A study of "piercing the corporate veil" in

Chinese New Company Law and its legal practice in China

By

Yao Cui

A thesis submitted in conformity with the requirements

For the Degree of Master of Laws
Graduate department of the Faculty of Law
University of Toronto

© Copyright by Yao Cui (2008)

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A study of "piercing the corporate veil" in Chinese New Company Law and

its legal practice in China

Yao Cui

Master of Laws

Graduate department of faculty of law, University of Toronto

2008

Abstract

In modern company law, the concepts of a separate corporate personality and Limited

liability protect shareholders from being liable for unlimited company's debts. This function

of modern company law encourages the development of capital economy, however, it also

poses a risk of abuse of the granted rights. Most modern company law systems have created

the doctrine of "piercing the corporate veil" to avoid this risk of abuse. China formally

established the doctrine of "piercing the corporate veil" in Chinese new company law in 2006.

This ended the uncertain status of the application of veil-piercing doctrine in Chinese law.

This thesis explores the development of the doctrine of "piercing the corporate veil" in

Chinese company law and aims to highlight why it is significant to legalize the veil-piercing

doctrine in Chinese new company law. The thesis also studies the expressed regulation of the

doctrine of "piercing the corporate veil" in Chinese new company law and its current legal

ii
practice in China. Accepting the significance of legalizing the doctrine in new law, the thesis

critiques the ambiguous scopes or narrow provisions of this new doctrine in legal practice;

and also makes some proposals on this issue. The thesis concludes that it is desirable to find a

feasible scope of application for the veil-piercing doctrine in China.

To Mom and Dad

iv
 Acknowledgements

I would like to thank Professor Edward Iacobucci for his guidance, help and

support in drafting of this thesis, and also to my friends Joel Daniel Haywood

and Dave George Christie for their patience and innumerable but always

accurate corrections. And especially, I want to say thanks to my dear parents

and all of my good friends for their encouragement and support while I

struggled drafting this thesis!

 T a b l e of C o n t e n t s

Acknowledgements

Introduction 1

Chapter 1: The introduction of "piercing the corporate veil" 4

(A) The doctrines of separate corporate personality and

limited liability of shareholders 4
(1) Salomon v. Salomon & Co. 4
(2) The definition of separate corporate personality 4
(3) The definition of Limited Liability 5
(4) The effects of separate corporate personality and Limited Liability 6
(B) The definition of "piercing the corporate veil" 8

Chapter 2: The development of "piercing the corporate veil" in

Chinese law 13

(A) No existence of "piercing the corporate veil" in China 13

(1) Background of the Enactment of previous Chinese
Company law (1993) 13
(2) Absolute Limited Liability 14
(B) Getting close to "piercing the corporate veil" 16
(1) Basic principles of Chinese civil and business law system 17
(2) Informally employ "piercing the corporate veil" in Chinese law 18

Chapter 3 : "Piercing the corporate veil" in Chinese new company law 21

(A)Article 20 and 64 of the Chinese new corporate law 21

 (B)Three prerequisites of applying "piercing the corporate veil" in
Chinese law 22
(1) Plaintiff and defendant of "piercing the corporate veil" 23
(2) Fact requirement 23
(3) The requirement of a consequential connection 24
(C) Circumstances where court have power to pierce the corporate veil in Chinese
new company law (2006) 24

Chapter 4: Critiquing the provision of "piercing the corporate veil" in

Chinese New Company Law 30

(A)Critiques of China's veil-piercing doctrine 30
(B)Proposals on the doctrine of piercing the corporate veil in Chinese law 35
(C)Challenges of excessive use piercing the corporate veil for courts 45
a) Avoid excessive veil-piercing in legal practice in China 45
b) veil-piercing and one-person company in China 47
c) A conservative attitude of "reverse piercing" 47

Conclusion 49
Introduction

The amended Chinese company law was adopted and promulgated on the 27 October 2005

with the new company law going into effect on the 1 January 2006. China undertook "a

major overhaul of its legal framework governing corporations by implementing this new

corporate law".1 Much of the previous Company Law2 was revised or eliminated, with

"many new provisions added".3 "This development was much anticipated by Chinese and

foreigners alike, as China's previous company law was unable to keep pace with its fast

growing economy".4 The sweeping changes brought about by the new law are aimed at

encouraging investment, relaxing restraints and protecting the interests of various

stakeholders. Chinese company law has been through a hundred years of history from the

very first "Chinese company regulations of 1904"5 during the Qin Dynasty, through the

enactment of the company law in 1993 , until the birth of the new company law of 2006 .

The one hundred years history of company law is a history of the evolving transformation of

China's market economy; it is the ongoing study of western legal systems and legal cultures

with contributions by Chinese legal scholars.

1
Huixin Liang, The amendment of the Chinese New Company Law, in Lin Li, Jun Feng, Yuzhang Wu,
Guangxing Zhang, Hailin Zhou & Minyuan Wang eds., Blue Book of Rule of Law-The Development Report of
Rule of Law In China, Social Sciences Academic Press (CHINA) 316 at 317
2
The previous Chinese company law was promulgated in 1993 in China, China established the company form in
China at the first time.
3
Baoshu Wang & Hui Huang, China's New Company Law and Securities Law: An Overview and Assessment,
(19 AUSTUL. J.CORP.L.2006 ) 229, 231-32
4
Weiguo he and Steven Robinson, China's corporate laws get major overhaul, Focus on Securities, (the lawyers
weekly, 2007) at 1
5
Qin Ding Da Qin Shang Lv-Chinese company regulations of 1904, which was the first commercial regulation in
China, and it was enacted by Commercial Department of Qin dynasty in 1904 in China. More historical details can
be found in Xiaochuan Ye, The Chinese law history, Beijing, China law press (1996).
6
Supra. Note 2
7
See Introduction above, for more on the amendment of Chinese new company law, and this law will be
discussed more in following chapters.

1
One of the highlights of the new company law is the formal establishment of the concept of

"piercing the corporate veil" in Chinese law. The notion of piercing the corporate veil did not

formally exist in Chinese company law prior to 2006. The new company law allows courts to

pierce the corporate veil under certain circumstances. In doing so, "it aligns Chinese

company law more closely with that of other market economies".8 The establishment of the

concept of "piercing the corporate veil" in the new company law occurred within the

particular backgrounds of Chinese society and China's legal development. With the

promulgation of the previous Chinese company law (1993), the company form was formally

established in both Chinese legal and economical regulations. However, due to the

underdevelopment of the legal framework governing corporations by previous Chinese

company law and the reality of the rapidly evolving transformation of China's market

economy, many used company form to avoid constrains of law. Illegal actions such as fraud

were very common, which seriously dispelled legal justice. On the other hand, in order to

adapt to the development of market economy and encourage investment, Chinese courts and

judges only saw one side of the company form under the legal practice of previous Chinese

company law. They unilaterally emphasized the notions of separate corporate personality and

limited liability of shareholders frequently damaging the interests of the company's creditors

and the public. If the courts failed to employ some suitable legal actions to stop and prevent

these damages, it would eventually break the foundation of modern company form.

Furthermore, the development of China's market economy would be hindered. "Piercing the

Ciyun Zhun, A study of doctrine of disregarding the corporate personality^ Beijing, Law Press 1998) at 353
corporate veil" was established by this need. Yet, compared with western countries where this

notable legal doctrine has been used for over a hundred years, the recent introduction of

"piercing the corporate veil" in Chinese legal life, inevitably possesses many uncertainties

and disadvantages. Consequently, questions are raised as how to best fit this concept into

Chinese law, such as why should Chinese courts pierce the corporate veil, under what

circumstances should Chinese courts pierce the corporate veil, make it is necessary and

worthwhile to study "piercing the corporate veil" in Chinese new company law and its legal

practice in China!
Chapter 1 The introduction of "piercing the corporate veil"

A) the doctrines of the separate corporate personality and limited liability of

shareholders

(1) Salomon v. Salomon & Co. '

The famous English judgment of Salomon v. Salomon & Co. (1987)2 established the

principle of separate corporate personality and its twin concept of limited liability of

shareholders. The House of Lords noted that: "The company is in law a different person

altogether from the shareholders...; and, though it may be that after incorporation the

business is precisely the same as it was before, and the same persons are managers, and the

same hands received the profits, the company is not in law the agent of the shareholders or

trustee for them. Nor are the shareholders, as members, liable in any shape or form, except to

the extent and in the manner provided for by the Act."3 "The twin concepts of separate

corporate personality and limited liability of shareholders remain the essential pillars of

modern company law and the courts in most common law jurisdictions have largely been
4
keen to maintain the principles as exemplified by Salomon".

