Piercing China's corporate veil: open questions from the new Company Law.

• Author: Wu, Mark

In 2006, China undertook a major overhaul of its legal framework governing corporations by implementing a new Company Law. (1) Much of the previous Company Law was revised or eliminated, with many new provisions added. (2) This development was much anticipated by Chinese and foreigners alike, as China's previous corporate law was unable to keep pace with its fast-growing economy) One of the highlights of the new Company Law is its formal establishment of the concept of "piercing the corporate veil" in Chinese law.

The concept of piercing the corporate veil is a longstanding feature of the corporate law of capitalist economies. An important corporate form in such economies is the limited liability corporation (LLC), a key attribute of which is that shareholders are not personally liable for corporate debts in excess of their investment in the LLC. Creditors seeking payment of debts or tort victims seeking redress generally can reach only the corporation's assets, not those of its shareholders. At times, however, courts ignore this corporate fiction and treat a corporation's debt as the debt of the corporation's shareholders. In doing so, courts "pierce the corporate veil."

The notion of piercing the corporate veil did not exist formally in Chinese statutory law prior to 2006. The new Company Law, however, allows courts to pierce the corporate veil under certain circumstances. In doing so, it aligns Chinese corporate law more closely with that of other market economies.

While this change is welcome, China's new Company Law fails to address important questions about the veil-piercing doctrine. This ambiguity negatively affects several constituencies. Creditors lack certainty about when they can expect to recover from a bankrupt debtor whose shareholders may have operated illegally. Shareholders lack clear guidance about what constitutes abuses of the corporate form against which they should monitor. Ordinary citizens harmed by tortious acts lack clarity about when they can tap into the deep pockets of parent corporations. Finally, foreigners who lend funds to Chinese companies, contract with or invest in shares of Chinese subsidiaries, or establish their own subsidiaries in China are denied a clear sense of the legal rules at play.

This Comment highlights legal ambiguities on two fronts--how the law is to be applied, and what its scope is. These shortcomings should be addressed in one of two ways. Either the State Council should promulgate additional regulations related to the new Company Law, or the Supreme People's Court (SPC) should issue to lower courts a judicial interpretation that establishes guidelines on how the new Company Law should be interpreted. (4) Unless one of these steps is taken, creditors, investors, and shareholders alike will face continued uncertainty about when courts can pierce a corporate veil.

1. DEVELOPMENTS IN CHINESE VEIL PIERCING

   Prior to 2006, China's veil-piercing doctrine operated in a state of uncertainty. Not until the 1990s, with the rise of the LLC as a corporate form in China, did the notion of a corporate veil become important. (5) In 1994, Chinese law formally recognized LLCs as "legal person[s]" with shareholder liability limited to the extent of the shareholder's "capital contributions" or "shareholdings." (6) However, the 1994 Company Law did not grant Chinese courts the right to pierce the corporate veil. Nor did any other statute confer such power. (7) As a result, most Chinese commentators agreed that China's law did not include piercing the corporate veil. (8)

   Despite the absence of an express statute, some enterprising Chinese judges implemented the concept informally during this period. For example, in replying to an inquiry made by the High Court of Guangdong province, the SPC implied that veil piercing may be permissible when the actual capital contribution made to a corporation is less than the amount of capital registered under that corporation. (9) The SPC has also affirmed a number of lower court decisions that pierced the corporate veil. (10)

   These cases, however, failed to establish clearly the doctrine of piercing the corporate veil for three reasons. First, because China is governed by civil law, cases hold no precedential value. (11) Second, the SPC's own case law suggested a mixed jurisprudence. The court reversed lower court decisions to pierce the corporate veil in cases that were factually similar to cases it affirmed. (12) Finally, veil piercing occurred in only selected provincial courts. (13) A uniform principle did not exist across China.

   This all changed with the 2006 revisions to the Company Law. Article 20 of the law states: "Where any of the shareholders of a company evades the payment of its debts by abusing the independent status of juridical persons or the shareholder's limited liabilities, and thus seriously damages the interests of any creditors, it shall bear joint liabilities for the debts of the company." (14) In addition, article 64 provides a veil-piercing provision relevant to single-shareholder LLCs. It states: "If the shareholder of a one-person limited liability company is unable to prove that the property of the one-person limited liability company is independent from his own property, he shall bear joint liabilities for the debts of the company." (15)

2. CRITIQUING CHINA'S NEW VEIL-PIERCING PROVISIONS

   Because of the relative lack of public transparency surrounding China's statutory drafting process, one can only speculate about why Chinese lawmakers felt compelled to include veil-piercing provisions in the new Company Law. There are at least three feasible motives. First, given China's burgeoning economy and the rising importance of LLCs, the government may have wanted to provide greater clarity to investors and creditors alike about when, if ever...