What changes will be made to a "one-person company" under the new Company Law?
Author: Yuan Jiahui, Master of Laws, Renmin University of China
Transferred from: iCourt Fa Xiu
The Company Law of the People's Republic of China (2023 Revision) (the "New Company Law") has systematically transformed one-person companies, not only deleting a special chapter on one-person companies in terms of structure, but also making substantial adjustments to the specific rules of one-person companies. Although a one-person company can provide various business conveniences to shareholders, its potential risks should not be overlooked.
Table of Contents
1. Overview
2. The new Company Law systematically transforms one-person companies
3. Judicial observation of the operational risks of a one-person company
Fourth, one-person corporate governance suggestions
bibliography
overview
Compared with other forms of company, a company with only one shareholder (i.e., a "one-person company", which does not include wholly state-owned companies) has a relatively short history, and the reason for its "difficult birth" is that legislators are concerned about the malicious abuse of the company's limited liability system by shareholders. At that time, although the legislation did not recognize one-person companies, it was undeniable that one-person companies were widely used in commercial activities due to their unique advantages such as reducing investors' business risks.
No law can be divorced from real life, and attitudes towards one-person companies are changing along with socio-economic development. It is generally accepted that the Law on Natural Persons and Corporations promulgated by Liechtenstein on 5 November 1925 was the first of its kind in the system of one-person companies. Since then, various countries have also put the legislative task of one-person companies on the agenda, and the one-person company system has officially appeared on the world stage of company law.
This law of development is also reflected in the legislative practice of the mainland company law. When the Company Law was promulgated in 1993, the number of shareholders of a limited liability company must be two or more, except for wholly state-owned companies, and a one-person limited liability company is not allowed to be established by a natural person. It was not until the revision of the Company Law in 2005 that a complete section of the one-person company system was first provided for at the legislative level, and the legal status of a one-person company was formally established at the level of the Company Law.
The new Company Law systematically transforms one-person companies
After the new Company Law came into effect, the term "one-person limited liability company" was no longer accurate, and should be replaced by "a company with one shareholder". Along with the change of title, the connotation of the one-person company system has also undergone significant changes.
First, the restriction that a single natural person can only establish a one-person company and that a one-person company may not establish a one-person company is abolished. Article 58 of the Company Law of the People's Republic of China (2018 Amendment) (hereinafter referred to as the "Company Law of '18") stipulates that "a natural person can only invest in the establishment of a one-person limited liability company. The one-person limited liability company cannot invest in the establishment of a new one-person limited liability company. "The new Companies Act abolishes this arrangement. In other words, after the new Company Law comes into effect, natural person A can create a one-person company B, and then company B can create a one-person company C (a "multi-storey one-person company"), and reasonably reduce the business risk of natural person A through the structural design of "layer by layer". The natural person A can also create a one-person company D, and then set up a multi-layer "firewall company" to carry out other businesses.
Second, the form of a one-person company is no longer limited to a limited liability company. The second paragraph of Article 112 of the new Company Law stipulates that: "The provisions of Article 60 of this Law that a limited liability company with only one shareholder shall not have a shareholders' meeting shall apply to a company limited by shares with only one shareholder." This shows that the form of a one-person company in mainland China has been extended from the original limited liability system to a company limited by shares. But does this mean that the new Company Law allows a company limited by shares to be established by a natural person? The answer should be no. Article 92 of the new Company Law stipulates that "for the establishment of a company limited by shares, one person or more than 200 persons shall be the initiators. Therefore, the second paragraph of Article 112 of the new Company Law should specifically refer to the special situation where the shareholder of the company is only one person due to special reasons after the establishment and initiation of a company limited by shares, for example, a company limited by shares acquires 100% of the shares by another company.
Third, the formal requirements should be simplified. Article 59 of the Company Law of '18 clearly requires that a one-person limited liability company shall indicate in the company registration that it is wholly owned by a natural person or a sole proprietorship by a legal person, and that this is stated in the company's business license, which is not explicitly required by the new Company Law (the same applies to the Regulations of the People's Republic of China on the Administration of Registration of Market Entities implemented in 2021). At the same time, the new Company Law retains the provision of the 18-year Company Law that a one-person limited company does not set up a shareholders' meeting. In addition, Article 240 of the new Company Law stipulates that a company may adopt simplified deregistration procedures with the unanimous consent of all shareholders. Accordingly, after the new Company Law comes into effect, shareholders of one-person companies in mainland China can choose to adopt simplified deregistration procedures to quickly complete the deregistration and liquidation of the company.
