Promoter shareholder liabilities for capital adequacy

By Wu Jiejiang, Jingtian & Gongcheng
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The Company Law provides that “limited liability”, with regard to a limited liability company, means that shareholders assume limited liability for debts of the company to the extent of their subscribed contributions. This is a general principle of the Company Law on limited liability of shareholders.

The Company Law and its judicial interpretations also contain exceptions for limited liability of shareholders, including joint and several liabilities of promoter shareholders for capital adequacy.

Definition of promoter shareholder

Article 1 of judicial interpretation III of the Company Law defines shareholders at incorporation of a limited liability company, or a company limited by shares, to be promoters of the company. In other words, provisions of the Company Law and its interpretations on obligations of promoter shareholders of a company are also applicable to initial shareholders of a limited liability company.

Joint and several liabilities of promoter shareholders for capital adequacy

Article 30 of the Company Law provides that, after the incorporation of a limited liability company, if the actual value of non-monetary assets as capital contributions for its incorporation is found to be notably lower than the value specified in the articles of association of the company, the shortfall shall be made up for by the shareholders who contributed that capital, and other shareholders at incorporation shall be jointly and severally liable.

Article 93 provides that, following incorporation of a company limited by shares, any promoter who fails to make full payment of capital contributions as stipulated in the articles of association shall pay the outstanding amount, failing which, other promoters shall be jointly and severally liable for the shortfall.

Article 13.3 of judicial interpretation III of the Company Law provides that, if a shareholder does not perform or fully perform his obligation for contribution at incorporation of the company, the plaintiff who files litigation as per applicable provisions may request the promoters and defendant shareholders of the company to assume joint and several liabilities.

Pursuant to the above-mentioned, promoter shareholders should be jointly and severally liable for capital adequacy of the company.

Several concerns relating to joint and several liabilities

(1) The joint and several liabilities for capital adequacy cover the current obligation of capital contribution at incorporation, and subsequent obligation of capital contribution. Is promoter shareholder’s joint and several liabilities for capital contribution “at incorporation of the company” as provided in the above-mentioned judicial interpretation III of the Company Law limited to the current obligation of capital contribution at incorporation, or should it include the obligation to pay subsequent contributions subscribed at incorporation under the subscription mechanism?

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Wu Jiejiang
Partner
Jingtian & Gongcheng

The Supreme People’s Court gave the answer in a press conference regarding judicial interpretation III of the Company Law, that article 93.1 of the Company Law is also applicable to limited liability companies. In other words, if a shareholder of a limited liability company does not pay his/her capital contribution as per the articles of association, promoter shareholders and such shareholder should be jointly and severally liable. Promoter shareholders should be jointly and severally liable for current obligation of capital contribution at incorporation, and the obligation for payment of subsequent capital contribution subscribed at incorporation, as agreed in the articles of association.

(2) Will the deadline of capital contribution that has not expired be accelerated? A promoter shareholder may be required to assume joint and several liabilities for capital contribution obligations of other promoter shareholders while the company is yet to be bankrupt or liquidated. In this case, according to the Minutes of National Working Conference on Trial of Civil and Commercial Cases by Courts, shareholders are entitled to maturity benefit under the registered capital subscription mechanism.

If a creditor requests the shareholder whose deadline of capital contribution has not expired to be liable for compensating outstanding debt of the company to the extent of his/her unpaid capital contribution, because the company is unable to repay the mature debt, the people’s court should not support such a request. Accordingly, promoter shareholders may defend themselves based on whether the deadline of capital contribution expires or not.

The minutes, however, provides exceptions for the legal defence: (i) in cases where the company is the enforced person, the people’s court exhausts its execution measures, but no assets are available for execution, and the company does not apply for bankruptcy even through it has the reason for bankruptcy; and (ii) after the debt is created, shareholders’ deadline of capital contribution is extended by resolutions of shareholders’ meeting, or general meeting, or other ways.

(3) Will the promoter shareholder assume joint and several liabilities when he/she is no longer a shareholder of the company? According to the judgment rule indicated in the civil judgment of the case over recovery of unpaid capital contribution ([2019] Wan 18 Min Chu No. 84), a promoter shareholder will not be exempted from his/her due joint and several liabilities for capital adequacy by transferring his/her equity to others and quitting as a shareholder of the company.

(4) Will the joint and several liabilities of a promoter shareholder be affected by whether his/her own proportionate capital contribution has been paid or not? As per the judgment rule indicated in the above-mentioned civil judgment, if a promoter shareholder who is required to assume joint and several liabilities for capital adequacy defends that he/she has paid the capital contribution as agreed, such defence is not in the scope of investigation of the case and the court would not support the defence, as it is irrelevant to the capital contribution made by the promoter shareholder who is requested to be liable for defect of capital contribution. In other words, whether the promoter shareholder has paid his/her own capital contribution in full does not affect his/her assumption of the joint and several liabilities.

In practice, some entrepreneurs decide to incorporate companies together with investors so as to avoid the tax risk of the arrangement that they incorporate companies first, and investors increase the registered capital by investments with a premium. In the case of joint incorporation, only investors are liable for paying the initial registered capital of the company; entrepreneurs may defer their payment of contributions. In this case, investors, as promoter shareholders, are objectively exposed to the potential risk of being requested to assume joint and several liabilities for capital adequacy. Such risk deserves the attention of market investors. They should take measures as early as possible to eliminate such risk.

Wu Jiejiang is a partner at Jingtian & Gongcheng

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