(By Bai Lituan) Registered capital is important part of a company’s assets and a guarantee on civil liabilities owed to people outside the company. Inappropriate registered capital reduction will directly affect a company’s ability to pay its debts and pose a threat to creditors’ interests. Therefore, the creditor notification process is a legal arrangement for maintaining a balance between legal person’s and personal interests and one of the prerequisites for exempting a shareholder reducing their capital contribution from liabilities to the extent of the registered capital decrease.
Should a shareholder who reduced their capital contribution illegally be responsible for additional compensation?
In Article 177 of Company Law, to reduce its registered capital, a company must prepare a balance sheet and a property list and send a notice to each creditor within ten days and make an announcement on a newspaper within thirty days from the date of the resolution to reduce the registered capital. Creditors can ask the company to pay or give a guarantee on the debts within thirty days from the date of receipt of the notice or without receiving the notice, forty five days from the announcement date.
Based on the above provisions, if deciding to reduce its registered capital, the company should not only send a notice to each creditor, but also make an announcement of registered capital decrease. In this case, creditors can ask the company to pay the debts in advance or guarantee payment of the debts. The registered capital cannot be reduced without the company doing this. In fact, for some reasons, many companies only make short announcements of registered capital decrease in a small area on newspapers. Legal authorities basically agree with how to decide such illegal registered capital decrease, especially after two cases decided by Shanghai and Jiangsu courts appeared on the Gazette of the Supreme People’s Court, in which the court found that the fact that company failed to send the registered capital decrease notice to each creditor when the shareholder knew the legal process and outcome of the registered capital decrease actually meant the shareholder withdrew the registered capital illegally and had basically the same impact on creditors’ interests as that of illegal capital contribution withdrawal. For these reasons, the shareholder should be responsible for additional compensation for the debts that the company cannot pay to the extent of the registered capital decrease.
Can a shareholder who reduced capital contribution illegally be added to defaulters?
In the (2021)J1102MC878 case I advised on, in the first trial the defendant reduced the capital contribution from RMB 50,000,000 to RMB 1,000,000 without sending a notice to the plaintiff I represented and changed the legal representative to avoid high consumption restrictions on the original legal representative. In the enforcement stage after we won the case, we requested the court add two natural people who were shareholders who reduced their capital contribution illegally to defaulters. The court held a hearing. During the hearing the judge held that illegal registered capital reduction should be deemed as capital contribution withdrawal and inclined to the view that the two shareholders should be added to defaulters. Under the pressure, the defendant raised money and paid the debts.
I searched cases in Shanghai with key words “illegal registered capital decrease” and “capital contribution withdrawal” and found that although not all courts in Shanghai agreed that shareholders of a company that illegally reduced its registered capital should be added to defaulters in the enforcement process, most of them did add them to defaulters. In (2019)H01ZY289, (2021)H0115ZY612 and (2018)H0104ZY374 cases, Shanghai No.1 Intermediate Court, Pudong Court and Xuhui Court found that the shareholder who reduced their capital contribution should be added to defaulters on the ground that the illegal registered capital decrease and the capital contribution withdrawal have the same effect on creditors. In (2020)H0120ZY74, (2020)H0110ZY260 and (2020)H0115ZY517 cases, however, Fengxian Court, Yangpu Court and Pudong Court found that an illegal registered capital decrease might not be found as capital contribution withdrawal and the shareholder who reduced their capital contribution should not be added to defaulters on the ground of not meeting legal conditions on which a person should be added to defaulters under the Regulations on Several Issues Concerning Change and Addition of Parties to Civil Enforcement Cases by the Supreme People’s Court.
Should a shareholder who reduced their capital contribution illegally without actually receiving payment for the capital reduction take the responsibility?
Since the paid-in registered capital system was changed to the subscribed registered capital system in China in 2013, for many liability limited companies with their registered capital in large amounts to pretend having much money. When they become aware that subscribed capital does not mean registered capital they do not need to pay, especially after the Minutes of the Ninth National Conference on Civil and Business Trials was published, setting out circumstances where a shareholder should accelerate payment of their capital contribution, many companies with their registered capital in large amounts started to reduce registered capital. Then it is common that a company reduces its registered capital not following the legal process, but the shareholder whose capital contribution is reduced does not receive payment for such reduction. In this case, should the shareholder be responsible for additional compensation?
An illegal registered capital decrease could harm reliance interests of creditors to whom debts are owed before the registered capital decrease. Therefore, shareholder’s responsibility for the company’s illegal registered capital decrease should be decided by considering whether the decrease has a substantive effect on the company’s ability to pay debts and the creditor’s interests. In the [Case No.(2021)SMS5976] case that appeared on the official website of Jiangsu High Court, the court held that registered capital decrease had a great effect on creditors because if the shareholder received payment for the decrease, the company’s net assets would be reduced, which meant the shareholder was recouped for their investment before creditors, or if the shareholder was not paid for the decrease, their investment in the company was changed from shares to creditor rights, which meant the shareholder and creditors would be in the same position in the order of payment for debts, the company had fewer assets that could be used to pay debts owed to creditors and the creditors should be given a notice and protected. In this case Leader’s act of reducing its registered capital illegally (without notice) caused actual harm to creditors’ rights and the three shareholders who reduced their capital contributions illegally should be responsible for paying the debts because legal outcomes of their acts of reducing capital contributions illegally were the same as those of illegal capital contribution withdrawal.
In sum, there are no big problems in finding an illegal decrease in a company’s registered capital as illegal withdrawal of shareholder’s capital contribution during trials. Even if the court prudently refuses to add shareholders to defaulters in the enforcement process, creditors can bring an opposition to enforcement action or seek legal remedies by bringing an action by filing a new case relating to substantive issues.