In addition, it should be noted that although the new Company Law does not specifically require a financial audit to be conducted at the end of each financial year for one-person companies. However, according to the first paragraph of Article 208 of the new Company Law, this obligation has been transformed into a general obligation that all companies are required to comply with. In other words, after the new Company Law comes into effect, a one-person company in mainland China will still need to carry out specific audit actions. Some arguments that the new Companies Act exempts one-person companies from the audit obligation are inaccurate.
Fourth, the presumption of confusion of personality in a one-person company is retained. Article 63 of the Company Law of '18 stipulates: "If a shareholder of a one-person limited liability company cannot prove that the company's property is independent of the shareholder's own property, he shall be jointly and severally liable for the company's debts." Article 23, paragraph 3 of the new Company Law inherits this provision, which means that the new Company Law still adopts the basic position of presumption of personality confusion with respect to one-person companies, which is also the biggest risk of one-person corporate governance. It should also be noted that, based on the wording of paragraph 3 of Article 23 of the new Company Law, it does not expressly limit the application of the presumption of confusion of personality only in limited liability companies. However, it remains to be seen whether the rule can be applied to a one-person company limited by shares after the new Company Law comes into effect.
Judicial observation of the business risks of a one-person company
(1) A substantially one-person company
The so-called "de facto one-person company" means that the real shareholder of the company is only one person, and the other shareholders are all "marionettes" or "nominal shareholders" who hold shares on behalf of the company, which is typically manifested as "husband and wife company" and "family company".
From a Comparative Law Perspective, Solomon v. The Solomon & Co.Ltd case is arguably the most classic case of a substantial one-person company. In this case, Solomon himself formed the Solomon Company and held the majority of the shares. In order to give the company the appearance of multiple shareholders and to meet the requirements of English law for the establishment of a company (the number of shareholders in the English law at that time was at least seven), he divided six of the company's shares equally among his wife and five children. The company's creditors claimed that Solomon and his company were in fact the same person and demanded that the corporate veil be lifted; The Court of First Instance and the Court of Appeal also held the same view, holding that the company was nothing more than an "avatar" of Solomon. The House of Lords reversed the decision of the Court of First Instance and the Court of Appeal: once a company is officially registered, it becomes a legal "person" distinct from Solomon. Perhaps Solomon took advantage of a loophole in the law, but Solomon was established in accordance with the law.
The idea conveyed in Solomon is that once a corporation is legally established, it has a separate personality in law. Even if the company has nominee shareholders and the company is a de facto one-person company, the company cannot be directly lifted on this basis. However, some cases in mainland judicial practice have taken a completely opposite view on this. In the (2019) Zui Gao Fa Min Zai No. 372 case, the Supreme People's Court held that Xiong and Shen were husband and wife and were both shareholders of Qingmanrui Company, and the interests of the two parties were highly consistent, so it was easy to cause the confusion of the joint property of the husband and wife and the company's property.
For example, in the (2022) Lu Min Shen No. 9215 case, the Shandong High People's Court also determined that the company involved in the case was a substantial one-person company based on the existence of a husband and wife relationship between Ming and Bao, and thus applied the special provisions of a one-person limited company, and ruled that Ming and Bao were jointly and severally liable for the company's debts. For example, in the case (2022) Jing Min Shen No. 7421, Zhou and Zhu argued that even if the company is a substantial one-person company, the reversal of the burden of proof should not be applied as a matter of course, but the Beijing High People's Court did not agree with this view.
The above-mentioned cases undoubtedly convey a red flag: some mainland courts have a relatively lenient criteria for the identification of a substantial one-person company, and when the shareholders of the company have a marriage or family relationship, the court will usually determine that the company is a substantial one-person company. When the company is identified by the court as a de facto one-person company, the court will usually apply the presumption of confusion of personality of a one-person limited company and require the shareholders of the company to bear the opposite burden of proof. If the shareholder is unable to provide evidence, the court will lift the corporate veil accordingly. More dangerously, this situation means that the spouses or relatives of a de facto one-person company are often jointly and severally liable to the company's creditors for "community property". Moreover, this trend has shown a clear growth trend after the Supreme People's Court announced the above-mentioned cases.