(2) The definition of separate corporate personality

1
Salomon V. Salomon & Co. (1987) AC 22
2
Ibid,
3
Ibid.
4
Clement C. Chigbo, Corporate, Limited Liability And Lifting The Veil of incorporation at 2
http://www.jonesbahamas.com/pdf.php?a=9631

4
The principle of separate corporate personality is simply state "recognition through the

instrumentality of law that certain organizations, such as incorporated companies, should

13
have legal status with rights and obligations". Although to be equated with the individual,

these organizations should be treated or seen as separate and distinct from individuals or

human persons. This will give "capacity to hold or own property rights and to sue or be sued

in their own right, without having to rely on the rights of the members of the company".14

Thus, once incorporated, "a company is conferred the juristic status of separate corporate

personality".15 Following the notion of separate corporate personality," the consequence of

registering a business as a company is to transform the business into an entity in its own right,

with legal and responsibilities that are distinct from those of its members".16 The company,

as a separate legal entity, owns its own property and there is "no legal connection between a

share in the company and the company's property".17

(3) The definition of Limited Liability

"Limited liability is the logical consequence of the existence of a separate corporate

personality". "Generally, the concept of limited liability means that since the company is

different from its members, the owners of property rights issued by a corporation, generally

in exchange for capital inputs, are not personally liable for the debts of the corporation to the

13
Ibid, at 1
14
Ibid.
15
Ibid.
16
Wouter Hubert F.M Cortenrard, Limited Liability in Economic theories of the corporation, (LL.M, University of Toronto,
1989) at 6
17
Huixing Liang, A study of Modern Company Law, (Beijing, Political Science and Law University Press, 1998) at 61
18
Dignam & Lowry Company Law, (New York, Oxford University Press Inc. New York, 2006) at 16
 6

extent that these exceed the subscription price of their shares". This is" unless they consent

to assuming personal liability for the debts of the concerned corporation beyond the

subscription price of their shares".20 In principle, "this means that the liability of corporate

shareholders is limited to their investment"21. This implies that "the personal assets of the

owners of a corporation are generally not available to satisfy the claims of its creditors in the

event that the corporation assets are insufficient to meet its debts".22 "Consequently, it can be

said that limited liability essentially means that shareholders of a corporation are under no

obligation to the corporation or its creditors other than to pay full consideration for their

shares".23"It follows that the capacity to repay the debts of a corporation is limited to the

assets of the corporation itself'.24

(4) The effects of separate corporate personality and limited liability

The concepts of separate corporate personality and limited liability of shareholders are the

key attributes of corporate status. It is this separate corporate personality that "makes

companies an attractive vehicle for commercial ventures, as the liability rests with the

company, rather than the shareholders, directors or company officers".25 From economic and

legal perspectives, these two essential modern company law concepts encourage investment

from shareholders, and place shareholders in a very favorable position. Limited liability

19
Compare Robert Charles Corporate Law, (Boston/Toronto: Little, Brown and Co. 1986) at 7
20
Ibid.
21
Wouter Hubert F.M Cortenrard, Limited Liability in Economic theories of the corporation, (LL.M, University of Toronto,
1989) at 100
22
Ibid.
23
Roger E, Meiners/James S. Mofsky/Robert D.Tollison, Piercing the veil of Limited liability, in: 4 Delaware Journal of
Corporate Law (1979) at 353
24
Wouter Hubert F.M Cortenrard, Supra note 21 at 100
25
Huixing Liang Supra note 17 at 65
grants shareholders a major right of avoiding personal liability for the complete debts of the

corporation after the transfer of assets. As a result of this transaction, the maximum risk that

shareholders bear is limited to a potential loss of the value of their investment. On the basis

of this advantage, "most investors will justify the choice of incorporation as the appropriate

vehicle for business and investment purposes".26 However, when a right is granted, it

generally exists with the risk of abuse. The doctrine of separate corporate personality grants a

corporation legal personality, in other words, a company is like a natural person from the

legal perspective. But actually, this person does not have its own mind and, therefore, cannot

factually make decisions in business and must be represented by a natural person in all

business and other activities. Generally, members of a company, such as the directors,

managers or officers who are either shareholders or nominated by shareholders, are referred

to as the representatives of a company in different transactions. Their decisions are the real

voice of the company. On the other hand, as business men, achieving the highest profits with

a minimum of risk is the real pursuit of investors (here referred to as the shareholders of a

company), company form is the perfect device to achieve this at certain circumstances.

Because of this close and special relationship between shareholders and company, it is very

likely that shareholders will use company form as a profit-making tool, transforming a

company into an agent with no separate personality by holding the company's assets, and

controlling the company for their own interests. One possibility of these situations is that the

separate legal personality of a corporate entity is dominated and controlled and being used as

Ibid, at 65
a shield for fraudulent or improper conduct and when a company becomes insolvent with

insufficient assets to pay off its creditors, the shareholders will escape liability for the

company's debts by sheltering behind the doctrines of separate corporate personality and

limited liability. Considering these situations, in some circumstances, the courts have

disregarded the company structure and affixed liability on the person behind the company.

This is variously referred to as "piercing (lifting) corporate veil" or "disregarding the

separate corporate personality".

B) The definition of "piercing the corporate veil"

The Western concepts of modern corporate law have already realized that corporate

personality is frequently faced with the risk of abuse. The notions of separate corporate

personality and limited liability should not dispel fundamental justice and fairness, so

naturally they are subject to some constraints. This includes "piercing the corporate veil" and

alternative approaches that deal with the problem by different means but may achieve similar

effects.

The Supreme Court of the United States was the first to break away from the notion that a

corporation is only a legal entity when its literal application would operate with injustice. In

the case of United States v. Milwaukee Refrigerator Transit Co. (1905)27, Justice Sanborn

United States V. Milwaskee Refrigerator Transit CO. 142 F. 247

noted that: "A corporation will be looked upon as a legal entity, as a general rule, and until

sufficient reason to the contrary appears; but, when the notion of legal entity is used to defeat

public convenience, justify wrong, protect fraud, or defend crime, the law will regard the

corporation as an association of persons; and, where one corporation was organized and is

owned by the officers and stockholders of another, making their interests identical, they may

be treated as identical when the interests of justice require it."28 This judgment was a

significant statement of "disregarding the corporate entity" or "piercing the corporate veil"

and also the first case of "piercing the corporate veil". Since then, the Courts maintain a

watchful eye on any misuse of the corporate form. The doctrine that was laid down in

Salomon v. Salomon has to be watched very carefully.

The phrase "piercing the corporate veil" is a colorful metaphor used by the Courts when the

separate existence of the corporation is ignored. Separate corporate personality and limited

liability jointly form the veil. Thus, '"piercing the corporate veil' refers to those situations

where the judiciary or the legislature has decided that the separation of the personality of the

company and the members is not maintained".29 It is widely used "by corporate creditors to

satisfy their claims out of the personal assets of the corporate shareholders, despite the

general rule of limited liability and separate corporate personality".30 The traditional

statement of the piercing the corporate veil doctrine is:

The law permits the incorporation of a business for the very purpose of escaping personal

28
ibid.
29
Dignam & Lowry, Supra note 18 at 30
30
Robert Charles Clark, "Corporate law", (Boston: little, Brown and Company, 1986) at 71.
 10

liability. Generally speaking, the doctrine of "piercing the corporate veil" is invoked "to

prevent fraud or to achieve equity"31

In the Canadian case, Big Ben Hotel Ltd. v. Security Mutual Casualty Co.,32 Callaghan J.

noted:

On the whole, Canadian and English Courts rigidly adhere to the concept set out in

Salomon, supra, that a corporation is an independent legal entity not to be identified with its

shareholders.

However, there are exceptions to the general rule and courts have lifted the corporate veil

to take into account the actions of the individual members, particularly in case of improper

conduct or fraud.

Because "piercing the corporate veil" has been a creation of case law and not legislation, the

situations where "the corporate veil" should be pierced are numerous with no definitive list to

refer to. "It should be noted that cases of "piercing the corporate veil" have been referred to

by various metaphors, such as "sham", "shell", "dummy", "fiction", "alter ego", and

"instrumentality". While these metaphors are vivid, it also discloses that it is very difficult to

define a criterion that can be applied universally."33 The Courts often rely on the principles

of good faith and abuse of rights to decide whether the veil should be pierced.

