CHINESE UPDATE: The Recent Judicial Development of “Piercing the Corporate Veil” in China

The Recent Judicial Development of “Piercing the Corporate Veil” in China

1.      Summary of “Piercing the Corporate Veil” and the relevant regulations

“Piercing the corporate veil” (also known as “forward disregard of corporate personality”, hereinafter referred to as the “forward disregard”), originated in the United States.  The doctrine is used to prevent shareholders from abusing the separate legal personality of a company and the limited liability of the shareholders from evading liabilities and harming the interests of the creditors of the company in question.  Under this doctrine, when the aforementioned situation occurs, the company’s separate personality should be denied, with the company’s veil lifted (pierced) and the shareholder to be held liable for the company’s debts.  The value of such a doctrine is to address an inherent problem in the limited liability system, to balance the interest between the shareholders and the creditors, and to promote good faith in transactions.

Article 20 Section 3 of the “Company Law of the People’s Republic of China” (hereinafter “People’s Republic of China” referred to as “PRC”) sets forth the Forward Disregard doctrine. Based upon this provision, and after exploring and consolidating years of judicial practice, the Supreme People’s Court of PRC (hereinafter referred to as “Supreme People’s Court” or “SPC”) issued the “Notice by the Supreme People’s Court of Issuing the Minutes of the National Courts’ Civil and Commercial Trial Work Conference” (hereinafter referred to as “Jiu Min Minutes[1]) on November 8, 2019, of which Section II (4) lists three common acts deemed to be abusing the separate personality of the company and the limited liability of its shareholders, i.e., confusion of personalities (failure to maintain separate identities [of companies]), excessive domination and control (failure to maintain separate identities of the company and its shareholder[s]), and significant capital inadequacy.  The Jiu Min Minutes made the decision making rules regarding forward disregard clearer to interpret.

Despite these written provisions under the Jiu Min Minutes, different courts have different interpretations of the legal facts and the laws.  Therefore, we believe a case study would help the parties to better understand and follow the rules of law, discover the legal principle and logic supporting the judgment and evaluate with greater certainty the legal risks involved.

In addition to ‘forward disregard’, there is also ‘reverse disregard’ and ‘horizontal disregard’ in Chinese judicial practice.

Reverse piercing the corporate veil (hereinafter referred to as “reverse piercing” or “reverse disregard”) means holding the company liable for its shareholders’ debts.  To evade their debts, shareholders sometimes ignore the company’s separate personality and transfer their own property to the subsidiary company.  Under such circumstances, the creditors may petition to disregard the corporate personality, so that the subsidiary company is held jointly and severally liable to its parent’s debts.

The horizontal piercing of the corporate veil (hereinafter referred to as “horizontal piercing” or “horizontal disregard”) means the disregard of the corporate personality between the affiliated companies that do not hold directly the shares of each other.  The same shareholder or the person in control, by taking advantage of his or her control over affiliated companies, abuses the separate corporate personality and transfers one company’s property or interest to another to evade individual debt.  The question then is whether the creditor may disregard the personality of the affiliated companies and hold these affiliated companies liable for the original debt.  Guiding Case No.15, published by the Supreme People’s Court, is instructive, providing the judicial rules under the horizontal disregard.  While they are not yet part of any statutes, as a matter of practice, the reverse disregard and horizontal disregard, along with the traditional forward disregard, constitute the framework of the multi-dimensional doctrine of the disregard of corporate personalities in judicial practice.

2.     Current judicial practice of disregarding the corporate personality

As mentioned above, due to the complexity of the transactional relationship between the parties, the shareholder’s abuse of the separate corporate personality varies from case to case, and the written legal system is not adequate to provide complete and sufficient rule guidance.  Chinese written law has not set forth specific provisions concerning the reverse disregard and horizontal disregard.  Thus we believe it is necessary to review, recapitulate and summarize how all three disregard doctrines, i.e., forward disregard, reverse disregard and horizontal disregard, developed in judicial practice, by means of a case study.

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[1] Jiu means the ninth (9th), which refers to the sequential number of the national conference of such nature.  Min is short for the Civil and Commercial Trial Work Conference.