It is intended to prevent the company’s shareholders from escaping liabilities by hiding under the corporate veil of limited liability.
This post was first published in CJO GLOBAL, which is committed to providing consulting services in China-related cross-border trade risk management and debt collection. We will explain how debt collection works in China below.
According to the news report, in July 2022, Zhang Kangyang, the son of Zhang Jindong, president of the Italian football club Inter Milan and the de facto controller of Suning.com (one of China’s largest e-commerce retailers) lost a court case in Hong Kong High Court, making him liable for US$255 million of debt as he had given his personal guarantee for his company in a financing deal.
As the company might have few assets in its possession, the verdict puts the creditors in the position to recover their assets from the vast personal assets of its de facto controller (actual controller).
This case indicates that for collecting debts from Chinese corporate debtors, it is better to have the de facto controller of the debtor act as a guarantor in advance.
1. Why do you need the de facto controller of the Chinese company to act as a guarantor in advance?
When it comes to debt collection in China, the biggest concern for creditors is that the debtor is a company with no assets left to settle the debt.
You have no means to investigate the responsibility of the de facto controller of the company, because he/she is just a shareholder of the company and only has limited liability.
Upon making a capital contribution to the company, the shareholder shall no longer be liable for the debts of the company. Moreover, the amount of capital contribution of most Chinese shareholders is not that high.
In fact, many Chinese companies, in their ambitious expansion, frequent and high-value transactions may involve funds or debts far exceeding their registered capital, and even exceed their net assets or asset scale by far.
However, the de facto controller of the company may have transferred the company profits to himself/herself legally or secretly by way of dividend distribution or other financial methods, leaving only the risk of assuming huge debts to the company.
At this time, you need to hold the de facto controller of the company liable.
2. It is common practice to have the de facto controller of the Chinese company act as a guarantor.
In China, financial institutions are well aware of such risks. Their approach is to make the de facto controller personally liable for guaranteeing the company’s debts.
A personal guarantee means that the de facto controller shall provide a guarantee for the debts with all of his/her own properties.
As most places in China do not have a personal bankruptcy regime (except for Shenzhen, the city that has just become the first and by far the only pilot zone of this regime), it also means that the de facto controller will also have to guarantee the debt with all of his/her future assets. Because he/she cannot be discharged from the outstanding debts through the personal bankruptcy regime.
Also, there is no mature trust regime in China, which allows the debtor to divide his/her assets into a trust. As a result, his/her assets usually remain in his/her possession and can be used to pay the debt.
In this way, Chinese financial institutions have a firm grasp of the de facto controller of the companies which are hidden behind the corporate veil of limited liability.
3. What should you do?
If you think that your transaction with the Chinese company is very important and the solvency of the Chinese company is in question, you may ask the de facto controller of the company to sign the contract, and explicitly specify that he/she will bear joint and several liabilities to the debts of the company.
In China, there are two kinds of guarantees:
(1) One type is general guarantee, which means that a guarantor will assume his/her guarantee liability only when the debtor fails to perform his/her obligations. As such, you are required to file a lawsuit with a court against the debtor first, win the lawsuit, and confirm the debtor still fails to satisfy the judgment before you require the de facto controller to act as a guarantor for the repayment of the debt.
(2) The other kind of guarantee is joint and several liability guarantee, which means that the guarantor and the debtor bear joint and several liability for the debt. In other words, if the debtor does not pay the debt, you can require either the debtor or the de facto controller, which acts as the guarantor, to pay the debt.
We suggest you opt for the second kind of guarantee because it is in the best interest of creditors to require the de facto controller to assume joint and several liability.
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Photo by JACQUELINE BRANDWAYN on Unsplash
Contributors: Meng Yu 余萌