"Commentators have long despaired of finding a single or coherent principle to explain the

31
Robet W Hamilton, The Law of Corporation in a Nutshell, 4* ed (St. Paul: West Publishing Co. 1996) at 100-101
32
[1980] ILR 807 (BCSC)
33
Weiguo He, The legal transplantation o f piercing the corporate veil" to China at 30
judicial response." Generally, there are situations where the courts in most common law

countries will consider piercing the veil35: (1) allegation of fraudulent conduct on the part of

the company's principals; (see Clarkson Co. Ltd. v. Zhelk36) (2) the company was clearly

undercapitalized to meet its foreseeable financial needs; (see Rickwell Developments Ltd. v.

Newtonbrook Plaza Ltd.37 (3) cases where the company was not incorporate for bona fide

business reasons but for other reasons, typically to take advantage of tax loopholes; ((See De

Salaberry Realties Ltd. v. Minister of National Revenue38) (4) non-arm's length transactions

between parent and subsidiary company

The traditional statement of "piercing the corporate veil" tells us that the doctrine of

"piercing the corporate veil" is invoked to prevent fraud or to achieve equity. Generally

speaking, the veil should be pierced to do justice. The twin notions of separate corporate

personality and limited liability and the doctrine of "piercing the corporate veil" are two

edges of the sword. Together they support the modern company form. Although separate

corporate personality is disregarded and the liability of the shareholders is no longer limited

when the veil is pierced, piercing the corporate veil is the best way to protect the separation

of corporate personality on some points. The veil will only be pierced when the corporate

personality is no longer distinct or separated from that of the members, when the

shareholders misuse company form so that separate corporate personality has been damaged,

34
Harris, Daniels, Iacobucci, Lee, Macintosh, Puri & Ziegel" Cases, Materials, and Notes on Partnerships and Canadian
Business Corporations" 4th ed.., (Toronto, Thomson Carswell ,2004) at 110
35
The following situations that I cite are from my course notes of Business Organization course.
36
[1967] 2 O.R 565 (H.C) 64 D.L.R. (2d) 57
37
[1972] 3 O.R. 199, 27 D.L.R. (3D) 651
38
[1974], 74 D.T.C.6235, 46 D.L.R. (3d) 100
when pulling off the mask is just for protecting the corporate form, and after damage is

compensated, the corporate personality is consequently recovered. Therefore, "piercing the

corporate veil" is not a way to damage or deny the existence of separate corporate personality.

To the contrary, it is a tool to maintain the legal personality of a corporation. The unlimited

nature of shareholders' liability when the veil is lifted is a way to protect the interests of the

company's creditors and the public. It is also a way to correct the wrongdoings of

shareholders and ultimately maintain justice and fairness. Therefore, piercing the corporate

veil, separate corporate personality and limited liability together play a significant role in

modern company law!

Chapter 2 The development of "piercing the corporate veil" in Chinese law

Most Chinese scholars agree that "the notion of piercing the corporate veil did not formally

exist in Chinese statutory law prior to 2006".' While separate corporate personality, limited

liability and piercing the corporate veil are longstanding features of the modern company law

in most countries, especially in common law countries, China has been through a process of

development of "piercing the corporate veil" in Chinese law. From no doctrine of piercing

the corporate veil to getting close to implementing the doctrine, until its formal legislation in

Chinese new company law in 2006, every stage possessed advantages and disadvantages.

However, it also discloses how China aligns itself to international practice.

(A) No existence of "piercing the corporate veil" in China

(1) Background of the Enactment of previous Chinese company law (1993)

The previous Chinese company law was promulgated in 1993. Before its promulgation, the

governing regulations were those passed by the administrative departments. "The most

influential administrative regulation was the Regulation Opinion on Limited Liability

Companies by the State Economic Reform Committee in 1992."2 This regulation was

composed of only 79 articles and was rather primitive. More importantly, because it was only

an administrative regulation, "its legal effect was dubious and resulted in the failure to apply

1
Ci yuanzhu, supra note 2 at 45
2
Weiguo He supra note 34 at 8

13
 14

it especially in those cases where there were several conflicting administrative regulations

enacted by different departments". l

Against this background, the previous company law came as a breakthrough in Chinese

legislation. It unified the various corporate regulations, assured the legal status of

"corporation", adopted some common corporate principles of western countries42 and

afforded some protection for shareholders. However, due to restraints from the social

environment and the underdevelopment of legal research at that time, the Chinese company

law (1993) took a simplistic approach on several major issues. Therefore, it was subject to

some major defects. "The company law (1993) continued the Chinese fervor for economies

in the mid 1980s; underlying it was the enthusiasm of Chinese governments to encourage

investments after several decades of seclusion".43 For this purpose, "they attached

overwhelming significance to the protection of majority shareholders thereby placing them in

an overly favorable position".44 The legal personality in Salomon was turned into an

"absolute limited liability" in China.

(2) Absolute Limited Liability

Ibid. 8
Details can be searched in Artcle 2,3 of the precious Chinese company law (1993)
Li Shan Jiang, A study of Chinese legislative issues in contemporary China, (Beijing, Law Press, 2002) at 102
Gong yun Gu, The understanding of Chinese New corporate law (Beijing, Beijing University Press,

2007) at 87
In the Chinese company law (1993), the main provision related to limited liability is Article

345:

All limited liability companies and companies limited by shares are enterprise persons.

In the case of a limited liability company, a shareholder is liable to the company to the

extent of the amount of the shareholder's capital contribution. A limited liability company is

liable for the debts of the company with all its assets.

In the case of a company limited by shares, its entire capital is divided into shares of

equal value and shareholders shall be liable to the company to the extent of the shares held

by them. A company limited by shares is liable for the debts of the company with all its'

assets.

This provision has confirmed the Salomon principle in China. It has established that "the

most significant feature of incorporation is the segregation of business profits and losses

from the personal accounts of the individual participants".46 However, it is a pity that there is

no mention whatsoever of restraints on limited liability. According to the General Principles

of Civil Law of China and the Chinese company law (1993), China is strictly adhering to

limited liability. First, shareholders are responsible to the extent of their capital

contribution/shares. Secondly, shareholders are not directly liable to the creditors of the

company.47

Company Law of People's Republic of China (1993), Article 3

Bruce Welling et. al., Canadian Corporate Law, Cases, Notes & Materials,2nd ed, (Toronto, Butterworths, 2001) at 99
Ciyun Zhu, supra note 2 at 368
Therefore, there is no theory of "piercing the corporate veil" in Chinese civil law and

company law.48 In 1993, Chinese company law formally recognized limited liability

companies as "legal persons" with shareholders liability limited to the extent of the

shareholder's "capital contributions" or "shareholdings". However, the 1993 Chinese

company law did not grant the courts the right to pierce the corporate veil. Nor did any other

statute confer such power. As a result, most Chinese commentators agreed that China's law

did not include piercing the corporate veil.50 The shareholders are virtually shielded behind

the corporate form from any liability They can always allege that any wrongs are committed

by the company and not by themselves and that they should not be held liable. On one hand,

the corporate system played a significant role in raising capital.51On the other hand, it

enabled bad-faith shareholders to unduly take advantage of the corporate personality to avoid

legal obligations or to reap illegal interest. Fraud has become rather commonplace.52

(B) Getting close to "piercing the corporate veil"

Company form and absolute limited liability in China made business men see the opportunity

to make profits through company device. Incorporating a company has become fashionable

in China after the Chinese company law (1993). However, company form did not develop

healthily in China due to the absolute limited liability and the absence of "piercing the

48
Junhai Liu Protection for Shareholders' rights in Corporations Limited by Shares, (Beijing, Law Press, 1997) at 362
49
Xianchu Zhang, Piecing the company veil and regulation of companies in China, in legal development in China: Market
economy and law at 129, 132
50
Ibid, at 129
51
Ciyun Zhu, supra note 2, at 3
52
Ibid.
corporate veil". Examples included newly incorporated companies claiming insolvency when

creditors came to claim debts; the creditors sued the company in order to get repayment but

ended with either insufficient repayment or the unexpected disappearance of the company.

These cases made creditors afraid of having business with a company and people started to

question the company form. Despite the absence of an express statue of a doctrine to avoid

these circumstances, Chinese courts are no longer completely blind. Due to the civil law

characteristics of China, on one hand, the courts try to find statues or legal principles in

current Chinese rule of law to prevent shareholders from abusing company form. On the

other hand, some enterprising judges informally learned and implemented the concept of

piercing the corporate veil during this period.

