Responsibilities of “Old” Company Founders for Capital Contributions

(By Tian Shanshan) The Chinese Company Law and legal interpretations thereof provide that founders are responsible for paying in full their capital contributions. However, should founders of a company be responsible for paying in full their capital contributions if the company was established before the Company Law 2005 took effect, the first law setting forth responsibilities of a company’s founders for paying in full their capital contributions? Another issue in this case is how to define the founder’s responsibilities and protect the creditors’ interests. Legal authorities didn’t deal with this issue in the same way.

1.Does the “new company law” apply to “old companies”?

The answer to this question is yes according to a decision made by Guangzhou Intermediate People’s Court in 2014, stating that the defendant, a company founder and small shareholder with 5% shares should be jointly liable to the other founders for the rest 95% capital contributions and interest on them.

The court held that pursuant to Article 2 of the Legal Interpretation I of the Company Law, Article 13 of the Legal Interpretation III of the Company Law applied despite the fact that the old company law did not require that shareholders be held jointly liable to each other for  other shareholder’s failure to pay in full its cash capital contribution and therefore the defendant should be held jointly responsible for the other shareholders’ failure to pay in full their capital contributions and interest on them. Article 28 of the Company Law 1993 and Article 31 of the Company Law 2005 did not clarify the above issue but stated that all founding shareholders should be jointly responsible for any shareholder’s failure to pay in full its non-cash capital contribution. In general, it is more difficult for shareholders to keep informed of the authenticity and sufficiency of non-cash assets. Shareholders who have fully paid their capital contributions should be held jointly responsible for not fulfilling their duty of care to other shareholders’ payment of capital contributions, especially non-cash capital contributions. The Company Law 1993 and the Company Law 2005 dealt with this issue in the same way.

2.Oppositions: In principle laws are non-retrospective

The Supreme People’s Court gave totally different reasons for its decision in the United Lighting Investment Co., Ltd. v. China Coal Exploitation Co., Ltd. shareholder capital contribution case.

First, Article 1 of the Legal Interpretation I of the Company Law stated that in principle the company law was non-retrospective. The founding shareholders of Longrun had reasonably expected what they were responsible for as shareholders under the law in effect when Longrun was established in July 2000. It was reasonable for the court of first instance to decide that the company law then in effect applied.

Second, Article 28 of the Company Law 1999 states that founders should be jointly responsible for failure to pay in full their non-cash capital contributions, without further clarifying the issue of whether founding shareholders should be held jointly responsible for a shareholder’s failure to pay in full its cash capital contribution. Accordingly, this Article 28 cannot apply to cash capital contributions because it is made for correct evaluation of non-cash property to prevent shares and creditor rights from being diluted by overestimated value of non-cash property.

Third, is Article 13 of the Legal Interpretation III of the Company Law applicable? Pursuant to Article 2 of the Legal Interpretation I of the Company Law, without applicable provision in an old law, a new law could apply following the principle of “using the old law to its advantage”. A court will take account of this issue only if it helps to make the deal done in a fair way without causing serious damage to what parties involved expected. Article 13 of the Legal Interpretation III of the Company Law which is based on Article 94 of the new Company Law does not state that founders of a limited company should be held jointly responsible for any founder’s failure to perform or fully perform its capital contribution obligation. Accordingly, provisions pertaining to limited liability companies thereunder also apply to limited companies. Article 94 first appeared in the Company Law 2005. China Coal was a minor shareholder of Longrun with no powers to supervise other shareholders’ capital contributions. If the new company law and Article 13 of the Legal Interpretation III of the Company Law applied in this case, China Coal would be responsible for far more than the shareholder responsibilities it was reasonably expected to take upon its establishment of Longrun.

Obviously, the Supreme Court decided following the principle that laws are non-retrospective.

3.Application of the Company Law and Legal Interpretations

Guangzhou Intermediate People’s Court and the Supreme People’s Court both held that founders not paying their capital contributions in full should be held jointly responsible for their company’s debts to the extent of principal and interest in their unpaid capital contributions. Opinions of the two courts on the two issues below were different. First, could the Legal Interpretation III of the Company Law reasonably apply to this type of cases pursuant to Article 2 of the Legal Interpretation I of the Company Law? Second, is the joint liability of founders under Article 13 of the Legal Interpretation III of the Company Law legally associated with Article 28 of the Company Law 1993? These issues are about the application of laws.

One of the important principles in ancient Roman law is “laws only apply to what happens in the future”. The principle that laws are non-retrospective accords with the principle of trust and interest protection. In simple words rules made today do not apply to anything done yesterday. The answer to the question of whether legal interpretations are retrospective may be different from academic and practical aspects, although it is generally believed that they are retrospective. Legal interpretations deal with how to properly understand and practice laws and only contain what has been stated in the laws. The supreme legal authorities cannot give any interpretation that is not originally stated in laws. Legal interpretations could be reasonably expected by the public to be retrospective.

In the capital subscription system shareholders of a company do not need to pay their capital contributions in full to set up the company. As a result, shareholders could acquire more shares than they can really afford to. As the Company Law of China includes no system in which establishment of a company could be deemed as void, defects in the establishment of the company in the above case can be cured only by founders paying the unpaid capital contributions in full. Based on legal principles of Article 28 and Article 93 of the Company Law, the Company Law and the Legal Interpretation III of the Company Law state that founders and shareholders are jointly responsible for creditor’s claims.

Some people believe in the first case that pursuant to Article 28 of the Company Law 1993 which doesn’t mention founder responsibilities for shareholder’s failure to pay in full its capital contribution, founders should be jointly responsible for overestimated capital contributions, let alone unpaid capital contributions in the first example case which is less serious. I don’t agree. The Legal Interpretation III of the Company Law was made for the capital subscription system under the Company Law 2005 which requires that founders be responsible for paying the unpaid capital contributions in order to prevent defects in the act of establishing a company and keep a balance between the low cost of establishing a company and the creditor right protection. It only conforms to the legal principle of Article 28 of the Company Law 1993, not the capital subscription system and is not exactly for the purpose of making accurate evaluation of non-cash capital contributions. The belief that the law applies to “less serious” cases is against its original purpose.

Legal interpretations made by comparing with a law without considering its original purpose usually misinterpret it, As the principle that laws are non-retrospective basically means, laws and their interpretations should accord with what parties involved expect. It is unfair to interpret a law in an unexpected way.

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