A Brief Discussion on the Issue of 'Over-Control'
Time:
2021-01-26
Author:
Lin Zigang
Source:
Guangxi Tongwang Law Firm
Visits:
575
In recent years, China has increasingly recognized the denial of the legal personality of controlled legal entities such as subsidiaries, and even cases of "reverse piercing of the corporate veil" have emerged (i.e., requiring subsidiaries to bear joint liability for the debts of the parent company). According to incomplete statistics, the corporate veil piercing rate in China is 63.04%, which is higher than that in the United States, the United Kingdom, Australia and other countries. The number of corporate legal personality denial cases is increasing year by year, and the piercing rate is also increasing year by year. Compared with higher-level courts, grassroots courts are more inclined to pierce the corporate veil. The piercing rate in economically underdeveloped areas is higher than that in economically developed areas, and the piercing rate is higher when the number of shareholders is smaller. It can be seen that piercing the corporate veil has become one of the major legal risks in the relationship between parent and subsidiary companies in China.
"Excessive Domination and Control", also known as "Improper Domination and Control", mainly occurs between parent and subsidiary companies, and group companies and their subordinate companies. It is an important situation in which the independent legal personality of a company is denied, and it falls under Article 20, Paragraph 3 of the "Company Law of the People's Republic of China", which stipulates that shareholders abuse the company's independent legal status and shareholders' limited liability to evade debt.
The United States refers to the situation where a parent company excessively dominates and controls its subsidiary as a "second self", that is, the control or domination exercised by the parent company over the subsidiary reaches the standard of the subsidiary becoming the "second self" of the parent company, that is, the parent company and the subsidiary are essentially two aspects of the same person. At this time, it can be considered as a denial of the independent legal personality of the parent company or the subsidiary. Therefore, if the parent company excessively dominates and controls the subsidiary, it may lead to the denial of the subsidiary's independent corporate personality, which may lead to the parent company's joint and several liability for the subsidiary's debts.
Shareholders should bear legal responsibility for acts of excessive domination and control. There is no disagreement on this point in either academia or the judiciary, but what is difficult to grasp in practice is what degree of control and domination constitutes "excessive". After all, as an independent legal entity established by the parent company, the subsidiary prioritizes the interests of the shareholders, obeys the will of the shareholders, and the parent and subsidiary companies act jointly, cooperate with each other, and form a coordinated economic entity, which is what it should be. Therefore, the parent company's control over the subsidiary is also inevitable. However, everything has a limit, and so does the parent company's control over the subsidiary. Excessive control will inevitably infringe on the subsidiary's independent legal personality, thereby affecting its ability to independently assume responsibility.
In the author's opinion, whether the parent company's domination and control over the subsidiary is excessive should be comprehensively judged based on factors such as the continuity and severity of the domination and control, and the scope and matters of the domination and control. If, in actual operation, the parent company deeply intervenes in the subsidiary's decision-making, operation and other matters, directly manipulates the subsidiary's decision-making, operation and other internal institutions, oversteps its authority to interfere with and decide the subsidiary's main business activities, and the subsidiary completely loses the ability to independently express its intentions, and everything is centered on the parent company's interests, and the subsidiary is only responsible for implementing the parent company's decisions, then we can determine that the parent company excessively dominates and controls the subsidiary, thereby denying the subsidiary's independent legal personality and requiring the parent company to bear corresponding responsibilities.
To this end, the author has compiled the following situations of excessive domination and control based on the relevant legal provisions such as the "Company Law" and the actual operation.
1. The board of directors' authority is eroded by shareholders
The shareholders' meeting generally decides on important personnel, financial and business matters of the company. According to Article 37 of China's Company Law, it mainly includes:
1. Important matters, including:
(1) Deciding on the company's business policy and investment plan;
(2) Reviewing the reports of the board of directors and the board of supervisors;
(3) Amending the company's articles of association;
(4) Major matters such as the company's division, merger, dissolution and liquidation.
2. Important personnel, including:
(1) Appointment of directors;
(2) Appointment of supervisors.
3. Important financial matters, including:
(1) Remuneration of directors and supervisors;
(2) Annual financial budget plan and final account plan;
(3) Profit distribution plan and loss recovery plan;
(4) Issuance of bonds;
(5) Increase or decrease of registered capital.
The authority of the board of directors is basically to implement the resolutions of the shareholders' meeting and refine the policies and plans decided by the shareholders' meeting. Article 46 of the Company Law stipulates that the authority of the board of directors includes:
1. Implementing the resolutions of the shareholders' meeting;
2. Refining the policies and plans decided by the shareholders' meeting, including:
(1) Deciding on the company's business plan and investment plan;
(2) Formulating the company's annual financial budget plan and final account plan;
(3) Formulating the company's profit distribution plan and loss recovery plan;
(4) Formulating a plan for the company to increase or decrease its registered capital and issue company bonds;
(5) Formulating a plan for the company to merge, divide, dissolve or change the form of the company;
3. Determining the company's internal management structure;
4. Deciding on the personnel and remuneration of the management team;
5. Formulating the company's basic management system.
Although Chinese law allows companies to adjust the functions and powers of internal institutions when formulating articles of association, judging from the articles of association of many companies, the functions and powers of internal institutions stipulated in most company articles of association, especially the functions and powers of the shareholders' meeting and the board of directors, basically copy the provisions of the Company Law, and some companies even grant the functions and powers of the shareholders' meeting to the board of directors to exercise. From this perspective, there is basically no problem of the shareholders' meeting eroding the authority of the board of directors.