(1) Basic principles of Chinese civil and business law system

There are three basic principles53 in Chinese civil and business law. They are "honesty and

credibility", "forbiddance of right abuse" and "public order and good customs". These three

basic principles are guidelines of people's social and business lives. Legally speaking, they

have compelling, interpretative and complementary functions. They are principles applied by

Chinese legislatures in legal practice, especially in some law blanks where they do not

adequate or expressed rules to employ. Courts attempt to use these three basic principles in

order to protect the interests of company's creditors when the company form is misused.

Doing so has a similar effect as that of "piercing the corporate veil" in certain circumstances

General Principles of the Civil Law of the People's Republic of China (1987), Chapter I Basic Principles
in China, especially when the problems first accrued with "absolute limited liability". Since

then, absolute limited liability is no longer absolute; however, the point of principles is to

allow for all possibilities to be encompassed under its subjective theme, as in reality, its

creation or evolvement under that subject is open-ended and unpredictable relying on choices

and options. This feature naturally makes judicial discretion play a big role in application of

these principles. On one hand, under the Chinese legal system, various cases have been

raised by the abuse of separate personality and limited liability and the courts have not been

able to find a relatively consistent standard to make a judgment of whether or not to use these

principles to hold shareholders to be liable for company's debts beyond their limited

liabilities. This makes judicial discretion too flexible and unstable. On the other hand, under

the Chinese civil law system, the decision made by one court for one case is not followed by

other courts unlike in common law system; Consequently, completely relying on these three

principles to resolve the problems of abuse of company form is far from sufficient to solve

this problem in China. Nevertheless, the application of these principles has begun to address

these problems.

(2) Informally employ "piercing the corporate veil" in Chinese law

As previously mentioned, despite the absence of an express statue, some enterprising Chinese

judges implemented the concepts informally during this period. For example, in replying to

an inquiry made by the High Court of Guangdong province, the Supreme People's Court
 19

(SPC) implied that veil piercing may be permissible when the actual capital contribution

made to a corporation is less than the amount of capital registered under that corporation.54

The SPC has also affirmed a number of lower court decisions that pierced the corporate

veil.55

These cases, however, failed to clearly establish the doctrine of piercing the corporate veil for

three reasons. First, because China is governed by civil law, cases hold no precedential value.

(However, the SPC can make a legal principle binding on a lower court by issuing a judicial

interpretation on a topic.56 Thus, under the Chinese legal system, it is through judicial

interpretations rather than precedents that the SPC performs statutory interpretation and

enacts legal principles.)57 Secondly, the SPC's own case law suggested a mixed
58
jurisprudence. The court reversed lower court decisions to pierce the corporate veil in

cases that were factually similar to cases it affirmed.59 Finally, veil piercing occurred in only

selected provincial courts.60

Chinese courts have encountered serious problems from absolute limited liability and the

absence of piercing the corporate veil. The use of general principles and the informal

implementation of the veil-piercing concept in some circumstances to avoid damages from

54
0n the Assumption of civil liability after an Enterprise Established by Another enterprise has been closed or gone out of
business; Reply of the SPC to high Court of Guangdong, Mar. 30, 1994) NO. 1994 [4] CHINALAWINFO
55
Zhang Xianchu, Piecing the Company Veil and Regulation of Companies in China (Beijing, China Law Press 1998) at
129, 132
56
Ibid, at 135
57
Ibid at 135
58
Ibid at 135, 136
59
Ibid, at 135-57
60
ZHONGGUO ANLIZHIDAO: MINSHI JUAN [Guidance On Chinese Cases: Civil Law] 387,391 (2006)
the situation of absolute limited liability can have a similar effect to veil-piercing, and it

helped maintain the justice of law; these attempts to intervene and prevent these cases are

getting closer to piercing corporate veil, but they are far from efficient.

In 2006, the doctrine of "piercing the corporate veil" was formally established in Chinese

new company law. Both the legal community and society as a whole find it much easier to

understand and apply. This is meaningful for Chinese judges who tend to be uncomfortable

with the alternative approach from the less clear guidance from highly flexible cases. I will

discuss this development in the following chapters.

Chapter 3 "Piercing the corporate veil" in Chinese new company law

As I discussed in previous chapters, prior to 2006, China's veil-piercing doctrine operated in

a state of uncertainty in Chinese law. In 2006, under the revisions to the Chinese company

law, the doctrine of "piercing the corporate veil" was formally established in the Chinese new

company law. "The concept of piercing the corporate veil is a longstanding feature of the

corporate law of capitalist economies".1 According to the corporate form and limited

liability generally, "creditors seeking payment of debts or tort victims seeking redress can

only reach the corporation's assets, not those of its shareholders".2 At times, however, courts

ignore this corporate fiction and treat a corporation's debts as the debt of the corporation's

shareholders. In doing so, the courts pierce the corporate veil. The doctrine of piercing the

corporate veil is spread into two different Articles of the Chinese new company law

(A) Article 20, and 64 of the Chinese new corporate law

In the Chinese new company law (2006), Article 20 noted:

The shareholders of a company shall abide by laws, administrative regulations and the

articles of association of the company, exercise their rights according to law, and shall not

Ciyun zhu, supra note 2 at 234

2
Ibid, at 100

21
 22

abuse their rights to damage the interests of the company or other shareholders nor abuse the

independent status of corporate legal person and shareholders' limited liability to damage to

the interests of the company's creditors.

The shareholders, who abuse their rights so as to cause losses to the company or other

shareholders, shall undertake the liability for compensation.

If the shareholders of a company abuse the independent status of corporate legal

personality and shareholders' limited liability to avoid debts and damage the interests of the

company's creditors, they shall undertake the joint and several liabilities for the company's

debts.

Article 64, in particular, provides a veil-piercing provision relevant to single shareholder

LLCs (Limited Liablity Companies) stating that:

If the shareholder of a one-person limited liability company cannot prove that the

property of the company is independent of the shareholders' own property, the shareholder

shall bear the joint and several liabilities for the company's debts.

(B) Three prerequisites of applying "piercing the corporate veil" in Chinese law

According to the Chinese new company law, firstly, we have to learn three prerequisites of

applying the doctrine of "piercing the corporate veil" in China. Currently, in China, these

three prerequisites must be satisfied when courts consider piercing the veil.
 23

(1) Plaintiff and defendant of "piercing the corporate veil"

Plaintiff: the plaintiff of a veil-piercing case in China includes natural individual persons,

legal persons, and other organizations, and they are limited to the company's creditors whose

interests are damaged by the misuse of separate corporate personality and limited liability in

a company. Therefore, "company creditors", "damaged interests", "misuse of separate

corporate personality and limited liability" compose the necessary characteristics of the

veil-piercing plaintiff in China; and they have to be satisfied at the same time.

Defendant: The defendants refer to positively controlling shareholders of the claimed

company, who have done things to abuse the separate corporate personality and limited

liability. Here, the dominated shareholders do not necessarily hold the majority stake of a

company, but they must be shareholders who manage the major transactions of the company

and receive the main profits from doing so.

(2) Facts requirement

In Veil-piercing cases, plaintiffs have to prove that there are facts of abuse separate corporate

personality and limited liability in the claimed company. These facts are what circumstances

courts should consider to pierce the veil. I will talk about these circumstances regulated in the

Chinese new company law (2006) in my following discussions.

(3) The requirement of a consequential connection

This requirement means that the damage of company creditors has to be caused directly by

the shareholders' abuse of separate corporate personality and limited liability. In other words,

if there is no proof that the damages are caused by the misuse of company form, the courts

won't apply "piercing the corporate veil" in Chinese law.

Currently, in China's veil-piercing legal practice, if these three factors are not satisfied when

creditors claim to left the corporate veil, courts would not do so.

(C) Circumstances where courts have power to pierce the corporate veil in Chinese

new company law (2006)

The legal practice of "piercing the corporate veil" is based on case law in most common law

countries. For example, Canadian doctrine depends entirely upon judicial discretion. China

overcame a huge challenge by legislating this doctrine in Chinese law, after establishing the

doctrine in the Chinese new company law, how does it apply in China's legal practice? Under

the Chinese civil law system, two articles of the new company law provide the courts with

the power to pierce the corporate veil by the following factors:

(1) Article 20 directly discussed two factors that the courts should consider: (a) whether the

abuse results in debt non-repayment,63 and (b) whether these non-repayment cases cause

See Chapter 3 , part A above: Article 20, 64 of the Chinese new company law at 19, 20
 25

actual injury to a party.

