China: Supreme People´s Court Clarifies Several Issues Regarding The Application Of The PRC Company Law

Last Updated: 2 September 2008
Article by Diarmuid O'Brien

Key Points:

  • Liquidation procedures and rights of creditors further elaborated

  • Increased potential liability for shareholders', liquidation committee and effective controllers

On May 19, 2008 the Provisions of the Supreme People's Court on Several Issues Regarding the Application of the PRC Company Law (II) (the "Provisions") became effective.1 The Provisions detail the practical application of the new PRC Company Law (the "Company Law") by the People's Court in hearing applications for dissolution and liquidation. In particular, the Provisions clarify the circumstances in which applications for dissolution can be accepted or rejected by the court and the rights of creditors including their rights against shareholders, directors, the liquidation committee and effective controllers of companies whose actions (or inaction) cause loss to the company and, indirectly, to the creditors.

Provisions state that in cases in which a shareholder or shareholders separately or collectively hold 10% or more of all shareholders' voting rights in a company, that shareholder or those shareholders can lodge an application for corporate dissolution in any of the circumstances detailed below, providing that the application complies with Art. 183 of the Company Law. In such a case, the shareholder(s) and company shall be the plaintiff and defendant respectively. The circumstances are as follows:

  1. When the company has failed to hold a shareholders' meeting or shareholders' general meeting for two or more consecutive years and the company is experiencing serious difficulties in terms of managing its business;

  2. When voting by the shareholders fails to attain the statutory proportion or the proportion detailed in the company's articles of association, the shareholders' meeting or general meeting has failed to render any valid resolutions for two or more consecutive years and the company is experiencing serious difficulties in terms of managing its business;

  3. When a stalemate or conflict exists among the company's directors for a prolonged period, the shareholder(s) have been unable to resolve that stalemate via a shareholders' meeting or general meeting and the company is experiencing serious difficulty in terms of managing its business;

  4. When the company experiences other types of serious business management difficulties to the point at which its continued operation will adversely affect the interests of the shareholder(s).

A court is expressly prohibited from accepting an application from shareholder(s) for corporate dissolution when any of the following claims are made: (i) that the company has failed to provide information requested by the shareholder(s) or has failed to satisfy or address a claim for dividends; (ii) that any rights or interests of the shareholder(s) have been damaged; (iii) that the company is losing money and is insolvent; or (iv) that liquidation proceedings have not commenced despite the company's business license having been revoked. The court may not accept an application for liquidation if an application for dissolution has already been filed by the shareholder(s). However, once the court has ruled to dissolve a company, the court may request that the shareholder(s) arrange for a voluntary liquidation per Art. 184 of the Company Law. If the court refuses an application for dissolution from a shareholder or shareholders, it must reject any other application from other shareholders based on the same facts or circumstances.

For example, if a dissolution has been filed for by the shareholder(s) as well as an order for the preservation of property and evidence, the court may grant the latter application(s) if appropriate security has been provided by the shareholder(s) and the granting of the order will not interfere with or disrupt the company's day-to-day business operations.

Once an application for dissolution is filed, the plaintiff (or, in default, the court) must notify the other company shareholder(s) with an invitation to participate in the proceedings. If any other shareholders apply to participate in the proceedings, the court will classify them as co-plaintiffs.

In dissolution applications, the courts are actively encouraged to promote mediation. In cases in which a mediated settlement provides for a reduction in registered capital or the sale of shares, the court must support the settlement if it can save the company. If an agreement provides for the company to purchase the plaintiff's shares, the company is obliged to complete the transfer or write-off of shares within six months. If mediation fails to achieve agreement regarding the company's continued existence, the court must promptly issue its judgment.

