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Case:

Company A was adjudicated bankrupt by a people's court in Shanghai due to poor operation. In the bankruptcy case of Company A, the bankruptcy administrator found that shortly after the incorporation of the company, Shareholder Jia transferred out his capital contribution of RMB 1 million under the name of "return of investment funds". On the basis of the relevant bank transaction records, the bankruptcy administrator initiated bankruptcy derivative litigation, demanding that the shareholder return the surreptitiously withdrawn capital contribution and compensate for interest losses, and that the legal representative and senior executives bear joint and several liability for the aforesaid surreptitious withdrawal of capital contributions. During the trial, the shareholder argued that he had fulfilled his obligation of making full capital contributions, and the paid-in capital had completed capital verification procedures. He further contended that the transfer of RMB 1 million recorded in the bank transaction flows did not constitute surreptitious withdrawal of capital contributions, but was repayment of loans incurred by the company in the early investment stage, and he did not commit any act of surreptitious withdrawal of capital contributions.

This article intends to elaborate on the concept of withdrawal of capital contributions, as well as issues including the criteria for determining such acts and the assumption of relevant liabilities, through the aforesaid cases.

I. Concept and Scope of Bankruptcy-derived Litigation

(I) Definition and Scope of Bankruptcy Derivative Litigation

Bankruptcy-derived litigation refers to litigations arising from various legal relationships related to the bankrupt enterprise during the course of bankruptcy proceedings. It covers a wide range of areas, including not only contract disputes such as sales contract disputes with suppliers and labor contract disputes with employees, but also tort disputes such as intellectual property right infringement disputes and environmental pollution infringement disputes. In addition, litigations related to shareholder liabilities, including those for the recovery of unpaid capital contributions and the recovery of withdrawn capital contributions, also constitute an important part of such litigations.

(II) The Relationship Between Bankruptcy-Derived Litigation and Bankruptcy Proceedings

Bankruptcy-derived litigation is closely linked to and interacts with bankruptcy proceedings. On the one hand, bankruptcy proceedings provide a specific context and framework for bankruptcy-derived litigation. In bankruptcy proceedings, the assets of the enterprise are under centralized management, and the rights of creditors are uniformly protected, which lays a foundation for resolving issues concerning property distribution and liability assumption in bankruptcy-derived litigation. On the other hand, the outcome of bankruptcy-derived litigation will also directly affect the advancement of bankruptcy proceedings. For example, the successful recovery of capital contributions withdrawn by shareholders can increase bankruptcy property, thereby altering the repayment ratio of creditors and the possibility of reorganization of the bankrupt enterprise.

II. The Concept of Withdrawal of Capital Contributions by Shareholders and Its Common Forms

Pursuant to the provisions of the *Company Law of the People's Republic of China* and relevant judicial interpretations, unlawful withdrawal of capital contributions by shareholders refers to the act that a shareholder, after making his/her capital contribution, withdraws the paid-in capital through such means as preparing false financial and accounting statements to fraudulently inflate profits for distribution, transferring out the paid-in capital via fabricated creditor-debtor relationships, transferring out the paid-in capital through affiliated transactions, or withdrawing the paid-in capital by other means without going through statutory procedures.

(I) Fabrication of Creditor-Debtor Relationship

This practice is usually manifested as that shareholders, through deliberate planning, create false certificates of creditor's rights and liabilities, such as forged IOUs, contracts and so on, to transfer company funds out in the name of debt repayment. The relevant manipulation tactics may be highly covert, involving collusion among multiple parties and complex financial arrangements. To identify and prevent such acts, it is required to conduct meticulous examination of the company's financial transactions, and focus on abnormal capital flows and unreasonable creation of liabilities.

(II) Use of Related-Party Transactions

Common types of related party transactions include transferring a company's high-quality assets to related parties at low prices, or procuring shoddy goods or services from related parties at high prices. To determine the reasonableness and legality of related party transactions, comprehensive consideration shall be given to factors such as whether the transaction price is fair, whether the transaction conforms to common market practices, and whether the necessary approval procedures have been followed. If a related party transaction materially prejudices the interests of the company and has no legitimate business purpose, it may be deemed as a means of unlawful withdrawal of capital contributions.

(III) Preparation of False Financial Statements

There are a wide range of means for the preparation of false financial statements, such as understating profits by overstating costs, or reducing the net assets of a company by concealing revenues. Financial audit plays a critical role in preventing such acts. Through the analysis of financial data, the examination of vouchers and communication with relevant personnel, professional auditors can identify anomalies and falsifications in financial statements.

(IV) Other Methods of Withdrawal of Capital Contributions

In addition to the aforesaid common methods, there also exist circumstances of direct embezzlement of company assets, such as shareholders' unauthorized misappropriation of the company's cash, fixed assets and other properties. Illegal profit distribution is another such method, that is, in violation of the company's articles of association as well as laws and regulations, the company distributes profits when it fails to meet the conditions for profit distribution or distributes profits in excess of the permissible limit, so as to indirectly achieve the purpose of surreptitious withdrawal of capital contributions. Such methods often cause more direct and evident damage to the property rights and interests of the company.