According to Article 20 and the three main propositions of applying "piercing the corporate

veil" mentioned above, the courts are very strict about its application in reality considering

that this is a nascent doctrine in China.65 Firstly, they are strict with confirming proof that

the claimed company is incapable of paying its debts and those payments must reach the

value of the company's unlimited liabilities before the courts will examine shareholders

liability. 66Secondly, creditors have to provide proof that their interests have been directly

injured by the shareholders' misuse of company form, especially by controlling or positively

shareholders.67 Therefore, "debt non-repayment" and "directly casual connection between

claimed actions and injured results" together affect the factors required to lift the veil of a

68
company in Chinese law.

It is worthwhile to examine the case of Beijing Boshilun Optical Co. Ltd. v. Changshan

Healthy Eyes Co. Ltd. (2007), that was heard after the new company law:. This case was the

first veil-piercing case examined by the Courts in Beijing following the new company law.

Bejing Boshilun Optical Co.Ltd. (hereafter, referred to as Boshilun) claimed its debts from

Changsha Healthy Eyes Co. Ltd. (hereafter, referred to as Healthy Eyes) and asked the court

to hold the shareholders of Healthy Eyes liable for its debts. The plaintiff provided proof that

64
Ibid. Article 20
65
Hui xing Liang, supra note 1 at 320
66
Ibid, at 320-327
67
Ibid.
68
Ibid.
the shareholders of Healthy Eyes incorporated another company in Shanghai. All products

bought by Healthy Eyes from Boshilun were transferred to the Shanghai company. When

Boshilun claimed payment from Healthy Eyes under the business contracts, Healthy Eyes

had nothing but the company form. The shareholders had already left Healthy Eyes and gone

to Shanghai leaving Healthy Eyes with no ability to pay off their debts to Boshilun. The

Beijing courts employed the doctrine of "piercing the corporate veil" to hold the shareholders

of Healthy Eyes liable for their company's debts. The judge noted that the shareholders of

Healthy Eyes had transferred property of the company and misused the company form to

make profits for themselves instead for taking regard for the company's interest. These

actions meant that Boshilun received no payment for selling products to Healthy Eyes with

the creditor's interest having been injured. Therefore, according to Article 20 of the new

company law, the veil should be pierced, and the shareholders of Healthy Eyes should be

held responsible for the debts of the company.69

Under the Article 20, on one hand, the courts dealt with this kind of case by using the

doctrine of piercing the corporate veil in cases where shareholders abuse company form so as

to avoid paying the company's creditors. This express statue makes judges feel comfortable

to hold shareholders liable for debts. On the other hand, the law does not confirm what kinds

of actions are to be classed as an abuse of company form. Judicial discretion plays a central

role in veil-piercing cases. This situation creates some problems which I will discuss more in

69
Court held shareholders liable, the first veil-piercing cases in Beijing, www.shanghailawyers.net
 27

following chapters.

(3) Article 64 raises another factor particularly relevant to the one-person company: the

commingling of assets.70

In consideration of one-person companies, Article 58 of the Chinese new company law (2006)

states that:

The incorporation and organizational structure of a one-person limited liability

company shall be applied to by the provisions of this section. A one-person limited liability

company referred to in this law shall mean a limited liability company that has only one

shareholder of natural person or legal person.71

The one-person company is a new company form in China acknowledged by the Chinese

new company law in 2006. In another words, the one-person company did not legally exist in

China prior to the promulgation of the new company law. The Chinese old company law

(1993) strictly detailed the number required to register a company in China. This legal

requirement was necessary while company form was a new concept in China. Due to the

underdevelopment of Chinese company law, the number required to register a company in

China prevented those shareholders with incapable capital ability incorporating a company so

as to protect the interests of creditors. However, with the rapid economic development, there

are more and more wealthy investors who want to incorporate companies on their own. They

70
See Chapter 3 Part A above: Article 64 of the Chinese new company law at 21
71
Ibid. Article 58
hoped to incorporate a company by themselves instead of looking for partners to make

greater profits and allow more flexible management of company business. The one-person

company form was established by this need. However, as a new concept, a one-person

company is more strictly subjected to many legal constraints of Chinese new company law,

particularly to the restriction of the doctrine of "piercing the corporate veil". In China,

forming one-person LLCS (Limited liability companies) now requires higher standards to be

met, with a minimum registered capital of 100,000 R.M.B to be paid in full upon

establishment. Individuals are limited to one such company and a one-person LLC cannot be

a shareholder of another one-person company. Referring to the veil-piercing principle, a

one-person company is certainly subjected to the general regulations of veil-piercing

addressed by Article 20. Article 64 deals in particular with the one-person company by

explicitly introducing the factor of "commingling of assets" which refers to a situation where

a single shareholder intermingles his/her own property with that of a one-person LLC. In this

situation, a single shareholder can more likely transfer company' assets for personal uses.

From the perspective of burden of proof, in a veil-piercing case, usually creditors /plaintiffs

are responsible for providing proofs of any misuse of company form. In cases of one-person

company, the burden of proof is reversed, single shareholder has to prove and convince

courts that the company's property is independent from their own; failure to do so will result

in the shareholder losing the benefit of limited liability.

In conclusion, China has been through the status of absolute limited liability, informally
implementing piercing the corporate veil, and eventually, the Chinese new company law

established the doctrine of "piercing the corporate veil'. This development has stopped the

uncertain state of piercing the corporate veil in China. The courts feel more confident to use

the statue to deal with relevant veil-piercing cases. The new company law expresses factors

of veil-piercing and these have started to be employed in legal practice. These facts have all

developed the notion of "piercing the corporate veil" in China. On the other hand, while the

doctrine of piercing the corporate veil is welcome, China's new company law still fails to

address important questions.72 This ambiguity negatively affects several constituencies and

also creates new questions in practice.73

Huixing Liang, supra note 1, 326-327

Ibid, at 327
Chapter 4 Critiquing the provisions of "piercing the corporate veil" in Chinese new

company law

(A) Critiques of China's veil-piercing doctrine

Strong debates about why and how to establish the doctrine of "piercing the corporate veil"

in Chinese new company law have occurred before and after the enactment of the new

company law. Because of the relative lack of public transparency surrounding China's

statutory drafting process, one can only speculate about why Chinese lawmakers felt

compelled to include veil-piercing provisions in the new company law. There are at least

three possible motives. First, "given China's burgeoning economy and the importance of

LLCs, the government may have wanted to provide greater clarity to investors and creditors

alike about when, if ever, veil piercing might occur"1. In other words, it did not want legal

uncertainty to constrain the development and growth of LLCs artificially. Second, "it may

have wanted to rein in enterprising judges and ensure greater uniformity in the doctrine's

application across lower courts".2 Third, "it may have wanted to strength the judiciary's

hand against corporate fraud. The National People's Congress Standing Committee report for

the amendment of the Company Law specifically mentioned the problem of shareholders

abusing the corporate form by illicitly transferring and commingling corporate assets".

1
Ciyun Zhu, supra note 2 at 359
2
Ibid., at 359-340
3
Ciyun Zhu, [Undercapitalization" and the Principle of Disregarding the Corporate Entity Under the Company]
www.fatianxia.com/paper-list.asp?!d=22670

30
 31

Formal legal recognition of the power to pierce the corporate veil deters against such abuse.

Although the new company law established this doctrine, Article 20 and 64 only partially

achieved the goals mentioned above.77 The nascent doctrine did not explain the provisions of

veil-piercing in a more certain way and falls short in two areas: First, Chinese new company

law (2006) provides insufficient guidance to Courts about how to proceed with the analysis

of a veil-piercing case78. Second, the scope of the new law is unclear. These shortcomings

and ambiguities have several negative affects: Creditor lack certainty about when they can

expect to recover from a bankrupt debtor whose shareholders may have operated illegally.

Shareholders lack clear guidance about what constitutes abuse of the corporate form against

which they should monitor. "Citizens harmed by tortuous acts lack clarity about when they

can tap into the deep pockets of parent corporations".79 Finally, foreigners who lend funds to

Chinese companies, contract with or invest in shares of Chinese subsidiaries, or establish

their own subsidiaries in China are denied a clear sense of the legal rules at play.80 This

comment highlights legal ambiguities on two aspects—how the law is to be applied, and

what its scope is.81 "Considering China's legal system, these shortcomings should be

addressed in one of two ways; "Either the State Council promulgates additional regulations

related to the new company law; or the Supreme People's Court should issue a judicial

interpretation that establishes guidelines on how the new company law should be

7
Xianzhu, Zhang, Piercing the company veil and regulation of companies in China, at 111
8
Ibid, at 128
9
Ibid. 129, 132
0
Ibid, at 132
1
Ibid, at 132
 32

interpreted". "Unless one of these steps is taken, creditors, investors and shareholders will

face uncertainty about when Courts can pierce a corporate veil".83

The path of achieving these goals is born with many difficulties, even in more mature

corporate law jurisdictions, there is still a lot of uncertainty with respect to veil-piercing after

many years of its legal practice. China has already taken its first step by legalizing this

doctrine in the Chinese new company law. It is hoped that this doctrine will have a wider

scope of provision, hence be more readily applicable in practice and does not remain a mere

dead letter law.

