Introduction
On July 1, 2024, the newly revised "Company Law of the People's Republic of China" (hereinafter referred to as the new "Company Law") will be officially implemented. The new "Company Law" innovatively introduces the concept of horizontal corporate personality denial and establishes an "integrated vertical and horizontal" rule for corporate personality denial. This aims to regulate the abuse of corporate independence by related enterprises while expanding the avenues for creditors to protect their rights. This article examines the judicial practice of highly mixed corporate personalities from the perspective of the Supreme Court's guiding cases, explores its connection with the substantive consolidation bankruptcy system for related enterprises, and provides compliance and rights protection recommendations for related enterprises under the new "Company Law."
I. Historical Evolution of the "Integrated Vertical and Horizontal" Corporate Personality Denial Rule
- 2005 Company Law: Article 20, Paragraph 3, explicitly stated: "If a company's shareholders abuse the independent legal status of the company and the limited liability of shareholders to evade debts, causing serious harm to the interests of the company's creditors, they shall bear joint liability for the company's debts." The birth of the vertical corporate personality denial rule was aimed at plugging the loophole of shareholders using the limited liability system and the independent legal status to evade debts. However, it was generally limited to the vertical joint liability of shareholders for company debts and did not extend to situations where related companies used the independent legal status system to evade debts.
- January 31, 2013: The Supreme Court issued Guiding Case No. 15, providing judicial guidance for resolving issues related to the identification of corporate personality mixing and the assumption of legal responsibility among related companies. The Jiangsu High Court used teleological interpretation to return to the legislative purpose of corporate personality independence, ordering the related companies that constituted "personality mixing" and the debtor to jointly bear responsibility for the debt in the case, achieving a breakthrough from "vertical denial" to "horizontal denial" of corporate personality.
- November 8, 2019: To unify the standards of judgment, the Supreme Court, based on the experience of trials at all levels of courts, provided a detailed discussion on the specific application of corporate personality denial in the Ninth "National Court Civil and Commercial Trial Work Conference Minutes" (hereinafter referred to as the "Minutes"). Article 11, Paragraph 2, explicitly emphasized "denying the corporate personality of subsidiaries or related companies," marking the inclusion of horizontal related companies in the scope of application of corporate personality denial at the normative document level.
- 2023 New Company Law: The comprehensive revision of the new "Company Law" actually provided a legal basis for the judicial application of horizontal corporate personality denial at the legislative level. Article 23, Paragraph 2, clearly states: "If a shareholder uses two or more companies under its control to implement the acts specified in the preceding paragraph, each company shall bear joint liability for the debts of any one of the companies." This provision, based on the existing overall approach of the "Minutes" and the judicial practice of the Supreme Court's guiding cases, summarizes the "integrated vertical and horizontal" corporate personality denial rule in "explicit terms," further improving the corporate personality denial system from the perspective of the responsible entities. Even if the related companies are formally independent without equity relationships, they should be "packaged" together with the shareholders to bear joint liability in the final responsibility allocation. This move not only effectively combats debtors using related enterprises to evade debts but also effectively expands the avenues for creditors to protect their rights.
II. Judicial Experience of the "Integrated Vertical and Horizontal" Corporate Personality Denial Rule in Substantive Consolidation Bankruptcy Practice
Unlike traditional vertical personality denial, "integrated vertical and horizontal" personality denial is a triangular piercing, i.e., a two-way denial of the behavior of controlling shareholders or actual controllers using the independent legal status of related enterprises and the limited liability of shareholders to evade debts and harm the interests of creditors, making each related enterprise merge into a unified debtor, with the assets and liabilities of each enterprise calculated and responsible externally as a whole.
The most common practical application field of the "integrated vertical and horizontal" corporate personality denial rule is enterprise bankruptcy. When the related parties under the same enterprise system meet the bankruptcy conditions specified in Article 2 of the "Enterprise Bankruptcy Law," such as being unable to repay debts when due, the related parties will be integrated into a unified entity to apply the bankruptcy system for the final and scaled cleanup of debts and claims. Based on Article 32 of the 2018 "Bankruptcy Trial Work Conference Minutes" (hereinafter referred to as the "Bankruptcy Minutes"), which standardized the judicial elements in practice, the substantive consolidation rule can be applied when "the corporate personality is highly mixed, the cost of distinguishing the property of each related enterprise member is too high, and the interests of creditors' fair compensation are seriously damaged."