(ii) Layer by layer penetration
As mentioned earlier, the Companies Act '18 had expressly prohibited a one-person limited company from setting up another one-person limited company as a shareholder again. The design of this system clearly reflects the concerns of legislators that shareholders can avoid legal liability by setting up a one-person company, thereby harming the interests of creditors. Despite the above-mentioned prohibitions, this provision cannot prohibit the realization of a multi-tiered one-person company structure by encouraging a shareholder to withdraw from the company after the company has been established (which also indicates that the previous legislation in mainland China prohibits the establishment of a one-person company may be futile). As a result, this kind of multi-layered one-person company still survives in mainland commercial activities. The question then arises as to whether such a special form of company can be penetrated layer by layer and require all companies to bear joint and several liability.
From the perspective of judicial practice, although there are considerable disputes, the mainland courts do not exclude the lifting of the corporate veil layer by layer, because it is a multi-layered one-person company in the form of a company. For example, in the case (2020) Yue 01 Min Zhong No. 12207, the court of first instance found that the company involved in the case was a multi-layered one-person company and failed to prove that the assets of the companies were independent, and then ruled that the companies should bear joint and several liability, which was also recognized by the Guangzhou Intermediate People's Court of the second instance. In the case (2022) Jing 02 Min Zhong No. 3682, the Beijing No. 2 Intermediate People's Court of the second instance also found that the defendant companies involved in the case were multi-storey and one-person companies, and failed to prove that the assets of the companies were independent, and it was not improper for the first-instance judgment that the companies were jointly and severally liable to the creditors. The Hangzhou Intermediate People's Court also held the same view in the case (2020) Zhe 01 Min Zhong No. 5192.
Of course, some courts have adopted a strict interpretation of the presumption of confusion of personality of a one-person limited company, holding that there is no clear legal basis for layer-by-layer penetration. For example, in the case (2019) Yue 2071 Min Chu No. 24556, the First People's Court of Zhongshan Municipality held that penetrating a corporate veil is sufficient to protect the interests of creditors, and that the liability of shareholders of a one-person company in the presumption of confusion of personality of a one-person company should be limited to the shareholders of the debtor, and should not be traced back to the shareholders of the debtor in the first case. In the case of Liao 01 Min Zhong No. 6804 (2023), the Shenyang Intermediate People's Court also recognized that the presumption of joint and several liability for the confusion of personality of a one-person company does not extend to the shareholders of a one-person limited company.
As the new Company Law still retains the rule of Article 63 of the Company Law of 18 on the presumption of confusion of personality of a one-person company, and no substantial technical adjustments have been made. After the new Company Law lifts the restriction that a company may no longer establish a one-person company, it is foreseeable that the above-mentioned disputes will further increase, and the risk of multi-layered one-person companies being uncovered at various levels still objectively exists.
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(3) The liability of the actual controller
The liability of the actual controller can be regarded as a further extension of the problem of layer-by-layer penetration. In other words, in a multi-layered one-person company, even if it cannot penetrate layer by layer, can the actual controller hidden behind the scenes be directly required to bear personal responsibility? For example, when natural person A creates a one-person company B, company B creates a one-person company C, and company C creates a one-person company D, even if the creditors of company D cannot require A, B and C to be jointly and severally liable to them through layer-by-layer penetration, can they directly request A, which is the actual controller of company D, to be liable for it?
In this regard, Article 11 of the Minutes of the Ninth People's Meeting stipulates that: "Where a controlling shareholder or actual controller controls multiple subsidiaries or affiliated companies, abuses his or her control to make the property boundaries of multiple subsidiaries or affiliated companies unclear, their finances mixed, their interests transfer to each other, they lose their personality independence, and they become a tool for controlling shareholders to evade debts, operate illegally, or even violate the law and commit crimes, they may deny the legal personality of the subsidiary or affiliated company and order them to bear joint and several liability based on the facts of the case." However, the Minutes of the Nine People's Meetings do not have the force of law and cannot be used as the basis for adjudication, and the new Company Law has not formally adopted this provision. Therefore, there is still no definite answer to the above question on the mainland.
In judicial practice, the courts are more likely to apply the relevant rules by analogy by purposefully expanding the interpretation of the system of personality confusion. In the (2020) Gui Min Zhong No. 15 case, the High People's Court of Guangxi Zhuang Autonomous Region determined that Xu controlled Xingtang Trading Company by establishing a number of offshore companies, and should be the actual controller of Xingtang Trading Company. On the question of whether Xu should be liable to Xingtang Trading Company, the court held that it was not clear whether paragraph 3 of Article 20 of the Company Law of '18 was applicable to entities that were not shareholders of the company but had a controlling or affiliated relationship with the company, but based on the basic jurisprudence of this article, the rule could be applied by analogy to determine that the actual controller and the company had mixed personalities. In the (2020) Zui Gao Fa Min Zhong No. 185 case, the Supreme People's Court also clearly held that other entities that are not shareholders of the company but have an association or control relationship with the company damage the interests of the company's creditors through the operation or control of the company are homogeneous with the abuse of the company's personality by the company's shareholders to harm the interests of creditors, and the legal person personality denial system should be applied by analogy. In the (2019) Zui Gao Fa Min Shen No. 6232 case, the Supreme People's Court clearly pointed out that the legislative purpose of corporate legal personality should cover the abuse of corporate legal personality by the actual controller of the company.