Article 20 and 64 of Chinese new company law address several factors of "piercing the

corporate veil", however, the law is unclear about whether these are the only factors that

courts may consider, or alternatively, whether courts may consider additional factors when

adjudicating a demand to pierce the corporate veil.

Article 20 generally regulates that courts will consider that "whether abuse results in debt

non-repayment", but it does not tell what the abuse is, how to justify it? Let us take

"fraud" as an example. The law does not mention whether or not the existence of fraud is a

82
Peter Howard Corne, Creation and Application of Law in the PRC. at 369, The judicial interpretation of Supreme
People's Court plays very significant role in both judicial and legislative aspects, and it has much force of law, especially
when new law has been established, judges expect more from SPC's judicial interpretation for new application of new
doctrines or some uncertain rules, which has very high legal effects in legal practice in China. And normally, after new law
enactment, SPC will promulgate judicial interpretation to supplement new law.
83
Hui xing Hang, Issues of piercing the corporate veil in Chinese new company law" at 123-124 and Ciyun zhu" The new
questions of application of piercing the corporate veil in China, at 15
84
Ibid, at 14, 15
 33

factor that a court may consider, but the fraud is commonplace in China before and after

Chinese new company law.85 Under the Anglo-American system, fraud is not a necessary

prerequisite. "Plaintiffs can seek to pierce the corporate veil even when the corporation did

not seek to defraud its creditor. Some civil law jurisdictions, such as Japan and Germany,

have adopted a similar system".86 "Under the French system a plaintiff must show that a

corporation committed one of three types of fraud before courts will pierce the corporate veil.

The corporation must have knowingly engaged in unlawful action, set out to intentionally

conceal the nature of the transaction, or deliberately engaged in fraudulent conduct

concerning a company's separate existence".87 China's new law does not take a clear

position on this discussion. From a textual perspective, it does not appear to require proof of

fraud. So, do judges have the flexibility to consider fraud as an additional factor when

adjudication? Or are they constrained by the factors delineated in article 20 and 64?

If the law grants judges the flexibility to consider additional factors, then the new law fails to

set clear boundaries on how judges should analyze a veil-piercing case.89 How much

flexibility do judge have? "Local judicial officials can craft their own multifactor analysis,

which raise the possibility that decisions will reflect local protectionist interests".90 "It also

85
Ciyun Zhu, supra note 83 at 16,17
80
Gerhard Wirth, Michael Arnold & Mark Greene, Corporate law in Germany at p23 -24 and Misao Tatsuta, A Parent
Corporation's Liability for Its Subsidiary's Obligations, in Law and Investment in Janpan (Yukio Yanigada et al. eds.,2000)
at 338, 340
87
Stephen.B Presser, Piercing the corporate veil S5.4 (2007)
88
Ciyun zhu, supra note 83 at 22
89
Liu Jun-hai, [ An Analysis of the Controversial Issues of Piercing the Corporate veil in the Context of the new corporate
law] (Shanghai, Tongji University Press, 2007) at 111, 115
90
Xin Chunying, Chinese courts: History and Transition at 185-214 (2004)

Note that, this kind of local protectionist is not a new issue in Chinese law, the most famous example of this in Chinese
commercial law appeared after the application of a new legal term of "unexpected benefits" after the enactment of Chinese
 34

weakens the integrity of judicial review, since higher-lever courts can effectively decided

whether to uphold or reverse lower courts' decisions on a veil-piercing case based on their

own set of arbitrary criteria designed to achieve a desired outcome."91

Another issue is that, under the new company law, "burden of proof in a veil-piercing case

generally belongs to creditors; creditors need to convince courts with reasonable proofs that

there are abuse actions and these abuse results directly injure creditors' interests so that the

veil needs to be lifted. However, due to the lack of a clear guideline of what these unlawful

actions are consisted of; creditors are not certain of what kind of proofs will be convincible;

shareholders are now worried of being veil-pierced because the existence of the new doctrine!

But the law does not mention what possibly constitutes these abuse actions? For plaintiffs,

this uncertainty makes the proving process more difficult and time-consuming; on the

defendant's side, how shareholders monitor themselves in their company management so as

to prevent being veil-pierced? How do shareholders defend themselves if creditors present

proofs in front of judges to appeal veil-piercing? Therefore, the uncertainties make the legal

practice of veil-piercing cases more difficult for both plaintiffs and defendants, and not quite

practical in legal practice.

On the other hand, if the factors listed in articles 20 and 64 are a closed set; it would raise a

new contract law in 1999. Many local courts applied this term unfairly in legal practice with much protection for local
ecnomy development, which made the application of Chinese new contract law be in an uneven status; author once
represented in such lawsuit which referred to the "unexpected benefit" legal term, the case was ended with unfaireness,
and author appealed in higher courts for clients. So the uncertaines of "veil-piercing" judgment will stimulates the growing
of local protectionist situation in Chinese law, which should be avoided as early as possible.
91
Ibid.
 35

different concern. The new law explicitly discusses only the rights of creditors. "Although

bankruptcies are an important context in which veil-piercing is invoked, they are, by no

means, the only ones."92 China's courts are bound to face "demands to pierce the corporate

veil in non-creditor situations, in the coming years".93 "Companies manage their business

and also are responsible for certain social or public responsibilities such as, environmental

class action lawsuits, as China confronts major environmental problems".94 In addition, with

increased worries about product safety, Chinese consumers are likely to seek greater

enforcement of consumer protection laws. The issue of whether or not a company has certain

social responsibilities is arguable. However, the development of social economy and

enlargement of companies' scales make companies have a broader influence upon social life.

The trend of companies carrying some social responsibilities is a result of growth of

companies' power. Many decisions made by companies are not only economical decisions

but also social decisions, these decisions can have significant impact on society. 1 believe that

the corporate social responsibilities should be regulated by company laws in some

circumstances. The Chinese economical market is developing rapidly, being prepared in the

new company law is better than waiting for the occurrence of problems.

The narrow textualist interpretation of the Chinese new company law suggests that the

company law's veil-piercing provisions may not cover all such litigants."95 If read literally,

92
Huixin Liang, supra note 83 at 237
93
Ibid.
94
Sarah Schafer, Taking China to Court, NEWSWEEK INT'L, Nov.20, 2006
www.manbc.msn,com/id/15672081/site/newsweek
Article 20 applies only to debt situations. As a result, "Chinese new veil-piercing provisions

96
are either too narrow or, at best ambiguous in their scope".

(B) Proposals on the doctrine of piercing the corporate veil in Chinese law

Considering those questions above, the Supreme People's Court and the State Council should

clarify how courts should consider a demand to pierce the corporate veil.97Although

veil-piercing cases are highly fact specific, some degree of judicial flexibility is desirable.

Chinese company law would benefit from clearly delineating its applicable scope and the

factors that may be considered by Courts in a veil-piercing case.

(a) Articles 20 and 64 of the Chinese new company law should specify that the factors

mentioned in those articles are not exclusive and should clarify additional factors that courts
98
may consider when adjudicating such cases. Doing so will provide clarity to judges,

shareholders, investors, and creditors about how the legal analysis should proceed in a

veil-piercing case.

(b) Delineating a multifactor list is common in other jurisdictions; China can take it as an

option. U.S. Courts commonly rely upon a set of eleven factors outlined by Frederick Powell

in the 1930s.99 "More recent commentators have suggested as many as thirty-one factors that

96
ibid.
97
Yunfang Zhu, [ Piercing the corporate veil: Essential Elements of shareholders'joint liability] (2006) at 26, 30
98
Xu Qiong, Jiekai gongsi renge fouren lilun de miansha [Uncovering the veil of the theory behind disregarding the
corporate entity] at p83, 84 (2006)
99
Frederick J. Powell, Parent and Subsidiary Corporations (1931) at 9
 37

should be taken into account".100 "German courts have also adopted a set of factors similar

to those used by U.S. courts, including commingling of assets, failure to follow formalities,

undercapitalization of assets, and the extent to which one company dominates another".101

"Japanese lower courts have also constructed a similar list of factors for deciding

102
veil-piercing cases".