Therefore, before the introduction of the new "Company Law," the embryonic form of the "integrated vertical and horizontal" corporate personality denial gradually appeared in the rulings of "substantive consolidation bankruptcy of related enterprises." This article takes the 29th batch of guiding cases released by the Supreme Court in 2021, consisting of 3 cases, as a typical example to illustrate the practical application of the "integrated vertical and horizontal" substantive consolidation bankruptcy system:
- Case One: Jiangsu Textile Industry (Group) Import and Export Co., Ltd. and its five subsidiaries' substantive consolidation bankruptcy reorganization case [(2017) Su 01 Po 6] (Guiding Case No. 163). In this case, the court pointed out that "the bankruptcy of related enterprise members should also be based on the principle of applying individual bankruptcy procedures. However, when there is a high degree of mixing of corporate personality among related enterprise members, the cost of distinguishing the property of each related enterprise member is too high, and the interests of creditors' fair compensation are seriously damaged, the substantive consolidation bankruptcy method can be applied to ensure that all creditors can be compensated fairly."
Overall, regarding the identification of "highly mixed corporate personality," the court believes that the main manifestations of the high degree of mixing of the personalities of the six companies are:
1. High overlap of personnel positions, without forming a complete and independent organizational structure;
2. Shared financial and approval personnel, lacking an independent financial accounting system;
3. High overlap and mixing of business, forming a highly mixed business entity, objectively leading to the difficulty in properly distinguishing the profits of the six companies;
4. There are a large number of related debts and guarantees among the six companies, making the assets of each company not completely independent, and the cleanup of debts and claims is extremely difficult.
- Case Two: Jiangsu Su Chun Liquor Co., Ltd. and related companies' substantive consolidation bankruptcy reorganization case [(2018) Su 0324 Po 1] (Guiding Case No. 164). In this case, the court believes that the three companies have a high degree of mixing in management, finance, personnel, and management, and the cost of distinguishing the property of each related enterprise member is too high. Therefore, in accordance with Article 32 of the "Bankruptcy Minutes," based on the application of the manager, the court ruled that the three companies should be substantially consolidated for bankruptcy reorganization.
- Case Three: Chongqing Jinjiang Dyeing and Printing Co., Ltd. and Chongqing Chuanjiang Knitting and Spinning Co., Ltd. bankruptcy manager's application for substantive consolidation bankruptcy liquidation case [(2015) Jin Fa Min Po No. 00001] (Guiding Case No. 165). In this case, the court denied the independent legal personality of Jinjiang Company and Chuanjiang Company because since their establishment in 1994 and 2002, the personnel, business, and assets of the two companies have been personally controlled by Feng Xiudan. There is a high degree of mixing in management, main business, assets, and liabilities. Jinjiang Company and Chuanjiang Company have lost the independence of legal property and legal will, and this situation has been significant, widespread, and continuous until the bankruptcy liquidation period in 2016, with a high degree of mixing of corporate personality between the two companies. In addition, the two companies cannot be completely distinguished in terms of management costs, debts, and claims, and the authenticity cannot be confirmed. At the same time, Chuanjiang Company's transfer of 85,252,480.23 yuan of operating liabilities to Jinjiang Company and the settlement of 21,266,615.90 yuan of external fundraising liabilities to Jinjiang Company have damaged the interests of Jinjiang Company and its creditors.
The court finally ruled that the corporate personality of the two companies is highly mixed, and the debts and claims of the two companies cannot be separated in their mutual operations, and separate liquidation will seriously damage the interests of creditors' fair compensation. Therefore, the manager's application for the merger of Jinjiang Company and Chuanjiang Company for bankruptcy liquidation meets the conditions for substantive consolidation.
The above related enterprise substantive consolidation bankruptcy cases have interpreted that the premise condition of "highly mixed corporate personality" of related enterprises has gradually become one of the important judicial bases in bankruptcy judicial practice before the substantive consolidation bankruptcy system has not yet been directly supported by higher-level laws. At present, the "integrated vertical and horizontal" corporate personality denial rule has directly stepped forward through the new revision of the "Company Law." For creditors after the implementation of the new "Company Law," the corporate personality denial rule can be used as a legal basis for applying for the substantive consolidation bankruptcy of related parties when related enterprises meet the bankruptcy conditions, and it can also be used to expand the path of rights protection by bearing joint liability when related enterprises do not meet the bankruptcy conditions.
