According to the Company Law, if the shareholder of a one-person limited liability company is unable to prove that the property of the company is independent of the shareholder’s personal property, the shareholder shall be joint and several liable for the debts of the company. In the context of this provision, it is generally understood that the current shareholder of a one-person company shall bear joint and several liabilities for the debts of the company. Accordingly, does the former shareholder still need to bear joint and several liabilities for the debt incurred in his/her holding period after the equity transfer? And does the current shareholder need to bear joint and several liabilities for the company’s debts incurred before the equity transfer? At present, there has been no explicit provision according to law. However, in existing judicial practice, judgments of deciding to bear joint and several liabilities can be found in a number of cases.
Type 1: The former shareholder of a one-person company is jointly and severally liable for the debts incurred during his/her holding period.
There are indeed judicial decisions supporting the claim that the former shareholder still needs to bear joint and several liabilities for the company’s debts after the equity transfer.
In Case (2019) Zui Gao Fa Zhi Min Zhong No.490, the Supreme Court held that, with regard to the liability of the appellant (the defendant in the first instance trial) HU, since HU was the sole shareholder of Zhunxinwei Company when the alleged infringement occurred, he, as the shareholder of a one-person limited liability company, shall bear the burden of proof for the company’s property being independent of his personal property; otherwise, he shall bear joint and several liabilities for the debts that Zhunxinwei Company shall be liable during his tenure as the sole shareholder. HU provided no evidence for the above facts. Therefore, he shall be jointly and severally liable for the debt of Zhunxinwei Company. HU defended that he had transferred the equity of Zhunxinwei Company. However, the Supreme Court held that if the shareholder of a one-person company failed to prove that the company’s property was independent of the shareholder’s personal property during his/her holding period, the joint and several liabilities borne by the shareholder for the company’s debts incurred during the holding period should not be extinguished by the equity transfer.
Zhunxinwei Company shall bear the liability for compensation to Serica Company for infringing on Serica Company’s patent rights of integrated circuit layout design. The accused infringement of Zhunxinwei Company was the cause of its debt that was incurred at the time of committing the accused infringement. As the sole shareholder of Zhunxinwei Company when it committed the alleged infringement, Hu failed to provide evidence to prove that the company’s property was independent of his personal property, and thus he shall bear joint and several liabilities for the company’s debts arising from the alleged infringement by Zhunxinwei Company.
In Case (2020) Jing 03 Min Zhong No.1015, Beijing Third Intermediate People’s Court held that, according to Article 20 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Modification and Addition of Parties in Civil Enforcement, if the property of a one-person limited liability company acting as the entity subject to enforcement, was insufficient to settle up the debts determined by effective legal documents and the shareholder of the one-person company cannot prove that the company’s property was independent of his/her personal property, the people’s court shall support the claim of the applicant for enforcement of changing or adding the shareholder as the person subject to enforcement that shall bear joint and several liabilities for the company’s debts.
In this case, for the period from April 24, 2015 to June 25, 2018, the appellant (the plaintiff in the first instance trial) ZHANG was the sole shareholder of Star Music Advertising Company, a third party in the first instance trial. ZHANG was liable for the burden of proof on the fact that his personal property was independent of the property of Star Music Advertising Company during his tenure as a sole shareholder. According to the bank statements of Star Music Advertising Company, during ZHANG[WJ1] ’s tenure as a shareholder, there were 39 financial transactions between him and the company’s bank account. Although ZHANG claimed that the financial transactions were related to a loan relationship between him and Star Music Advertising Company, he failed to provide sufficient evidence to support his claim. Therefore, ZHANG cannot prove that the property of Star Music Advertising Company was independent of his personal property.
According to the ascertained facts, the debt owed by Star Music Advertising Company to HU was incurred in the period when ZHANG served as the sole shareholder of ascertained facts, and the property of Star Music Advertising Company was not sufficient to repay the debt owed by Star Music Advertising Company to the respondent (the defendant in first instance trial) Hu. Therefore, given that ZHANG cannot prove that the property of Star Music Advertising Company was independent of his personal property, the court of first instance decided that HU’s application to add ZHANG as the person subject to enforcement of (2018) Jing 0105 Zhi No. 8510 case was justified by law, and rejected ZHANG’s claim accordingly. This Court has no objection to the decision by the court of first instance. ZHANG’s appeal claimed that he shall not bear joint and several liabilities for the debt owed by Star Music Advertising Company to Hu in Case (2018) Jing 0105 Zhi No. 8510. Since this appeal claim lacked factual and legal supporting materials, this Court does not support it.
