Disregard of corporate personality, also known as piercing the corporate veil, is a system designed to prevent shareholders from abusing the independent corporate personality of a company in order to escape their responsibilities to creditors and the public interest.
Hardly a novelty, the concept made its debut in China’s Company Law in article 20 of the 2005 revision, although it was more or less a principle at the time. When searching for cases where the disregard of corporate personality concept was supported by a court, it becomes obvious that, so far, only when a defendant admits to operating “one crew, two banners”, such as in Hainan Deer Industry Development v Hainan Union Asset Management (2018), can the test of overlapping staff be proven and corporate personality be disregarded.
Senior Partner
Ronly & Tenwen Partners
Tel: +86 133 9122 1001
E-mail: qujianjun@rtlawyer.com.cn
The minutes of the National Courts’ Civil and Commercial Trial Work Conference in 2019 became a great source of practical information and provided specific trial guidelines for the corporate personality regime. Articles 10 to 12 of the minutes listed scenarios that might trigger a disregard of corporate personality. These articles also set out criteria for judgement, including significant capital inadequacy, confusion of personalities and excessive domination and control.
Article 23 of the new Company Law updated the disregard of corporate personality concept to the following:
- Where a shareholder of a company evades the payment of its debts by abusing the company’s independent status of legal person or the shareholders’ limited liabilities, and if it seriously injures the interests of any creditor, it shall bear several and joint liabilities for the debts of the company.
- If a shareholder uses two or more companies under its control to commit the act prescribed in the preceding paragraph, each company shall be jointly and severally liable for the debts of any of the other companies.
- If the shareholder of a company with only one shareholder is unable to prove that the property of the company is independent from his/her own property, he/she shall bear joint liabilities for the debts of the company.
The new Company Law added a horizontal disregard mechanism. Where it originally only covered one-person limited liability companies, it now also applies to one-person joint stock limited companies. Overall, the amendment demonstrates a tendency to protect creditor interests. However, in judicial practice, the minutes remain the best reference.
Common scenarios
Associate
Ronly & Tenwen Partners
Tel: +86 131 2293 7528
E-mail: songyanhong@rtlawyer.com.cn
Significant capital inadequacy. Does the shareholder have paid-up registered capital? Is the company manifestly insolvent with respect to its debts? If the shareholder is demanded to bear supplementary liability only on the basis of defective capital contribution, the debt may never be settled in full if the registered capital was inadequate. However, claims based on disregard of corporate personality may subject the company to unlimited joint and several liability.
Nevertheless, the minutes’ criteria for determining capital inadequacy are still vague and must be combined with other factors to make a comprehensive judgment.
Confusion of personalities. Confusion of property, which is the core issue in confusion of personalities, refers to a state of indistinguishability between a shareholder’s property and company property. This can be quite difficult to prove in court, although it can be done by way of audit.
Considering that all company treasurers are now required to be registered and publicly available, if the company and the shareholder have the same finance controller and audit unit, proving confusion would be much easier.
Confusion of businesses and confusion of personnel are also issues of corporate personality confusion. In an effort to save costs, many companies opt for the “one crew, two banners” approach, or set up social security and other labour relations only in the shareholder’s own company.
A fourth issue is confusion of domicile, where a company and shareholder use the same office space.
Shareholder’s excessive domination and control. Transferring benefits between a parent company and subsidiary, or between fellow subsidiaries, could result in the shareholder reaping all the revenue while the company shoulders all losses and debts. Some shareholders even abscond with company assets, or transfer high-quality claims or projects to their new companies that operate similar businesses, in order to escape from the original debt.
Debt evasion and money laundering. There are shareholders that set up companies purely for money laundering or evading debt. This is often accompanied by other illegal acts such as contract fraud. Evidence may be secured by reporting it as a criminal case.
Vertical and horizontal
Vertical disregard of corporate personality, which takes place between a company and its shareholder, does not permanently revoke a shareholder’s limited liability. Rather, the added liability applies only to the case in question. Shareholders that abuse the independent status of a legal person and limited liability to evade debts and seriously injure the interests of creditors should be held directly and jointly liable.
In debt litigations, if a defendant is a one-person company the plaintiff should absolutely add the shareholder to its list of defendants, requiring them to assume unlimited joint and several liability for the company’s debts. As long as the shareholder cannot provide annual audit reports, such a claim is usually supported by the court.
Horizontal disregard of corporate personality, on the other hand, involves two or more affiliated companies controlled by the same shareholder, usually by way of investments, agreements or human resource arrangements. In litigation, the plaintiff may additionally sue the shareholder behind the sibling companies.
In these times of economic downturn, non-performing assets have surged and the number of cases involving dormant companies – no property, no staff and no office – have likewise skyrocketed. Going forward, disregarding the corporate personality, piercing the corporate veil and seeking recourse directly from the shareholder are expected to play a vital role in the protection of creditors’ interests.
Qu Jianjun is a senior partner at Ronly & Tenwen Partners. He can be contacted by phone at +86 133 9122 1001 and by email at qujianjun@rtlawyer.com.cn
Song Yanhong is an associate at Ronly & Tenwen Partners. She can be contacted by phone at +86 131 2293 7528 and by email at songyanhong@rtlawyer.com.cn