III. Compliance Recommendations for Rights Protection Based on the "Integrated Vertical and Horizontal" Corporate Personality Denial Rule
The formal establishment of the "integrated vertical and horizontal" corporate personality denial rule essentially puts forward higher requirements for the internal governance level of group enterprises. Groups should effectively regulate various behaviors between related companies to avoid the continuous piercing of debts due to the mixing of personalities of related parties, thereby dragging the entire group into a debt abyss; at the same time, external creditors should also establish a sense of rights protection in the era of the new "Company Law," and pay special attention to the collection and preservation of evidence related to personality mixing when engaging in commercial transactions with group enterprises.
- (1) Rights Protection Recommendations for External Creditors Based on the "Integrated Vertical and Horizontal" Corporate Personality Denial
The improved corporate personality denial rule expands the responsible entities from shareholders to shareholders and related companies at the legislative level. The main criterion for identifying related enterprises is whether the debtor and the identified object are "highly mixed in personality." The most fundamental criterion for whether the personality is mixed is whether the company has independent will and whether the property is mixed. The accompanying business mixing, personnel mixing, and business premises mixing are only supplementary criteria. In commercial practice, shareholders and related companies often use the debtor's company funds and property without compensation, or shareholders use the funds of subordinate companies to repay their own debts, and shareholders provide the funds of subordinate companies for other related companies to use without compensation. These behaviors are often covered up by various "technical" financial records, which makes it difficult for external creditors to provide evidence. Moreover, external creditors almost never have access to real internal debtor accounting books, accounting vouchers, financial accounts, and other materials.
In this situation, external creditors should fully utilize their position as trading counterparts or commercial partners, improve their sensitivity to the trading behavior and creditor-debt relationship of group enterprises, pay special attention to whether there are unconventional operations such as the mixing of collection accounts, the mixing of company assets, and the mixing of business and financial personnel among the related companies in group enterprises, and record them. In addition, creditors can use the business scope stated in the company's business license, external business promotion materials, external recruitment information materials, external signed similar business contracts, and other obtainable materials, or try to start from publicly available information such as social security, industrial and commercial registration of senior management information, and published litigation and arbitration cases, to comprehensively and comprehensively show the strong clues that may exist between related subjects, and use this as a handle to persuade the people's court to grant certain investigation and evidence collection powers. By obtaining key evidence such as the internal real fund flow, financial accounts, and audit reports of the group enterprise, it is possible to clarify whether the debtor's property is mixed with its shareholders or related companies.
- (2) Compliance Recommendations for Companies Under the "Integrated Vertical and Horizontal" Corporate Personality Denial Context
The new "Company Law" provides a new path for external creditors to pursue responsibility from related parties. Correspondingly, the debtor company and its shareholders and other related subjects should pay more attention to internal audits and effectively regulate the independence of the company in commercial activities with shareholders and related companies to avoid being identified as personality mixing and having to bear joint liability with related parties.
From the perspective of corporate compliance, whether each subject within the group enterprise has an independent and sound financial management system is the key to proving financial independence and avoiding personality mixing. Related enterprises should avoid the use of common property and mixed accounts. The group level should strictly control the approval process of funds between related parties to ensure that the company's property is always under its independent management and control and is not used at will according to the wishes of the actual controller or specific shareholders. At the same time, to avoid financial mixing caused by "no financial records," the company must have financial personnel to manage different categories and different subjects of financial data and accounts, standardize the records of various fund transactions, and retain true, accurate, and complete financial records.
In addition, for other potential mixing risks of related companies, if there is an overlap in the business scope of related companies, it is necessary to avoid the use of common sales manuals and distribution agreements in the distribution process, pay attention to distinguishing company information in external publicity to prevent the chaotic use of company seals; related companies should clarify the corporate governance structure and avoid overlapping positions in directors, supervisors, and senior management to avoid mixing of governance structures; avoid the same location for related companies to office, and distinguish the registered office and main office of the company. In summary, group enterprises should pay attention to clarifying the boundaries between each related subject in all aspects, reduce the frequency of related transactions and related party dealings, and strictly control potential legal disputes between related subjects.
Conclusion
The improvement of the "integrated vertical and horizontal" corporate personality denial rule, while promoting the strengthening of creditors' rights protection, also puts forward higher requirements for the legal governance and independent governance capabilities of group enterprises in the era of the new "Company Law." At the important time when the new "Company Law" is introduced and the "Enterprise Bankruptcy Law" is about to be revised, the "integrated vertical and horizontal" corporate personality denial rule can be expected to play a more routine and more basic role in practice, and ultimately more effectively protect the legitimate rights and interests of the vast majority of creditors.