The Provisions establish that once a voluntary liquidation has been sanctioned, a liquidation committee must be established within 15 days. However, if the company fails to form a liquidation committee, delays the liquidation procedure or undertakes an unlawful liquidation process that threatens the interests of creditors, the opportunity exists for any creditor(s) or, in default, other shareholder(s) to apply to form a liquidation committee. In granting an order for dissolution, the court is obliged to act promptly in appointing members to the liquidation committee. The Provisions state that members may be drawn from shareholders, directors and senior company management and from law and accounting firms or others with the necessary professional experience and qualifications. While this is not expressly stated, it appears that shareholder(s), creditors and possibly other interested parties are entitled to file objections to the proposed appointments to the liquidation committee. So long as a liquidation process can be commenced and a committee appointed, the company cannot be formally liquidated until all civil proceedings, to which the company is a party, have been concluded. A court-organized liquidation must be completed within six months, but extensions can be sought if circumstances warrant additional time.

Significantly, the Provisions establish increased rights and protections for creditors at the expense of the liquidation committee, the shareholders and third party controllers whose actions (or inaction) cause losses to creditors. In the usual ways, such as via newspaper advertisements, the committee must announce the pending liquidation and notify all creditors. If the liquidation committee fails to do so, and such violation results in losses to creditors, the liquidation committee itself must assume liability for any losses incurred. Our understanding is that, for the committee members, that liability would be joint and several. Similarly, if a failure by shareholders to appoint a liquidation committee and commence a liquidation results in losses to creditors, the shareholder(s) will be liable for any related losses incurred by the creditors. Notably, if the failure to act is caused by a party that effectively "controls" the company, liability will rest with those persons. The rights of creditors are further elaborated upon via the following clarifications:

  1. Affording them the right to question and call for verification of the list of creditors prepared by the committee. If creditors object to the results of any reverification, they may apply to the court for examination and confirmation.

  2. Creditors who fail to make a claim on time are entitled to register their declaration at any time prior to the conclusion of the liquidation.

  3. If the undistributed property of the company is insufficient to satisfy sums due a creditor, the creditor is entitled to claim settlement from any residual company property distributed to the shareholders. However, creditors may not file a liquidation application against the company merely because the company's undistributed assets and assets derived from shareholders resulting from a distribution of residual company assets are insufficient to satisfy the entirety of a creditor's claim.

  4. If shareholders have failed to pay any part of the subscribed registered capital, and the claims of creditors cannot be satisfied in their entirety, the aggrieved creditor may apply to the court to have the defaulting shareholders assume joint and several liability for the debts of the company up to the amount of the uncontributed capital.

  5. If a liquidation committee violates laws, regulations or the company's articles, thereby causing loss to the company or its creditors, an application to impose liability on the committee may be filed by the company or creditors (as the case may be) against the liquidation committee.2

  6. The liquidation committee is entitled to negotiate a settlement and debt repayment program with all creditors. The court will approve such a program providing it is supported by all the creditors and the court is satisfied that it does not prejudice the interests of other interested parties. In undertaking a liquidation procedure, it is important to note that: (i) in the case of a voluntary liquidation, the committee's liquidation report must be filed with and approved by the shareholders' meeting and (ii) in a court-organized liquidation, submission to and approval by the court is required. If the committee fails to obtain that approval, the committee bears liability for any losses incurred by creditors. Liability also attaches to any shareholders, directors and effective or actual controllers of company (as the case may be) for any losses incurred by creditors as a result of deregistration of the company without conducting liquidation.

The Provisions are a welcome elaboration on China's Company Law and will serve to considerably assist the courts and all interested parties in undertaking liquidation procedures.

Footnotes

1. Adopted at the 1447th meeting of the Judicial Committee of the Supreme People's Court on May 5, 2008; Judicial Interpretation No.6 [2008] of the Supreme People's Court.

2. If a liquidation committee violates laws, regulations or the company's articles, aggrieved shareholder(s) who separately or collectively hold just 1% or more of the company's shares for not less than 180 consecutive days can file a suit with the court against the liquidation committee for recovery of those losses

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