Joint and several liability for capital increase defects
When a debtor enters bankruptcy proceedings and a shareholder is found to have defects in a capital increase, while being unable to make up the shortfall, creditors can only seek satisfaction of their claims by asking the other shareholders to bear joint and several liability for the deficiency. This article examines the jurisprudential basis for such joint liability under the Company Law and its judicial interpretations, and assesses the rationale behind this mechanism.
Judicial divergence
Company A, a limited liability company, was jointly established by companies B and C, with a registered capital of 8 million yuan, fully paid in by both shareholders. After incorporation, the two shareholders decided to admit Zhang San as a new investor and to increase the company’s registered capital to 18 million yuan, of which Zhang contributed 10 million yuan through six residential properties under his name.
After company A entered bankruptcy liquidation, the administrator discovered that the six properties Zhang had contributed had never been registered under the company’s name, but were instead used to repay his personal debt to company C. By that point, company A, Zhang, and company B had all become insolvent. The administrator therefore brought an action seeking to hold company C jointly liable for the portion of the capital contribution that Zhang had failed to make.
The court held that article 13(3) of the Provisions of the Supreme People’s Court on Several Issues concerning the Application of the Company Law of the People’s Republic of China (III) limits founders’ joint and several liability to situations arising “at the time of the company’s establishment.” Once the company is formed, its operations and management are principally handled by directors and senior executives, rather than the founders. Moreover, founders may not be controlling shareholders and may even have withdrawn from the company, ceasing to be shareholders. As such, they no longer bear any statutory duty to supervise or verify subsequent capital contributions.
On this basis, the court concluded that the founders’ joint and several liability extends only to the actual capital contributions made during the company’s formation. It therefore dismissed the administrator’s claim seeking to hold Company C jointly liable for Zhang’s failure to fulfil his capital subscription.
With respect to such cases, the Supreme People’s Court issued two almost opposite rulings on 31 October 2018 and 29 December 2018. In Ma Yan v SASAC of Jilin Provincial Government (2018), the court held that article 13 of provisions III provides specific, clear and unequivocal rules regarding defective capital contributions, their nature, the parties liable, and the form of liability.
From the perspective of statutory interpretation, the court reasoned as follows. On the one hand, when a company increases its registered capital, the responsibility for calling in capital from shareholders falls within the duty of diligence owed by directors and senior management. Failure to fulfil this duty can harm the interests of the company and its other stakeholders; therefore, directors and senior managers should bear liability to the relevant right‑holders.
On the other hand, the liability borne by other shareholders differs from that of the shareholder participating in the capital increase and the founders. Other shareholders are not parties to the capital‑increase agreement with the company and thus have no obligation to contribute additional capital. Nor do they stand in a partnership relationship with the shareholder making the additional contribution, and therefore have no mutual obligation to guarantee each other’s capital injection. On this basis, it cannot be concluded that other shareholders should assume joint and several liability for defects in the capital increase.
In Shiyan Municipal Construction Engineering and Others v Dongfeng Motor Corporation and Others (2016), the Supreme People’s Court adopted a different stance. It held that article 13(4) of provisions III applies where, in the course of a capital increase, a shareholder fails, wholly or in part, to meet the obligation to contribute capital. In such cases, if the company, other shareholders, or creditors consider that the directors or senior executives have neglected the duties of loyalty and diligence set out in article 147(1) of the Company Law, they may pursue corresponding liability against them. A capital increase, the court observed, expands a company’s operations and its capacity to assume obligations, and in substance is no different from the shareholders’ initial capital contributions at incorporation. Accordingly, shareholders whose additional contributions are defective should bear the same liability as they would for defective capital contributions at the time of incorporation.
Doctrinal analysis
This article argues that rejecting joint and several liability for defective capital increases is not well‑founded.
First, under the Company Law, any capital increase requires a resolution of the shareholders’ meeting supported by at least two‑thirds of the voting rights. Capital formation, whether at incorporation or through later increases, is therefore driven by the shareholders themselves. Second, under the subscribed‑capital regime, the actual payment of capital by shareholders may lag behind the company’s establishment, and a considerable portion of contributions occur after incorporation. It is therefore of little substantive meaning to confine liability to “the time of incorporation.
Third, both the founders’ agreement and any shareholders’ resolution approving a capital increase express the shareholders’ collective intention to contribute capital, providing the very foundation for joint and several liability. Finally, articles 50 and 51 of the Company Law make clear that, for both initial and subsequent subscribed capital, shareholders and the board alike are obliged to call in the capital contributions. If they fail to do so, shareholders bear joint and several liability, while directors are liable in damages.
Application of provisions
Capital contributions are the bedrock of a company’s ability to operate and honour its obligations. Legally, there is no real distinction between the capital subscribed by the founding shareholders and that subscribed in a later increase. Since the Company Law was first enacted in 1993 and through seven rounds of amendments up to 2023, it has consistently required that when a limited liability company raises its registered capital, new subscriptions are subject to the same rules as those governing initial contributions. In short, the rules that apply at incorporation also govern capital increases.
Because the Company Law provisions on timing, form and performance of contributions, the board’s duty to call for payment, statutory forfeiture of shares, ban on capital withdrawal and acceleration of maturity all extend to capital increases, there is no basis for excluding the joint and several liability of shareholders within the scope of any unpaid capital where defects arise. Whether at incorporation or in a later capital increase, bankruptcy creditors know less than the shareholders. Denying joint and several liability for defective capital increases simply because of gaps in judicial interpretation would run against the purpose of the Company Law and undermine judicial fairness.
Li Yansheng is a managing partner at Guantao Law Firm. He can be reached by phone at +86 138 5995 7267 and by email at liys@guantao.com
Xu Chuanyuan is a partner at Guantao Law Firm. He can be reached by phone at +86 159 8096 5397 and by email at xuchy@guantao.com
