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Over the past one to two years, the number of cases involving objection to execution, action for objection to execution, disputes over shareholders' impairment of the interests of company creditors, and property division lawsuits has witnessed a sharp surge. Most of such cases are a series of derivative lawsuits filed by creditors when their claims fail to be satisfied after the people's courts render judgments on property-related disputes and the judgments are enforced. These derivative lawsuits arise from circumstances including withdrawal of capital contributions by company shareholders, debt evasion by company shareholders by means of equity transfer, and debt evasion by individuals through fraudulent transfer of real property, among others. Recently, the author handled a case where a shareholder was added to bear liability for the company's debts on the ground of withdrawal of capital contributions, which triggered reflections on the civil liability and criminal liability concerning "withdrawal of capital contributions".

Q: Under what circumstances shall an act be deemed as withdrawal of capital contributions?

Pursuant to Interpretation (III) of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China, circumstances of "illicit withdrawal of capital contributions" include:

(I) Preparing false financial and accounting statements to falsely inflate profits for distribution;

(II) Withdrawing its capital contribution by fabricating a creditor-debtor relationship.

(III) Withdrawing the capital contribution by means of related party transactions;

(4) Any other act of withdrawing capital contributions without complying with statutory procedures.

Among the aforesaid circumstances, the most common conduct under the fourth circumstance is the act of briefly transferring funds into and out of accounts for the purpose of obtaining capital verification. Prior to March 1, 2014, shareholders in China were required to obtain a capital verification report for company incorporation, therefore many company promoters chose to raise bridge funds through intermediary service providers within a short period of time, and transfer capital contributions into and out of accounts in a short time frame. Under such circumstance, such conduct is generally deemed as withdrawal of capital contributions, since the transfer-out act is not carried out in accordance with any statutory procedures, nor is it based on normal transaction relationships, and no reasonable evidence proving the legality of the capital flow can be provided. (Reference cases: Supreme People's Court Civil Retrial Application Case No. 4683 (2021), Supreme People's Court Civil Retrial Application Case No. 3194 (2019))

Q: What legal liabilities shall a shareholder who unlawfully withdraws his or her capital contributions bear to the creditors of the company?

Pursuant to Paragraph 2 of Article 14 of the *Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China (III)*: Where a creditor of a company requests that a shareholder who has withdrawn capital contributions assume supplementary compensation liability for the portion of the company's debts that the company is unable to settle within the scope of the principal and interest of the withdrawn capital contributions, and that other shareholders, directors, senior managerial personnel or actual controllers who have assisted in the withdrawal of capital contributions bear joint and several liability therefor, the people's court shall uphold such request.

Q: How to commence the procedure for joining shareholders who have illicitly withdrawn their capital contributions as parties to be held liable in civil cases?

Generally, there are two methods available for creditors to choose from.

Type 1: Directly append the shareholders who have unlawfully withdrawn their contributed capital as persons subject to execution in the execution procedure (execution objection procedure).

Legal Basis: Article 18 of the *Provisions of the Supreme People's Court on Several Issues Concerning the Alteration and Addition of Parties in Civil Execution*: Where a for-profit legal person as the person subject to execution has insufficient property to pay off the debts specified in an effective legal instrument, if the execution applicant applies for altering or adding the shareholders or capital contributors who have withdrawn their capital contributions as the persons subject to execution to bear liability within the scope of the withdrawn capital contributions, the people's court shall support such application.

The second approach is to directly file a lawsuit on the ground of liability for damage to the company's creditors' interests caused by shareholders.

Legal Basis: (1) Article 35 of the *Company Law of the People's Republic of China*: After a company is incorporated, no shareholder may withdraw its capital contributions. (2) Article 14 of the *Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China (III)*.

Q: How can a creditor make the optimal choice between the above two alternatives?

Advantages and Disadvantages of the First Approach:

Advantages: No additional litigation fees will be charged by the People's Court for the execution objection procedure initiated in the execution process, which can save litigation costs for creditors. Where the applicant or the respondent is dissatisfied with the ruling approving or rejecting the application for adding a person subject to execution, the remedy channel is to file an execution objection lawsuit with the People's Court. At present, for the procedure of execution objection lawsuit, the overwhelming majority of courts collect case acceptance fees in accordance with the charging standards for property-related cases under the *Measures for the Payment of Litigation Fees*, while a small number of courts collect case acceptance fees based on the standards for non-property-related cases. Therefore, from the perspective of litigation costs, most creditors will choose to try to add the person subject to execution in the execution procedure first.