Among many factors103, considering China's own situation, Chinese courts should consider

the following factors in the multifactor list of veil-piercing cases:

(1) "Inadequate capitalization"

"Inadequate capitalization" is also called "thin capitalization" or "undercapitalization", and it

generally means that the capitalization is very small in relation to the nature of the risk the

business of the corporation necessarily entails. This factor "commonly emphasized by courts

in deciding whether to allow creditors to go beyond the corporations' assets"104 is concerned

with the extent of the company's capitalization. The reason for veil-piercing from an

economic perspective is that "the lower the amount of a firm's capital, the greater the

incentive to engage in excessively risky activities"105, usually, is "based on likely economic

100
Cathy S. Krendl & James R. Krendl, Piercing the Corporate Veil: Focusing the Inquiry, 55 DENV.L.J.1,(1978) at 52-55
101
Presser, supra note 86 S 5.5, 2007
102
Ibid. S 5.6
103
Note that, these factors are among those most commonly considered by courts in other jurisdictions, it is only a
suggestive not an exhaustive list.
104
Frank D Easterbrook, Daniel R .Fischel, The economic structure of corporate law, First Harvard University press
paperback edition, (Harvard University Press, Cambridge, Massachusetts, London, England, 1996) at 59
105
Ibid.
V

38

needs rather than legal requirements".106

"The extent of a firm's capitalization is most important in situations involving involuntary

107
creditors, where high transactions cost preclude negotiation." The taxicab industry has

been a major area where "thin capitalization" raises the issue of "piercing the corporate veil"

in North America. A simplified model is that the common shareholders set up numerous mini

taxi companies each with only 1 or 2 cabs, and then set another company to operate the

central garage and another one to run the dispatching service. All the companies are

controlled by these shareholders and the profits go to their hands. "The problem is that these

mini companies would only buy entity that can be responsible for the damages".1 Hamilton

holds that, although the majority opinion in Walkovzaky v. Carlton refused to hold the

shareholders liable in the case, "courts are much more likely to 'piercing the corporate veil'

and hold shareholders liable in tort case when the elements of marginal capitalization and

systematic dispersal of assets are combined."109

In China "inadequate capitalization" is not a new problem, many investors try to reduce these

business risk with low capital investment, non-repayment cases raised by "Thin

capitalization" are a common situations now, and need to be regulate.110 It is necessary to

consider this factor as a possibility of veil-piercing in China both from economic and legal

106 Weguo He, supra note 34 at 32

107 Supra note 104
108 Robert Hamilton, supra note 55 at pi06
109 Robert Charles Clark, supra note 54 at p78-79
110 Ciyun Zhu, supra note 2 at 140
 39

perspectives; On the other hand, an undercapitalization analysis should also include whether

creditors were intentionally misled about the financial strength of the corporation.111

(2) Fraudulent investment

"Fraudulent investment", in China, occurs either when the capital of a company is not

actually invested into the corporation, or when it is invested but is then withdrawn without

due process.112 Chinese companies are plagued with many problems like this. Although,

Chinese corporate law has very low capital investment for registering a company, it still

cannot avoid shareholders doing so.

The situation that the capital of a company is not actually invested into the corporation is a

situation where shareholders claim that they have already invested the required capital into

the registered company but actually they haven't.

Professor Ciyun Zhun argues that the so called "corporation" did not get authentic

independence due to the lack of capital.113 In her opinion, the shareholders shall be held

jointly liable with the corporations and not just to the extent of the balance of actual

111
Ibid, p 148, 149
' n LiuJun Hai, A study of piercing the corporate veil in China. At pi 3
113
Ciyun Zhu, supra note 2 at p 359, 378
 40

investment and stated investment.114 We can see that the rationale being that the lack of

capital means loss of independent corporate personality, and without corporate personality

the liability could only be joint; Besides, "the loss resulting form the fraudulent investments

may considerably surpass the balance"115, so it would be unfair for the creditors to limit the

liability to the extent of the balance. Therefore, in China, fraudulent investments should be

one of the criteria to pierce the corporate veil.

(3) Whether the corporation failed to observe corporate formalities:

Such as holding separate board meetings, keeping separate records, maintaining separate

offices and accounts, filing separate tax returns, and holding separate deeds to property.

(4) Whether the parent company interfered excessively in the management of the

subsidiary.

(5) Whether the parent and subsidiary companies conducted joint activities, such as

purchasing, advertising, or public relations, and if so, whether payment for such

activities was unfairly distributed across the two companies.

Factors (3),(4) and (5) present another major situation where veil-piercing should be applied

in different ways. This situation "involves parent-subsidiary combinations, where creditors of

114
Ibid, at 345, 346
115
Weguo He, Supra note 34, at 59, 60
 41

116
the subsidiary attempt to reach assets of the parent." The "parent-subsidiary

combinations" mainly exist as a state of uncertain separated legal personality between a

company and shareholders; it is generally presented with a confusion of assets or financing

and management between parent company and subsidiaries.

In China, the separation of management, assets, and financing between parent companies and

the subsidiaries is necessary to assure the independence of the corporation from its

controlling shareholders.117 "Historically and culturally, many old and big companies

transferred from State-Owned-Enterprises enjoy limited liability, but their operations, profits

118
and personnel are ultimately controlled by the governments". "Under the privileges of

government, these companies are hoped to bring some profits".119 "The fatal defect was that

these subsidiaries corporations did not gain the 'independence'".120 The dominant status of

majority shareholders further destroyed them. Two enterprises are managed under two names

but one management team. Financially, Subsidiaries Corporation turn to be a money machine

for parent company, however, when subsidiaries failed to perform their legal obligation, the

parent companies refused to be responsible for these liabilities and alleged that they should

not be held liable because their liability is limited. This issue was initially raised in the

publicly listed corporations in China, but it is even worst in the numerous medium-small

close corporations that are subject to less stringent regulations now. Shareholders take

advantage of limited liabilities in these corporations which lack of separation of assets,

116
Ibid, at 56
117
Tian tao shi A study on the legal issues of related enterprises. (Beijing, law press. 1998) at 9.10
118
Weguo He supra note 34 at 56
119
Ibid, p 34, 35
120
Ibid P 35
 42

management, and financing. The high confusion of a separate corporation personality and

that of shareholders is contrary to the independent corporate personality principle;

accordingly, the corporate veil shall be pierced in this situation.

121

(6) Whether corporate assets were diverted for personal use.

Such diversion, if it occurs without payment or prior agreement, is often evidence of an

alter-ego relationship between the shareholder and the corporation. Some Chinese courts and

scholars have stressed the importance of this factor. The judgment of case Beijing

Chengxiang Haodu Construction Co. v. Yang Jinggui122has shown this concern. Bejing xiang

Haodu Construction Co. (hereafter, referred to Haodu Co.) signed a construction agreement

with Jingbaoma Co. According to the contract, Haodu Co needed to finish the construction

project by the end of 1996, Jingbaoma would pay the construction fee equivalent to

3437070.61yuan after the project was finished completely. Haodu finished the construction

on time, and claimed for the construction fee from Jingbaoma under the contracted date. Yet,

while constructing, Yangjinggui (the controlling shareholder of Jingbaoma Company)

transferred the ownership of this project to another company named Nonggong Company at

the price of 4,000,000yuan, Nonggong Company paid 4,000,000yuan to Jingbaoma Company.

By the time Haodu finished the project and claimed for payment from Jiangbaoma, they

found out that Jingbaoma has been dissolved. However, before dissolve, Jingbaoma

Company did not pay off company's debts, and shareholders all claimed their shares and
121
Ciyun Zhu note 2 at 156,157
122
Bejing, Chengxiang Haodu Constr, Co. vl. Yang Jinggui, CH1NALAWINFO (Beijing High People's Ct., July 31 2002)
dividends. Under certain facts, courts hold shareholder Yangjinggui liable for Jingbaoma

Company's debt in this case, stated that shareholders abused company form, diverted

company's asset illegal, which injured Haodu's interests, so shareholder is held for

company's debts. This situation is not new but a commonplace these days in China, and

shareholders diverted assets of company for personal interests occurs in China via different

situations, so this circumstance should definitely be considered as a situation where courts lift

the corporate veil.

The six circumstances listed above are not exclusive but flexible; they are situations that

Courts have already faced in legal practice in China. Should China proceed down such a path,

it ought to stipulate how courts are to balance the various factors considered in their

analysis.123 Given the rapidly evolving transformation of its market economy, China would

be best benefit from this kind of "totality of the circumstances" test.124 The totality of the

circumstances test requires courts to consider the overall context under which the alleged

suspicious or fraudulent corporate activity occurred, in addition to the specific factors.

