Piercing the Corporate Veil

In their reply, the metal plant and machine company argued that the Company was properly established as a limited liability company, as evidenced by its business license. Moreover, they had paid in their registered capital in full. Accordingly, they claimed, they should bear no further liability for the debts of the Company.

The old age commission conceded that it had not paid in its registered capital. However, it argued that it could not be held liable for the debts of the Company as the Company was a limited liability company and had been issued a business license.

In any event, the commission claimed that it had no money.

The court decided that even though the Company had been issued a business license, the Company did not qualify as a legal person under the PRC Administration of Enterprise Legal Person Registration Regulations, which required a minimum of Rmb300,000 in registered capital. Accordingly, the court held all three investors jointly and severally liable. The Guarantor eventually recovered the outstanding amount from the machine company through compulsory enforcement.

Some Basic Principles

This case demonstrates that PRC courts are, in certain circumstances, willing to pierce the corporate veil.1
Piercing the corporate veil is where the courts hold the investors in a limited liability company liable beyond their subscribed registered capital for the debts of the company. In general, courts are reluctant to provide this remedy because the main purpose of choosing to establish a limited liability company is to limit the liability of the investors. However, in certain circumstances, courts will look beyond the form of the company in order to protect creditors of the company against fraud and unfair practices.

Failure to Pay in Subscribed Capital

The most typical situation is where one or more of the investors has failed to pay in the subscribed registered capital, or pays it in but then immediately withdraws it. In 1994, the Supreme People's Court issued the Reply to Questions Concerning Civil Liability Borne by Investing Enterprises After the Invested Company is Terminated or Ceases Operation. The reply provided that invested companies shall be deemed to lack legal status and investors shall bear civil liability for the debts of the company in which they invested even if the latter has been issued an enterprise legal person business license where:

a) the investors, in fact, fail to pay in their capital;

b) the amount of capital paid in does not meet the minimum capital requirements provided in the PRC Administration of
Enterprise Legal Person Registration Regulations or other regulations;²or

c) the company fails to meet other requirements for legal person status.³

Other Circumstances

Courts may also pierce the corporate veil:

a) when the parent company mixes its assets with the assets of the newly established company;

b) where the parent company treats the company's assets as its own, or

c) where the parent company ignores the subsidiary's corporate structure and exercises direct control over the subsidiary.

State-owned enterprises are often guilty of such overreaching, perhaps because they have yet to adjust to the requirements of a market economy. In the old centrally planned economy, parent companies paid little attention to legal forms, and managed subsidiary companies in a top-down, bureaucratic fashion. Such behavior exposes them to liability under today's rules.

Feng Jinwei
Yi Wen Law Firm, Beijing

ENDNOTES:

1. It also raises the interesting issue of why the two companies that had paid in their capital in full were held jointly liable.
2. The minimum capital requirement depends on the nature of the company. See, for example, Article 23 and Article 78 of the PRC, Company Law and Article 15.7 of the PRC, Administration of Enterprise Legal Person Registration Regulations.
3. See, for example, the requirements set out in Article 37 of the PRC, Civil Law General Principles, Article 7 of the PRC, Administration of Enterprise Legal Person Registration Regulation and Article 19 and 73 of the PRC, Company Law.