From the above effective judgments, it can be seen that, whether at the stage of litigation or enforcement, the former shareholder of a one-person company needs to bear joint and several liabilities for the company’s debts when the following conditions are met: ① The company’s debts were incurred during the period when the former shareholder held the equity of the one-person company; ② The former shareholder cannot prove that his/her personal property is independent of the property of the one-person company during the holding period. And the independence of personal assets, with reference to the judgment criteria and identification factors for “personality confusion” in the Minutes of the National Court Work Conference for Civil and Commercial Trials, can be checked and adjusted in the following aspects:
1. The company’s funds and property are used by the shareholder for free without any financial records.
The financial records, in addition to simply showing the company’s financial transactions, also reflect, to a certain extent, the nature of the funds and the legal relationship between the shareholder and the company in relation to the funds. If there are no financial records, the most direct manifestation is that the personal accounts cannot be separated from the public accounts clearly and the nature of the funds is ambiguous. More importantly, if the company’s funds are directly used by the shareholder for personal purposes without any explanation, the company’s independent will may be mixed with the shareholder’s personal intentions and the company’s property may be mixed with the shareholder’s personal property. Therefore, it is impossible for the legal personality of a one-person company to be independent, as it has become the shareholder’s tool for his/her personal life and production.
2. The company’s funds and property are used by the shareholder to repay his/her debts, or the company’s funds are provided by the shareholder to affiliated companies for free use, without any financial records.
The second and the first identification factor are two different external manifestations based on the same legal essence. In this circumstance, if the company’s property is used by the shareholder for personal purposes without any legal or voluntary basis, the independence of the company’s property, as well as the independent will of the company as a legal entity, cannot be discussed at all.
3. The company’s account books and the shareholder’s account books are mixed with each other, making it impossible to distinguish the shareholder’s personal property from the company’s property.
This identification factor directly stipulates the manifestation and consequence of property confusion. However, in judicial practices, it should pay attention to the legal justification of proving that it is difficult to distinguish the shareholder’s personal property from the company’s property.
4. The shareholder’s own proceeds are not distinguished from the company’s profits, resulting in unclear interests between both parties.
One of the important manifestations of the independent legal personality of a corporate entity is the enjoyment and independence of corporate property. In this circumstance, it is impossible to manifest that the company is a legal entity with an independent legal personality since it is only a tool and means for the shareholder to obtain benefits.
5. The company’s property is recorded in the name of the shareholder and owned and used by the shareholder.
This identification factor is even more severe than the fourth factor in terms of property confusion and the shareholder’s malicious behavior. The company’s shareholder has obviously abused the company’s independent status as a legal entity and the shareholder’s limited liability with mala fide intention and even has incurred external liabilities in the name of a limited liability company but attributed to himself the consideration (benefit) of the company’s liabilities and the profits derived from the company’s operations, which has essentially transferred his/her personal liabilities and taken possession of the company’s legitimate interests.
6. Other cases of personality confusion.
In the circumstance of personality confusion, there is often simultaneous confusion between: the company’s business and the shareholder’s business; the company’s employees and the shareholder’s employees, especially financial personnel; and the company’s address and the shareholder’s address. However, in the trial of the case, the key to review is still the components of personality confusion, and other aspects of confusion are often only supplementary to personality confusion.
Type 2: The current shareholder of a one-person company is jointly and severally liable for the debt incurred before the equity transfer.
Regarding whether the current shareholder needs to bear joint and several liabilities for the company’s debts incurred before the acquisition of the equity after acquiring the equity of the former shareholder, there are also relevant cases in judicial practice for reference. Shandong Higher People’s Court recently, by adopting a case to explain law provisions, analyzed specific circumstances and legal basis for the former shareholder still being liable for company debts after the equity transfer and bearing joint and several liabilities together with the new shareholder.
In Case Lu Fa [2023] 280 published on the WeChat official account of Shandong Higher People’s Court, ZHENG A, the former shareholder of Qingdao XX Mechanical Equipment Company (a one-person limited liability company established by a natural person in 2018) transferred 100% equity of this company to ZHENG B and completed the equity change registration in November 2021. In June 2021, the plaintiff ZHANG and the defendant Qingdao XX Mechanical Equipment Company executed the Processing Customized Contract, according to which the plaintiff customized a polyester plastic wire drawing machine from the defendant with the total contract price amounting to RMB1.38 million. After the contract performance was deadlocked, the plaintiff ZHANG filed a lawsuit against Qingdao XX Mechanical Equipment Company, ZHENG A, and ZHENG B as co-defendants to Jiaozhou People’s Court and claimed that the former shareholder ZHENG A and the current shareholder ZHENG B shall bear joint and several liabilities on the grounds that the mechanical equipment company was a one-person company and there was a confusion between the shareholder’s and the company’s properties.