Not every factor needs to be presented, but the more factors, the more likely it is that a court

will pierce the corporate veil to protect and maintain justice. This test has been used by some
126
American courts under the guide of an equity theory, and evolved from criticisms that

previous theories of veil piercing applied by courts were "In practice.. .virtually

123
Ciyun zhu , supra note 2 at 145
124
Ciyun Zhu supra note 2 at 145
125
Ibid, p 145,46
126
See a case White v. Winchester Land Dev. Corp.,
 44

indistinguishable from one another." Applying a multifactor analysis and test would

bring greater certainty about the legal test in veil-piercing cases and greater flexibility for

128
courts to consider the individual factual circumstances of each case.

(c) Veil-piercing for non-creditors and social responsibilities in China

China should clarify if the provisions apply to non-creditor contexts, and consider company's

social responsibilities. Other jurisdictions have applied the doctrine broadly. For example, in

the United States, if the corporate form has been abused and the assets of the tortfeasor are

insufficient, courts will mandate that a parent company compensate tort victims.129 "U.S.

courts have also created an exception for public policy, which courts have applied in antitrust

cases to strike down "shell companies" established to circumvent antitrust laws".130 Besides,

Canadian and American law have already settled precedence of veil-piercing cases involved

in company's social responsibilities. So, if China's courts clarify these aspects, tort victims

will be able to judge when they can be compensated from the pocket of the parent company

so as to balance the justice and fairness; secondly, "facing the rapid transformation of

economic market, China is walking toward international practice, economy development

causes more and more social problems, such as environmental problems, product safety

problems, among others, Companies as entities which make profits by managing businesses,

127
James D. Cox & Thomas Lee Hazen, Cox & Hazen on corporation (2d ed 2003) at 279
128
Huixing Hang, supra note 1 at 200
129
Robert B Thonpson, piercing the corporate veil: An Empirical Study, (1991) at 1036, 1058-59
130
Corporate, limited liability and lift the veil of a corporation, at p24, also see Love v. State, 972 S.W.2d 114 (Tex. App.
1998)
 45

are also members of the whole society, and naturally carry some reasonable social

responsibilities, therefore, the application of the doctrine of veil-piercing in China in these

circumstances is unavoidable after China entered into international markets"131. Clarifying

these aspects, can make Chinese company law be prepared for future challenges, and also

warn those investors of companies being watchful of their social responsibilities while they

are making profits.

(d) Continued use of the three fundamental principles of Chinese civil and business law in

veil-piercing cases: Piercing the corporate veil needs Chinese judges to be brave and

comfortable with the flexibility of using it to deal with various situations, besides the Chinese

new company itself, judges can always have a positive attitude with fundamental principles

132
of Chinese civil and business law in China's veil-piercing cases when the new company

law does not have certain guideline.

(e) Except the proposals above, under China's legal procedural systems, these efforts should

either make State Council to promulgate additional regulations related to the doctrine of

piercing the corporate veil in the Chinese new company law, or the Supreme People's Court

should issue a judicial interpretation133 to guide the lower courts on how the new company

law should be interpreted.

131
Ciyun Zhu, supra note 2 at 293
132
See Chapter 3 above : the development of piercing the corporate veil in China, (b) getting closer to veil-piercing, they
are "honest and credibility", "fairness and voluntary", "public orders and good customs", mainly idea of these principles is
to maintain justice of law.
133
See Chapter 4 A: stated the significant role of judicial interpretation of SPC
(C ) Challenges of excessive use piercing the corporate veil for courts

The application of new company law brings big challenges to Chinese judges, regarding to

the judicial discretion of China's veil-piercing cases, there are some questions I want to

present:

a) Avoid excessive veil-piercing in legal practice in China.

Every granted right generally faces a possibility of being abused. While we encourage

Chinese courts to feel confident and flexible to use veil-piercing doctrine, they also need to

be careful with its possibility of excessive use. The experience of China's absolute limited

liability should give them a lesson to prevent abusing veil-piercing doctrine in Chinese new

company law this time. The situation of absolute limited liability in China occurred under a

background of an underdevelopment of Chinese economy and China's old company law

system; Veil-piercing doctrine is established by the rapid development of Chinese economy

and the international practice. Compare to past, Modern company law system has already

developed in many common law countries, and China should learn from old experiences and

not make same mistakes when they use the new doctrine of piercing the corporate veil as

what they did with absolute limited liability. With the rapid development of the world

economy, the doctrine of "piercing the corporate veil" has been developed and also applied in

much broader situations than in the past in order to improve company form and maintain

justice and fairness of law. Due to the unclear provisions of the veil-piercing doctrine in
Chinese new company law, it is likely that this doctrine will be abused. The goal of "piercing

the corporate veil" is to correct injustice, however, if this doctrine itself cannot be used fairly,

it will not be able to maintain justice and will only damage the modern company form. So it

is important to avoid abusing the doctrine of "piercing the corporate veil" in China. Chinese

courts should not abuse this doctrine but apply it carefully with much caution. The courts

should also take into account of the characteristics of Chinese legal system and accordingly

mould this doctrine to meet the specific needs of this system.

b) veil-piercing and one-person company in China

As a new company form, one-person company was acknowledged in a need of China's

economy. The establishment of one-person company form in Chinese new company law

encourages investment, and relaxes retrains of company incorporation in China. However,

after the statement of Article 58 about one-person company form, Article 64 particularly

emphasizes the relationship between the veil-piercing doctrine and one-person company. In a

one-person company, the relationship between the single shareholder and company is closer

than that of other company forms, and it is more difficult to tell the distinction between them

in company's transactions on certain aspects. The one-person company is more likely to be

used as single shareholder's agent, or profit-making tool; as I discussed in previous chapters,

"burden of proof of veil-piercing belonging to the single shareholder of a one-person

 48

company shows us that it is more likely for Chinese courts to lift the veil in one-person

company. The possibility of veil-piercing is increased so that there are more chances to abuse

veil-piercing doctrine. Therefore, China's courts should be more concerned with preventing

abuse of piercing the corporate veil in one-person company so as not to place one-person

company to an unstable state in China.

(c) A conservative attitude of "reverse piercing"

In veil-piercing cases, creditors are the plaintiffs who claim courts to lift the veil of a

corporation. In some cases, the shoe are on the other foot. "A shareholder argues in a suit

against a third party defendant that the separate existence of the corporation should be
134
ignored on policy grounds". When China legislated "piercing the corporate veil",

scholars invoked this concern, but the New Chinese Corporate Law did not make it very clear

about whether or not it is reasonable. But courts don't deny there might be possibilities to use

it in future..

Robert W. Hamilton, The Law of Corporations, (4th ed.,

Conclusion

In modern company law, companies possess a separate corporate personality. The company is

a separate entity; it is distinct from that of its members, which decides that shareholders of a

company are only responsible for limited liability of a company, and it is the company which

is liable unlimitedly for its debts. Only under specific circumstances, the separate entity of a

company will be disregarded, which is called "piercing the corporate veil' or "disregard the

separate personality of a corporation'. Modern company law is based on the separate

corporate personality and limited liability of shareholders, nevertheless, "piercing the

corporate veil" is not a complete denial of the company form, but an exceptive doctrine that

"attempts to balance the benefits of limited liability against its cost". .The corporate

personality is restored after veil-piercing if the company is not dissolved.

The doctrine of piercing the corporate veil is applied to specific cases. This doctrine occurs in

a need of justice and fairness, and it is used to prevent and redress the abuse of having

separated the corporation from its shareholders and recognizing a distinct corporate

personality. Therefore, the separate corporate personality, limited liability of shareholders and

piercing the corporate veil together maintain the basis of modern company law, disregarding

and effacing any one of the three principles will endanger the modern company form.

1
Supra note 104 at 55

49
The Chinese new company law (2006) established the principle of piercing the corporate veil,

which is a big accomplishment and goes towards building the modern company law system

in China. This doctrine is established for redressing unlawful actions therefore its application

has to rely on a legal context. The new law does not clearly address some important questions,

which leaves scope for much judicial flexibility and a rather ad hoc application of the

doctrine. This is not to deny that the adjudicative process necessarily requires some amount

of flexibility, however, the doctrine of veil-piercing still needs to be clearly defined in

Chinese corporate law because of the lack of clear guidelines for its application.

Either the factors listed in Articles 20 and 64 are a close set or not, the new law raises more

problems from its uncertainties of the applicable scope of veil-piercing doctrine. The

Supreme People's Courts and State Council need to make efforts to clarify how lower courts

should consider a demand to pierce the corporate veil. The new company law is not exclusive;

a feasible scope of application veil-piercing doctrine is desirable.