In addition, although the Supreme People's Court's Guiding Case No. 15, XCMG Construction Machinery Co., Ltd. v. Chengdu Chuanjiao Industry and Trade Co., Ltd., et al., a dispute over a sales contract, was a case of confusion of horizontal personalities, the presiding court also explicitly mentioned the view that the actual controller should be jointly and severally liable for the company's debts. According to the above case view, the scope of the mainland's legal personality denial system covers the actual controller. According to this line of thinking, the provisions on the confusion of presumptive personality of a mainland one-person company should also be applicable to the actual controller.
One-person corporate governance advice
(1) Comprehensively consider the type of legal person
Compared with other types of for-profit legal persons, the biggest advantage of corporate legal persons is the limited liability protection of shareholders. However, by combing through the relevant cases, it is not difficult to find that a mainland one-person company can only enjoy "limited" limited liability protection, and the veil of a mainland one-person company may be lifted in a variety of ways. From this point of view, the form of a one-person company may not be better than that of a sole proprietorship, and a sole proprietorship may even be better than a one-person company in terms of taxation (a sole proprietorship does not pay enterprise income tax in accordance with the provisions of the Enterprise Income Tax Law, but is like a partnership in which the individual investor pays individual income tax).
Despite this risk, it should also be noted that the new Company Law further relaxes the control of one-person companies. As for tax issues, one-person companies can also reasonably avoid taxes by "paying wages". Therefore, if the risk of a one-person company can be reasonably controlled, a one-person company can still be an ideal investment tool.
In addition, since mainland courts are more willing to lift the corporate veil of "de facto one-person company", it may not be wise to set up a husband-and-wife company or family company in the mainland. In an ordinary one-person company, the husband or wife of the other party may still be able to invoke Article 1064 of the Civil Code and other provisions on joint debts of husband and wife to defend themselves, but in a "de facto one-person company", the debts have been "recognized" as joint debts of the husband and wife through judicial procedures, and this defense seems to have lost its usefulness.
(2) Earnestly respect the company's procedures
In a one-person company, the will of the shareholders cannot be substituted for the will of the company. The Company Law of the People's Republic of China continues to stipulate that a one-person company does not need to set up a shareholders' meeting, but this does not mean that the will of the company's shareholders directly represents the will of the company. Specifically, shareholders of a one-person company should still comply with the provisions of Article 60 of the new Company Law and carry out specific actions. In addition, when carrying out business activities abroad, it is also necessary to clearly distinguish between the identity of shareholders and the main body of the company, so as to avoid the appearance of confusion of corporate personality and unfavorable evidence.
(3) Clearly distinguish the company's assets
As pointed out in the Minutes of the Nine People's Meetings, the core of the confusion of corporate personality lies in the confusion of property. In almost all of the cases cited in this article, the courts have lifted the corporate veil on the grounds that the shareholders could not prove that they were independent of the company's assets. Therefore, whether or not the company can prove the independence of the company's property will become the decisive point of the relevant litigation. Well-organized financial books, accounting books, financial statements, and year-end audit reports issued by independent third-party institutions will be a powerful tool for shareholders to win. In this sense, Article 208 of the new Company Law is not so much an obligation of shareholders as a guide for legislators on how shareholders of one-person companies can protect themselves.
(4) Avoid excessive domination and control
As the actual controller of the company, if it abuses the control of the company to the detriment of the interests of the company's creditors, it may bear the corresponding liability for compensation. Common forms of abuse of corporate control include, but are not limited to, improper transfer of benefits, one company bears all debts while another company enjoys all benefits, transfer of company assets to evade corporate debts, etc. As illustrated in the case above, this risk is further amplified in one-person companies. In this regard, all investors must sort out the correct concepts, make reasonable use of the institutional design of one-person companies, and avoid turning one-person companies into tools that harm others.
bibliography
1. Shi Tiantao, "On Company Law", Law Press
2. Joint and Several Liability of a Double-tier One-Person Company: The Dual Perspectives of Company Law and Civil Procedure Law, People's Justice, No. 22, 2023