During the litigation process, it was concluded through judicial appraisal under legal entrustment that the structural form of the involved equipment cannot guarantee the roundness of plastic filament products to meet the requirements agreed in the contract, and the related accessories were not consistent with the national standards. ZHENG A defended that he was no longer a shareholder of the company and should not be held jointly and severally liable for the company’s debts and that there was no legal basis for the plaintiff to claim he should bear liabilities in accordance with the provisions of Article 63 of the Company Law. ZHENG B defended that he was not a shareholder of the company at the time when the debt was incurred, unaware of and without any fault in the incurring of the debt. According to the principle that “no faults mean no liabilities”, he should not be held accountable. Neither ZHENG A nor ZHENG B submitted evidence to prove that company property was independent of personal property.
The court held that, with regard to shareholders’ liabilities, ZHENG B should bear joint and several liabilities for the company’s debts on the grounds that: Qingdao XX Machinery Equipment Company was a sole proprietorship; ZHENG B, as the current sole shareholder, failed to prepare financial accounting reports at the end of each fiscal year and had them audited by an accounting firm; and ZHENG B also failed to provide evidence proving that his personal property was independent of the company’s property during his holding period. ZHENG A shall also bear joint and several liabilities for the company’s debts on the grounds that this kind of joint and several liabilities did not extinguish due to the equity transfer because of the following: Although ZHENG A was not a shareholder of the company, the debt was incurred in his holding period; ZHENG A failed to submit evidence to prove that his personal property was independent of the company’s property during the holding period, which meant the company’s personality was denied. Therefore, the joint and several liabilities borne by the company’s shareholder was his own liability for the settlement of the debt, rather than the liability for settlement of debts in lieu of a company based on his identity as the company’s shareholder.
The court further analyzed and explained the case according to law: Due to the lack of checks and balances among shareholders, a one-person company shareholder was more likely to take advantage of controlling the company, blurring the line between company property and personal property to use the company’s property for his/her personal use, and at the same time, harming the interests of creditors by abusing the independent legal personality of the company and the limited liability of the shareholder to evade debts. In this circumstance, in order to protect the interests of the company’s creditors and reduce transaction risks, the Company Law strengthened the legal regulation and supervision of a one-person limited liability company by stipulating that a one-person company shall prepare a financial accounting report at the end of each fiscal year and have the report audited by an accounting firm, and the report shall also include special audit matters regarding the independence of the shareholder and company property as well as the principle of reversed burden of proof for denial of corporate personality. If the one-person limited liability company failed to comply with above stipulations, it indicated that the company lacks independent property and financial autonomy, and there is confusion between the shareholder’s and the company’s properties. In the case of a third party claiming that a one-person company and its shareholder have mixed properties, the shareholder shall be held accountable for the burden of proof due to the adoption of the presumption of abuse of corporate personality and application of the principle of reversed burden of proof.
In this case, the current shareholder ZHENG B was the current sole shareholder of the defendant. Although the debt involved in the case was incurred before the equity transfer, the company’s debt always existed and was not settled. The debt would not be extinguished by the transfer of the company’s internal equity and the property used to bear the liability was still the company’s property. Changes in equity and capital in the company did not affect the company’s legal entity status, and hence the corresponding rights and obligations should be inherited by the changed entity by way of universal succession. Therefore, ZHENG B, as the sole shareholder of the company, shall bear joint and several liabilities for the company’s involved debts since he failed to provide evidence to prove that the company’s property was independent of his personal property.
And for the former shareholder ZHENG A, although he had transferred the equity in 100% and was no longer a shareholder of the company, the debt was incurred in his holding period. He neither prepared a financial accounting report at the end of each fiscal year and had the report audited by an accounting firm, nor submitted evidence to prove the independence between company property and personal property. In addition, he used his personal account to collect part of the payment in the process of execution and fulfillment of the contract with the plaintiff ZHANG. In the circumstance of ZHENG B’s failure to prove his innocence, the company’s independent personality shall be denied by applying the presumption of abuse of corporate personality, and the liability of the shareholders behind the company shall be claimed directly.
The joint and several liabilities borne by the shareholder is his/her own liability for the settlement of the debt, rather than the liability for settlement of debts in lieu of a company based on his identity as the company’s shareholder, so this kind of joint and several liabilities did not extinguish due to the equity transfer and ZHENG A shall bear joint and several liabilities for the company’s debts incurred during his holding period.
