1. SUMMARY OF THE DISREGARD SYSTEM OF LEGAL ENTITY
The independent personality of a corporation and the limited liability of shareholders are the two great cornerstones of the modern corporation system. The corporate system plays a significant role in inducing investment and promoting the rapid accumulation of capital. However, in another aspect, this system has been maliciously abused and used as a tool to promote illegal profits.
The Disregard of the Legal Entity System was introduced in China when the "Company Law" was amended in 2005.1 However, since the above regulations are very theoretical and abstract, there were many problems in the application of this system and the judgment of each court. Some examples include the inconsistent results of similar trials and the lack of persuasiveness of the grounds and logic of the trial results.
Accordingly, in 2019, the Supreme People's Court of China ("SPC") published the "Minutes of the National Courts' Civil and Commercial Trial Work Conference," which stipulates detailed criteria for judgment on the disregard of legal entities. Judgment is to be based on whether there is a so-called confusion problem in which corporations and shareholders or affiliates are mixed and do not have separated property, employees, and business, whether shareholders have excessive control over the corporation, and whether such control has caused serious damage to creditors.
Since the introduction of this system, the proportion of cases in which a legal entity was disregarded has risen to around 70%. Accordingly, some scholars argue that the disregard system of legal entities should be applied under strict conditions.
In recent years, courts have rarely accepted a party's claim of disregard for the legal entity. This is partly due to the lack of explicit circumstances regarding the disregard of a legal entity, but more importantly, the court is cautious in its application because it is difficult for the counterparty to present clear evidence of the abuse of a legal entity2.
2. BURDEN OF PROOF FOR THE DISREGARD OF A LEGAL ENTITY
a. The General Principle of Burden of Proof
According to the Civil Procedure Law of China, "Who advocates who proves," (the party bears the burden of proof for its claims). That is, the classification theory of legal requirements is a principle3.
However, in the case of the disregard of a legal entity, it is almost impossible for the creditor to prove "confusion in property, employees, and business" because such information, especially information on property such as the debtor's books and financial transactions, belongs to the debtor. Therefore, it is very unfair for the burden of proof to be allocated to creditors according to the basic principle thereof.
Of course, there is an exception to the burden of proof in Article 634 of the Chinese Company Law that disregards the legal entity of a one-person company ("OPC"). However, this rule only applies to OPCs, and shall not be further discussed in this article.
b. Provisions for Reducing the Burden of Proof and Practical Problems
The SPC has established easing regulations to address issues where debtors control the material evidence, making it difficult for creditors to obtain proof such as disputes that are contrary to their legal personality.
(1) Provision for Mitigating the Burden of Proof
As described above, Article 47 of the "Several Provisions of the Supreme People's Court" stipulates that the party who controls evidence such as books, must disclose the evidence in order to alleviate the difficulty in acquiring evidence controlled by the other party.
In addition, Article 67(2)5 of the Civil Procedure Law stipulates that the People's Court shall collect evidence that is difficult for the parties to obtain for objective reasons.
Therefore, for disputes related to the disregard of a legal entity, creditors shall obtain significant evidence, such as financial transaction information, by applying for an order to investigate the evidence with the court.
The above provisions are in accordance with the order of the writ system and the court investigation evidence collection system for the purpose of guaranteeing equality of arms and the right to collect evidence from the litigants. Of course, this is controversial. For example, the system of the order of writ may undermine the judge's neutral judgment, and the order of the writ system may infringe on the parties' right to not submit documents that are not related to the case, such as commercial secrets.6
However, the ultimate purpose of a lawsuit is to find out the truth and provide relief to the victims. If there is a problem in the implementation of a certain system, it is desirable to supplement the system through legislation rather than to reject the system.
(2) Practical problems
The main issue is that the court has great discretion in the practical application of the above two evidence systems. In the case of civil litigation, there are few cases in which the court actively conducts investigation and collects evidence. Usually, at the request of the party, the court issues an investigation order thereto and the party collects evidence. However, the evidence provider commonly does not actively cooperate without the court's attendance, even if the court orders the investigation.