Disadvantages: (1) At present, most adjudications on the addition of a person subject to enforcement in the enforcement procedure are mere formalities. For circumstances such as shareholders' capital withdrawal, malicious transfer of equity by shareholders to evade debts, and malicious transfer of property by individuals to evade debts, the people's courts generally will not easily render a ruling approving the addition, which further requires creditors to file an enforcement opposition lawsuit. (2) The successful addition of a person subject to enforcement in the enforcement procedure shall be premised on satisfaction of the condition that "the property of the person subject to enforcement is insufficient to pay off the debt specified in an effective legal instrument". (3) Although Paragraph 2 of Article 29 of the *Provisions of the Supreme People's Court on Several Issues Concerning the Modification and Addition of Parties in Civil Enforcement* stipulates that creditors may apply for preservation of the property of a third party in the procedure of adding a person subject to enforcement, in practice, the author has encountered situations where some courts reject creditors' applications for preservation measures filed in such procedure, which will incur certain time costs for communication, while property preservation is the most critical link in such cases.

Advantages and Disadvantages of the Second Approach:

Advantages: (1) Filing a lawsuit directly on the ground of liability for shareholders' infringement of the interests of the company's creditors can reduce the time spent by creditors in the execution objection procedure. Pursuant to Article 28 of the *Provisions of the Supreme People's Court on Several Issues Concerning the Change and Addition of Parties in Civil Execution*, the execution court shall render a ruling within 60 days from the date of receipt of the written application for changing or adding parties submitted by the applicant. In practice, many execution courts issue rulings beyond the statutory time limit. Therefore, where a case involving the addition of debt-bearing subjects is highly controversial, choosing this approach can shorten the case handling time procedurally. The case handling cycle and the time for creditors to recover payment are often very important factors to be considered in handling execution cases; (2) Where a lawsuit is filed directly, the people's court shall, in accordance with the provisions on preservation in the *Civil Procedure Law of the People's Republic of China*, take preservation measures against the added defendant upon the application of the creditor, and the creditor may even apply for pre-litigation property preservation.

Disadvantages: Creditors are required to pay litigation costs and property preservation fees in advance at the initial stage of litigation. Execution cases for which such procedures are initiated usually involve a relatively large subject matter amount, and litigation costs are charged in accordance with the calculation criteria for property cases as prescribed in the *Measures on the Payment of Litigation Costs*.

Question: Where a shareholder commits the act of unlawfully withdrawing its capital contributions, does such act constitute a criminal offense?

According to Article 159 of the Criminal Law of the People's Republic of China: Where sponsors or shareholders of a company, in violation of the provisions of the Company Law, withdraw their capital contributions after the establishment of the company, such act shall constitute the crime of withdrawing capital contribution if the amount involved is huge, the consequences are serious, or there are other serious circumstances.

The Company Law of the People's Republic of China, which came into force on March 1, 2014, revised the paid-in registered capital registration system to the subscribed registered capital registration system. Except where otherwise stipulated on the paid-in registered capital of companies, the provisions on the statutory time limit for capital contribution of companies are abolished, and a system is adopted under which shareholders (promoters) of a company independently agree on such matters as the amount of subscribed capital contribution, form of capital contribution and time limit for capital contribution, which shall be recorded in the articles of association of the company.

On May 20, 2014, the Supreme People's Procuratorate and the Ministry of Public Security jointly issued and implemented the *Notice of the Supreme People's Procuratorate and the Ministry of Public Security on Strictly Handling Criminal Cases Involving Falsely Reported Registered Capital, False Capital Contribution and Flight of Capital Contribution in Accordance with the Law*, which explicitly stipulates that except for companies that apply the paid-in registered capital registration system in accordance with the law, no shareholders or promoters of a company shall be held criminally liable for the crimes of false capital contribution and flight of capital contribution.

Meanwhile, Article 4 of the Notice of the Supreme People's Procuratorate and the Ministry of Public Security on the Provisions (II) concerning the Standards for Filing and Prosecution of Criminal Cases under the Jurisdiction of Public Security Organs, which came into force on May 15, 2022, also clarifies that Article 159 of the Criminal Law of the People's Republic of China only applies to companies that implement the paid-up registered capital registration system pursuant to law.

What are the types of "companies implementing the paid-in registered capital registration system in accordance with the law"? According to the types of companies temporarily not subject to the subscribed registered capital registration system as announced in the Annex to *Companies Subject to the Paid-in Registered Capital Registration System in Accordance with the Law*, the scope includes: joint stock limited companies established by public offering, commercial banks, foreign-funded banks, financial asset management companies, trust companies, finance companies, financial leasing companies, labor dispatch enterprises, among others.

In conclusion, save that the act of withdrawing capital contributions committed by shareholders of companies adopting the paid-in registered capital registration system pursuant to the law of China may constitute a criminal offense, shareholders of companies applying the subscribed registered capital system who commit such an act may not be held criminally liable for the Crime of Withdrawing Capital Contributions.

Therefore, after the corporate economic cases we handle enter the enforcement procedure, where the People's Courts find no assets available for enforcement upon investigation, we may apply to the case-handling judge for an investigation order during the enforcement phase, review the bank statements showing the flow of shareholders' capital contribution funds, and resolve the dilemma of difficult enforcement by starting with the issue of shareholders' capital contributions.