Shandong Higher People’s Court further clarified through analysis that, in practice, there were still cases where the shareholder of a one-person company transferred part of the equity to a third party or split and transferred 100% of the equity to multiple individuals in order to avoid joint and several liabilities for company debts after the occurrence of company transactions or debts, thereby changing the one-person limited liability company into an ordinary limited company with multiple shareholders, and considering that the company was no longer a one-person company, therefore, the shareholder no longer needed to bear joint and several liabilities for debts incurred before the change in company equity.
This is not feasible. Although China’s current law has no clear provisions on the issue of the temporal sequence between the assumption of liability by the one-person limited company shareholder and the incurring of the debt, it can be known by analyzing the legislative purpose of Article 63 of the Company Law that, this provision is designed to avoid the case that the one-person company shareholder has the company become his/her personal tool and shell to avoid debt through abuse of the company’s independent personality as a legal entity and the shareholder’s limited liability, thereby seriously harming interests of the company’s creditors. If the shareholder of the one-person company is only limited to the current shareholder, it is tantamount to encourage the shareholder to abuse their absolute control over the company, using the company as a tool for personal profit-making and debt evasion and maliciously transferring his/her equity to evade debts, which is obviously contrary to the legislative intent.
Therefore, for debts incurred during the operation of a one-person company, even if the company has changed to an ordinary limited company through equity transfer, the principle of reversed burden of proof is still applicable to the former one-person shareholder to prove that the company’s property and the shareholder’s personal property were independent of each other during his/her holding period. If this cannot be proved, the former shareholder still needs to bear joint and several liabilities for the debt.
In April 2023, the People’s Court of Huaiyin District, Jinan City, Shandong Province, also in its WeChat official account, carried out a certain extended discussion about the issue of assumption of liabilities by the shareholder of a one-person company, which clearly explained the shareholder’s liability in the event of a change in the company type resulting from the equity change (transformation between a one-person limited liability company and an ordinary limited liability company).
The court believes, on the premise that the shareholder cannot prove the company’s property is independent from his/her personal property, the issue that whether the shareholder of a one-person company needs to bear joint and several liabilities for the company’s debts mainly involves two circumstances.
One circumstance is the change from an ordinary limited liability company to a one-person limited liability company, in which circumstance whether the debt is incurred before the current shareholder became a sole shareholder or during the tenure of the sole shareholder, the sole shareholder shall bear joint and several liabilities for the company’s debts. And judicial views of different courts on this issue are almost consistent, that is, they believe that the company’s operation is a continuous process, and the property confusion by the current shareholder infringes on the company’s entire property, including the company’s property before the equity transfer, thereby affecting the realization of creditors’ rights. Therefore, the current shareholder should be jointly and severally liable for all the company’s debts before and after the equity transfer; otherwise, it will result in the negative legal consequence of unequal protection of interests among creditors.
The other circumstance is the change from a one-person limited liability company to an ordinary limited liability company, in which circumstance the one-person company shareholder needs to bear joint and several liabilities for debts incurred before the equity transfer, as it can be presumed that this shareholder has abused his/her rights and evaded his/her debts, thereby seriously harming the interests of creditors. Whether the one-person company shareholder is liable for the new debt incurred after the equity transfer shall be determined on a case-by-case basis, such as whether the shareholder has fully discharged his/her capital contribution obligations.
Conclusion
It can be seen from the above case and legal analysis that, on the premise that the shareholder can not prove that his/her personal property and the company’s property are independent of each other, the formal shareholder of a one-person company is generally required to assume joint and several liabilities for the company’s debt incurred during his/her holding period and the assumption of liability will not be changed due to the equity transfer; the new shareholder of the one-person company is usually required to assume joint and several liabilities for the company’s debt and the liability is not affected by the time of debt formation; in the case of a change in the company type resulting from the equity change, the former and the current shareholder both will be jointly and severally liable for the debts of the company if the change is to become a one-person company. If the change is to become an ordinary limited liability company, the assumption of debt liability before the change is consistent with the foregoing, and that after the change shall be analyzed on a case-by-case basis.
However, for individuals, as a shareholder of a one-person company, it is the fundamental principle for mitigating personal financial liability risks to maintain the independent legal personality of the company and the independence of property from the shareholder’s personal property. And for companies, given a one-person company increases the risk of shareholder’s abuse of rights and limited liabilities at the same time of availability to advantages of low cost and high efficiency, having legal risk awareness and completing annual company financial statement audits and special audits on property independence according to experience and lessons learned are basic and effective measures for risk prevention.