III. Four Constituent Elements for Recovering Capital Contributions Unlawfully Withdrawn by Shareholders

(1) Subject Element

The subjects of unlawful withdrawal of capital contributions are generally shareholders of a company. However, under certain circumstances, indirect shareholders, actual controllers and other parties who play a leading or assisting role in the act of unlawful withdrawal of capital contributions may also be determined as subjects of such acts. The key to identifying the aforesaid subjects is whether the person concerned has actual control over and influence on the company's capital contributions, and has committed the act of withdrawal through certain means.

(II) Subjective Elements

Subjective intent is a critical factor in determining a shareholder's unlawful withdrawal of capital contributions. This requires a comprehensive assessment of the shareholder's behavioral motivation, purpose, and level of awareness of the withdrawal conduct. Where a shareholder actually knows that its act violates the provisions of the Company Law of China and the company's articles of association, yet still intentionally transfers out its capital contributions without reasonable commercial purpose or legitimate justification, it may be determined that such shareholder has the subjective intent to unlawfully withdraw capital contributions.

(III) Act Elements

There are various specific acts of unlawful withdrawal of capital contributions, among which common ones include fabrication of claims and debts, taking advantage of related party transactions, preparation of false financial statements, etc. In addition, transferring company funds to personal accounts or accounts of related parties through various covert means, or reducing the company's assets by such means as unlawful capital reduction and disguised distribution of profits, may also constitute an act of unlawful withdrawal of capital contributions. These acts share the common feature that they lead to the reduction of the company's capital and impair the property rights and interests of the company.

(4) Element of Consequence

The act of unlawful withdrawal of capital contributions must have caused damage to the interests of the company, other shareholders or creditors. Such damage may be manifested as reduction of corporate assets, decline in corporate debt repayment capacity, impairment of the equity value of other shareholders, failure of creditors' claims to obtain full satisfaction, among other scenarios. The determination of damage consequences shall be made through comprehensive assessment in light of the specific facts of the case and relevant financial data.

IV. Features of Disputes Concerning the Recovery of Capital Contributions Unlawfully Withdrawn by Shareholders in Bankruptcy Derivative Litigation

(1) Complex Legal Relationships

Such disputes often involve the intertwining of multiple legal relationships. First, there exists a capital contribution relationship between shareholders and the company, and shareholders shall perform their capital contribution obligations in accordance with the company's articles of association and the provisions of laws. Second, there may be a contractual relationship between shareholders, which covers stipulations on matters including the method, proportion and time limit of capital contribution. Third, a debt relationship exists between the company and its creditors, who are entitled to require the company to discharge its debts with its property. In addition, in the process of unlawful withdrawal of capital contributions, relationships such as transaction relationships with related parties and fund transfer relationships with financial institutions may also be involved. These complex legal relationships interact with each other, which increases the difficulty of case handling.

(II) Difficulties in Evidence Collection

When a company enters bankruptcy, it is generally in a state of financial disarray with unclear accounts, and relevant financial materials may be missing, damaged or tampered with. This renders evidence collection extremely difficult. For example, to prove that a shareholder has unlawfully withdrawn its capital contributions, it is necessary to obtain the complete chain of evidence of capital flow, including contracts, invoices, bank transaction statements, etc., but such materials may be incomplete or inaccessible. In addition, the authenticity and integrity of electronic evidence are also difficult to guarantee, and witness testimony may be affected by various factors and thus lack credibility.

(III) Severe Conflict of Interest

In bankruptcy derivative litigation, there are obvious conflicts among the interest claims of parties including shareholders, bankruptcy administrators and creditors. Shareholders tend to evade liabilities to minimize their own losses; bankruptcy administrators shall represent the interests of all creditors and make every effort to recover the unlawfully withdrawn capital contributions; creditors hope to maximize the bankruptcy property so as to increase their own repayment ratio. Such intense interest conflicts lead to tit-for-tat confrontation between all parties in the litigation, which increases the adversarial nature and complexity of the case.

(IV) The case has a significant impact

The handling outcomes of such disputes have a significant impact on the advancement of bankruptcy proceedings, the distribution of bankruptcy property, the restructuring or liquidation of enterprises and other relevant aspects. If the capital contributions unlawfully withdrawn by shareholders can be successfully recovered, it will not only increase the volume of bankruptcy property and raise the repayment ratio for creditors, but also create conditions for the restructuring of the enterprise. Conversely, if the withdrawn capital contributions cannot be recovered, it may plunge bankruptcy proceedings into a deadlock, fail to effectively protect the legitimate rights and interests of creditors, and even undermine social stability and economic order.

