The corporate veil or the corporate personality is a legal term refers to the separation of the corporate entity from the shareholder in a litigation. When shareholders’ liabilities in China become personal.
In such case, the court usually renders the shareholder personally liable for the debts, negligence, or mismanagement of the business, and personal assets may be reached.
In China, the shareholder holds the highest authority in the governing corporate structure. The shareholder may protect company interests by initiating legal proceedings against the appointed or elected directors, supervisors, or senior management who neglect their duties in accordance to the laws and administrative regulations. And such actions cause the company to suffer damage.
A shareholder of a limited liability company (‘LLC’) is liable for the company to the extent of the capital contribution it subscribes. A shareholder of a company limited by shares shall also be liable for the company to the extent of the shares it subscribes.
The Shareholder is generally liable to the extent of their capital contributions or shares. The company will be liable for the debts.
However, there are cases in which shareholders’ liabilities in China become personal. For foreign shareholders, understanding the corporate veil is crucial in establishing the governing body of the corporate entity. Below, we outline the main cases that shareholders could be held personally liable.
Abuse of Shareholder Rights
In a joint venture or board of shareholders, the interest of the individual shareholder may conflict with the interest of the company. The individual shareholder may abuse shareholder’s rights for the benefit of the individual. Therefore, the company suffers damages and losses. In such cases, the Chinese law permits shareholder(s) to hold the violating shareholder liable for compensation.
Under Provisions on Several Issues concerning the Application of the Company Law of the People’s Republic of China V (‘The Provisions’), shareholders are strictly prohibited from the following:
- abusing shareholders’ rights, the independent company’s status as a legal person, or
- the limited liability of shareholders.
Any shareholder that causes loss to the company or other shareholders by such abuse will be liable for compensation.
In practice, shareholders in a board of shareholders have the right to initiate legal proceedings against another shareholder(s) who are acting against the interest of the company. Examples include: diverting company funds or profits, entering into contracts against the interest of the company and so forth.
Equally, the Provision can be applied where there is a sole shareholder. The court can hold the shareholder personally liable if they abuse the company’s independent status or their limited liability.
Insolvency
If a company goes insolvent, there are certain situations where the courts may hold shareholders liable for the outstanding debts. Such liability can be applied to the following circumstances in insolvency.
The Controlled Company
The corporate status of a controlled company is ignored if:
(i) its financing and management are closely connected to its parent company. It does not have any independent decision-making authority; and
(ii) it is induced to entering a transaction beneficial to the parent company, but detrimental to it as well as any third party.
The Alter Ego
An Alter Ego company is not treated by its owners as a separate entity.
Undercapitalisation.
The shareholder(s) shall bear supplementary compensation liability to creditors to the extent of the capital not contributed. Additionally, the shareholder(s) shall bear the interest for the part of debts that cannot be repaid. This is provided that a shareholder fails to fulfill or fully fulfill its obligation of capital contribution.
Breach of Duty
If the shareholder commits a breach of duty, such as:
(i) failure to establish a liquidation group within the statutory time limit and to commence the relevant liquidation process;
(ii) any delay in the performance of obligations during the liquidation;
(iii) any malignant disposition of the corporate properties upon the dissolution of the corporation or without carrying out the relevant liquidation work in accordance with the law.
(iv) conducting the corporate cancellation procedure by deceiving authorities with a false liquidation report.
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