However, from the perspective of actual operation, many group companies often replace the will of subordinate companies with the will of the parent company and the group company. When subordinate companies make many decisions, the authority of the board of directors is often eroded by shareholders or shareholders' shareholders. The specific manifestations are:
(1) The parent company decides on the appointment of middle-level personnel of the subordinate company.
In many group companies, the hierarchy is strict, and the power of personnel is taken back by the parent company. The personnel appointment of the subsidiary is not made by the shareholders or the board of directors of the subsidiary, but by the parent company. For example, the parent company appoints the general manager of the subsidiary. This behavior is actually an erosion of the board of directors' power to appoint and remove personnel.
(2) The parent company's system is directly applicable to subordinate companies.
In theory, the parent company and the subsidiary are two independent legal entities. The parent company's system cannot naturally bind the subsidiary. It must be formulated and approved by the subsidiary itself before it can bind the subsidiary. However, in practice, many parent companies directly stipulate that the system applies to the subsidiary when formulating the system, and directly apply the parent company's system to assess, reward, and punish the subsidiary and its personnel during execution. This behavior has obviously eroded the power of the subsidiary's board of directors to formulate the subsidiary's basic management system.
(III) The parent company decides the internal structure of the subsidiary.
Similarly, in order to facilitate the management of the subsidiary, the parent company requires the subsidiary to establish certain internal institutions through documents, and even directly decides the internal institutions and their powers of the subsidiary. This behavior obviously also erodes the corresponding powers of the board of directors.
II. The parent company decides the subsidiary's business management behavior
This situation is also very common. The specific manifestations are:
(I) The parent company approves the specific business matters of the subsidiary
For example, in terms of hiring intermediary agencies and purchasing materials, it is stipulated that the parent company must approve the matter after the amount exceeds a certain amount. Only after the parent company signs and approves the approval form can the subsidiary sign the relevant contract with the outside world. In fact, these matters are all matters that the subsidiary decides independently, but if the parent company has to make decisions, the subsidiary's independent decision-making power has been disguisedly deprived, and the subsidiary's own will cannot be realized.
(II) The parent company uniformly allocates and arranges the subsidiary's business
For example, whether to engage in a certain business is not up to the subsidiary, but is uniformly arranged by the parent company. In this case, the subsidiary may carry out some businesses that it would not otherwise carry out in order to cooperate with the parent company or other brother companies to complete the task. For example, a subsidiary that never engages in trade participates in trade as a link in financing trade in order to cooperate with a brother company in financing.
(III) Joint and several guarantees and loans within the group
The high-quality subsidiary uniformly applies for loans from the bank, or provides guarantees to the bank for the parent company to obtain bank loans, and then allocates the loans to the brother company or the parent company for use. External loans or guarantees are matters decided by the company based on its own capital needs, but if it is at the request of the parent company, the subsidiary's business management rights are obviously also infringed.
III. The parent company uniformly centralizes and allocates the subsidiary's funds
Unified and centralized management of funds, which is uniformly allocated and used by the parent company, is a capital management method that some national companies like to use in recent years. Under this model, in addition to leaving a small portion for the subsidiary's daily use, all the remaining funds are transferred to the financial company set up by the parent company, or to the parent company's account, and managed by the parent company in a unified manner. When the subsidiary needs to use funds, it must apply to the parent company, and the parent company or the financial company directly pays the third party.
Under this model, the funds belonging to the subsidiary are collected and allocated by the parent company free of charge. This method bypasses the risk of the public security, procuratorate and law system sealing up and freezing the subsidiary's funds, and also infringes the subsidiary's right to independently use the funds.
IV. The shareholders' meeting makes decisions that are obviously not in the interests of the company
Under normal circumstances, the company's shareholders usually consider how to safeguard the company's interests when making decisions, but in the relationship between the parent company and the subsidiary, the parent company, as the shareholder of the subsidiary, may make resolutions that harm the interests of the subsidiary when deciding on the subsidiary's affairs, such as withdrawing high-quality assets or conducting related transactions at low prices to transfer benefits. This phenomenon is not uncommon, and the behavior and will of the subsidiary depend on the will of the parent company, and it cannot independently exercise its decision-making power.
The above situations are the situations in which the parent company excessively dominates and controls the subsidiary, which I have summarized based on the current common situations. These situations cannot exhaust the ways and methods of the parent company's domination and control of the subsidiary. In practice, there are still many situations of control and domination. Even the parent company's control and domination of the subsidiary cannot be judged on the surface. Therefore, how to determine the parent company's excessive domination and control of the subsidiary should be judged in practice based on various situations, and should not be generalized.