In the litigation practice of China, for financial transaction information, which is a very important evidence in disputes over a legal entity, the applicant must provide account information to the court when applying for an investigation on financial transaction information. However, the only account that creditors can legally get is the officially registered corporate account of the debtor. But, in many cases, debtors conceal their funds by using multiple accounts, including those of affiliated companies. Therefore, it is very difficult for creditors to prove the "confusion in property."
Regarding the provision of evidence of financial transaction information in South Korea, the financial information of the holder is strictly guaranteed pursuant to Article 4 of the "Act on Real Name Financial Transactions and Confidentiality." However, if there is an order to submit such information by the court, the holder must disclose the financial information. Based on this, in the practice of litigation, the creditor can check all financial information related to the case without providing clues such as the debtor's account number to the court.
Ultimately, it is a matter of properly balancing the protection of personal information with its use. In China, since the full-scale research and legislation on personal information protection systems are at a fledgling stage, the level of the operating system for protection and use of personal information is not high. Therefore, in litigation, the court takes a very cautious stance when dealing with requests for investigation on financial information, etc., for fear that it may become a problem due to the infringement of personal information.
Fortunately, in this regard, China is actively researching and seeking solutions for information and legislative technologies.7 Therefore, it is expected that the difficulties that creditors face in acquiring proof will be gradually resolved.
c. Theological Discussion on the Burden of Proof for the Disregard of Legal Entity
In academia, there is an opinion that argues for a partial shift of the burden of proof in the case of a litigation against a legal entity. From this point of view, after the plaintiff first proves the defendant's abuse of the independent personality of the legal entity and the limited liability of the shareholders, the serious damage of the plaintiff's interests, and the causal relationship between the defendant's abuse and the plaintiff's damage, the burden of proof lies with the defendant. It is argued that the defendant must prove that there is no confusion in property, business and employees.
Of course, the plaintiff's proof is sufficient to prove this issue at a rudimentary level. For example, "一套人马，两块牌子" (two corporations or human members are almost identical.)
When considering equity as the highest value pursued by litigation, the above view that part of the burden of proof should be shifted in a litigation against a corporation is reasonable.
3. ADVICE FOR BUSINESSES
In a lawsuit against a corporation, the creditor must bear a very heavy burden of proof. Businesses should always be vigilant with litigation in mind when making transactions. When multiple affiliates of a counterparty are involved in a transaction, the joint responsibility commitment of these affiliates is a particularly effective countermeasure.
If joint liability negotiations fail, it is necessary to at least identify the transaction risks and come up with countermeasures through basic investigations on subjects including the capital, CEO, and shareholders of the contracting party.
Footnotes
1. According to Article 20(3) of the Company Law, in the event that the shareholders of a company abuse the company's independent status and the shareholder's limited liability system to evade debt or cause significant damage to the interests of the company's creditors, they shall be jointly liable for the company's debts.
2. Miao Wang, "A Study on the Doctrine of the Disregard of the Corporate Entity in China Corporation Law, 「Northeast Asian Law Journal」 Volume 14 No. 1, p5.
3. According to Article 67(1) of the Civil Procedure Law of the People's Republic of China, a party shall be responsible for providing evidence in support of his or her allegations.
4. According to this provision, in the case of a single-shareholder company, the shareholder must prove the separation of the company from its assets. In other words, the burden of proof is passed to the debtor, not the creditor. This is to protect creditors because an OPC is closer than a general company with two or more shareholders and often abuses corporate personality. This article is to discuss general companies, not OPCs.
5. According to Article 67(2), if the parties and agents cannot collect evidence for reasons beyond their control, or if the People's Court deems that evidence is necessary for the trial of the case, the People's Court shall investigate and collect the evidence.
6. Pengxiaoye(彭箫野), discuss perfecting the order of writ，the site of the higher people's court of Hunan province https://hunanfy.chinacourt.gov.cn/article/detail/2017/09/id/2994258.shtml，visited in31-08-20222.
7. The ordinance on social credit information promulgated in various cities, such as Shanghai and Hebei province in China, stipulates the scope of inquiry and use according to the type of information.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
