinese law. Essentially, shareholders are only liable to the company for their capital contributions and not to a creditor of the company, apart from the few exceptions set out above. Before Interpretation III, creditors had to sue the company and could not sue the shareholders directly unless the company was dissolved. This change means that there is now a considerable potential risk involved in establishing joint venture companies.

(iii) What is the scope of liability?

The scope of liability due to failure to properly contribute capital includes both the outstanding capital amount and the related accrued interest.

(iv) Besides payment claims, what other rights does the company have vis-à-vis defaulting shareholders?

The company is allowed by way of shareholders' resolution to exclude the defaulting shareholder or to limit its rights, such as the right to profits, pre-emptive rights to new issuance, rights to distribution of assets after liquidation, etc.

(v) Shareholders who fail to duly perform their capital contribution obligation cannot use limitation of action as a defence in a lawsuit.

4. Unlawful capital withdrawal

Interpretation III specifies certain circumstances that constitute fraudulent withdrawal of contributed capital. They include:

(i) transferring funds out of the company by creating false debts and credit relationships or through related party transactions;

(ii) increasing profits via fraudulent financial reporting and distributing said profits;

(iii) transferring company funds after capital contribution verification; and

(iv) withdrawing capital in other ways without following legitimate procedures.

As to the consequences, the withdrawing shareholder must compensate the company and the company's creditors for all losses and damages incurred due to the capital withdrawal. Further, any shareholders, directors, senior management personnel or actual controlling persons who assist a shareholder in withdrawing its capital contribution are jointly liable. Lenders of capital to a shareholder are also jointly liable if they have agreed that the capital will be withdrawn after being verified to compensate such lender and the shareholder cannot make up the difference created by the withdrawal.

5. Acknowledgement of the concept of nominal shareholder

Interpretation III clarifies the legal interests of nominal shareholders and actual contributors. In general, a contract between a nominal shareholder and an actual contributor will be respected by the court when clarifying their respective legal interests.

If the actual contributor requests a change to the registered shareholder, the issue of a capital contribution certificate, to be recorded as a shareholder of the company, to be recorded in the Articles of Association and filed with the competent Administration for Industry and Commerce, he must obtain the consent of more than half the shareholders excluding the nominal shareholder.

If the nominal shareholder directly disposes of equity interests to a bona fide third party, the court will usually support the validity of said disposal. The actual contributor may claim damages against the nominal shareholder.

With regard to FIEs, however, the Provisions on Several Issues concerning the Trial of Disputes involving Foreign-invested Enterprises of 16 August 2010 need to be considered. Any acknowledgement of nominal shareholders in FIEs is subject to the approval of the competent Authority of Commerce. It is by no means clear whether the Authority of Commerce will allow their approval system to be bypassed in favour of any nominal shareholders. Approval and registration are the basis of the FIE regime in China. Therefore, the practical relevance of Interpretation III is likely to be minor in this regard.

6. Other issues

Interpretation III also contains regulations on the consequences of failure to properly fulfil contributions in kind, improper transfer of identical equity interests to multiple parties, etc.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 28/06/2011.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions