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When a debtor enters bankruptcy proceedings and a shareholder is found to have defects in capital increase while unable to make up the shortfall, creditors can only satisfy their claims by asking other shareholders to bear joint and several liability deficiency. This article examines such joint liability under the Company Law and its judicial interpretations.

Judicial divergence

Company A was a limited liability company jointly established by companies B and C, with registered capital of RMB8 million (USD1.1 million), fully paid by both shareholders. After incorporation, the two shareholders admitted Zhang San as a new investor, increasing the registered capital to RMB18 million, of which Zhang contributed RMB10 million through six residential properties under his name.

After company A entered bankruptcy liquidation, the administrator discovered that the six properties Zhang contributed were never registered under the company¡¯s name, but instead used to repay his personal debt to company C. By that point, company A, Zhang and company B had all become insolvent.

The administrator therefore sought to hold company C jointly liable for the portion of capital contribution that Zhang failed to make. The Supreme Court held that article 13(3) of the Provisions on Several Issues concerning the Application of the Company Law (III) limits founders¡¯ joint and several liability to situations arising ¡°at the time of the company¡¯s establishment¡±.

Once a company is formed, its operations and management are principally handled by directors and senior executives, rather than the founders. Additionally, founders may not be controlling shareholders and may even have withdrawn from the company, ceasing to be shareholders. As such, they no longer bear any statutory duty to supervise or verify subsequent capital contributions.

On this basis, the court concluded that the founders¡¯ joint and several liability extends only to the actual capital contributions made during the company¡¯s formation. It therefore dismissed the administrator¡¯s claim seeking to hold company C jointly liable for Zhang¡¯s failure to fulfil his capital subscription.

Yet with respect to such cases, the Supreme People¡¯s Court has issued two almost opposite rulings. In Ma Yan v SASAC of Jilin Provincial Government (2018), the court held that article?13 of provisions III presents specific, clear and unequivocal rules regarding defective capital contributions, their nature, the parties liable, and the form of liability.

From the perspective of statutory interpretation, the court reasoned that, on one hand, when a company increases its registered capital, responsibility for calling in capital from shareholders falls within the duty of diligence owed by directors and senior management. Failure to fulfil this duty can harm the interests of the company and its other stakeholders; therefore, directors and senior managers should bear liability to the relevant rights holders.

On the other hand, the liability of other shareholders differs from that of shareholders participating in the capital increase and the founders. Other shareholders are not parties to the capital increase agreement with the company, so have no obligation to contribute additional capital. Nor do they stand in a partnership relationship with the shareholder behind the additional contribution.

Therefore, they have no mutual obligation to guarantee each other¡¯s capital injection. On this basis, it cannot be concluded that other shareholders should assume joint and several liability for defects in the capital increase.

But in Shiyan Municipal Construction Engineering and Others v Dongfeng Motor Corporation and Others (2016), the Supreme People¡¯s Court adopted a different stance. It held that in case of a capital increase, article?13(4) of provisions? III applies where a shareholder fails, wholly or in part, to meet the obligation to contribute capital.

In such cases, if the company and other shareholders or creditors consider that directors or senior executives have neglected the duties of loyalty and diligence set out in article?147(1) of the Company?Law, they may pursue corresponding joint and several liability against them.

A capital increase, the court observed, expands a company¡¯s operations and its capacity to assume obligations, and in substance is no different from the shareholders¡¯ initial capital contributions at incorporation.

Accordingly, shareholders whose additional contributions are defective should bear the same liability as they would for defective capital contributions at the time of incorporation.

Doctrinal analysis

However, it is arguable that rejecting joint and several liability for defective capital increases is not well-founded. First, under the Company Law, any capital increase requires a resolution of the shareholders¡¯ meeting, supported by at least two-thirds of the voting rights. Whether at incorporation or later increases, capital formation is driven by shareholders themselves.

Second, under the subscribed-capital regime, the actual payment of capital by shareholders may lag behind the company¡¯s establishment, with considerable contributions coming after incorporation. It is therefore of little substantive meaning to confine liability to ¡°the time of incorporation¡±.

Third, both the founders¡¯ agreement and any shareholders¡¯ resolution approving a capital increase express the shareholders¡¯ collective intention to contribute capital, providing the very foundation for joint and several liability.

Finally, articles?50 and?51 of the Company Law make clear that, for both initial and subsequent subscribed capital, shareholders and the board alike are obliged to call in the capital contributions. If they fail to do so, shareholders bear joint and several liability, with directors liable for damages.

Application of provisions

Capital contributions are the bedrock of a company¡¯s ability to honour its obligations. Legally, there is no real distinction between capital subscribed by the founding shareholders and that subscribed later.

Since enactment, the Company Law has consistently required that when a company raises its registered capital, new subscriptions are subject to the same rules as those governing initial contributions.

In short, the rules that apply at incorporation also govern capital increases.

Simply because of gaps in judicial interpretation, there seems to be no basis for excluding liability of shareholders for unpaid capital when defects arise This would run against the purpose of the Company Law and undermine judicial fairness.

Li Yansheng is a managing partner at Guantao Law Firm. He can be reached by phone at +86 138 5995 7267 and by email at liys@guantao.com
Xu Chuanyuan is a partner at Guantao Law Firm. He can be reached by phone at +86 159 8096 5397 and by email at xuchy@guantao.com