V. Criteria for Determination and Difficulties in Judicial Practice

(I) Criteria for Determination

1. Examination of Fund Flow

When examining the flow of funds, the people's court shall focus on whether the outbound transfer route of funds is clear and reasonable, and whether it is relevant to the normal business operations of the company. Where the flow of funds is unclear or obviously irrelevant to the company's business, it may be determined as abnormal. In the meantime, the people's court shall also examine the final destination of the funds after transfer, and whether there exists any circumstance where the funds flow back to shareholders or related parties.

2. Determination of the Authenticity of Transactions

To determine whether a transaction between a shareholder and an affiliated party or a third party is authentic, relevant evidence such as transaction contracts, invoices and goods delivery vouchers shall be examined. Where a transaction lacks a reasonable commercial purpose, the transaction price is manifestly unreasonable, the transaction terms are unduly preferential, or under other similar circumstances, such transaction may be deemed a false transaction, which constitutes unlawful withdrawal of capital contributions.

3. Inference of Shareholders' Subjective Intent

The people's court generally infers a shareholder's subjective intent based on a comprehensive review of a series of acts and conducts of the shareholder. Such factors include, inter alia, the shareholder's words and deeds before and after the transfer of funds, whether the shareholder has participated in the relevant decision-making process, and whether the shareholder has concealed the company's financial position or made misleading representations in that regard. Where a shareholder fails to provide reasonable explanations and corresponding evidence to justify the fund transfer act, he or she may be determined to have the subjective intent of unlawful withdrawal of capital contributions.

(II) Difficulties

1. Acquisition and Probative Force of Evidence

(1) Incompleteness of financial materials

Incomplete financial records of bankrupt enterprises are one of the primary obstacles to evidence collection. Due to chaotic corporate management, unsound financial systems and other factors, important financial vouchers may be missing and account books may be disordered, making it impossible to accurately trace the flow and use of funds. To resolve this issue, it may be necessary to obtain evidence through other channels, such as collecting relevant materials from relevant financial institutions and tax authorities, or obtaining circumstantial evidence through investigations into the company's employees and business partners.

(2) Determination of Electronic Evidence

In the digital era, electronic evidence such as emails, electronic contracts and data from financial software plays an increasingly important role in proving unlawful withdrawal of capital contributions. However, the authenticity, integrity and reliability of electronic evidence are often subject to challenges, as relevant data may be tampered with, deleted or falsified. Therefore, when conducting judicial determination of electronic evidence, professional technical measures shall be adopted for forensic appraisal and analysis, and such electronic evidence shall be cross-corroborated with other evidence.

2. Intertwining of Legal Relationships

(1) Intersection with Other Civil Disputes

Such disputes may overlap with other civil disputes including contract disputes, tort disputes and security disputes. For example, the act of capital withdrawal by a shareholder may simultaneously constitute a tort against the company, or a transaction contract concluded with an affiliated party may be void for violation of laws and regulations. When handling such cases, it is required to accurately distinguish the nature of different legal relationships and applicable laws, so as to avoid confusion in the application of law.

(2) Concurrence of Criminal and Civil Liabilities

Under certain circumstances, a shareholder's act of withdrawing capital contribution may simultaneously constitute a criminal offense, such as the Crime of Withdrawing Capital Contribution, and a civil tort. In such cases, the relationship between criminal and civil procedures shall be properly handled, so as to both ensure the smooth conduct of criminal proceedings and safeguard the lawful rights and interests of civil subjects. Generally speaking, where criminal proceedings have been initiated, the trial of the relevant civil case may be suspended, and shall be resumed after the criminal judgment becomes legally effective; however, if the trial of the civil case is not dependent on the outcome of the criminal judgment, the trial may proceed.

VI. Allocation of Burden of Proof

(I) Initial Burden of Proof of the Bankruptcy Administrator

1. Functions of the Financial Audit Report

Bankruptcy administrators usually entrust professional audit institutions to audit the financial conditions of bankrupt enterprises. The audit report can serve as an important basis for discovering clues and preliminary evidence of withdrawal of capital contributions. An audit report can reveal issues including the company's capital flow, the authenticity of its financial statements, and the existence of abnormal transactions, among others. If an abnormal outbound transfer of funds is detected and no reasonable explanation can be provided therefor, it may constitute preliminary evidence of withdrawal of capital contributions.

2. Collection of Internal Corporate Documents

The bankruptcy administrator shall collect internal documents of the company such as resolutions of the shareholders' meeting, resolutions of the board of directors, financial statements and accounting vouchers. Such documents may contain important information concerning shareholders' capital contributions, fund utilization, profit distribution and other relevant aspects. Where any decision or act of a shareholder is found in violation of the company's articles of association as well as laws and regulations, such documents may be used as evidence for proving unlawful withdrawal of capital contributions.

(II) Shareholders' Burden of Proof for Rebuttal

1. Reasonable Explanation of Fund Usage

Shareholders shall provide reasonable explanations and statements for the transfer of funds, such as proving that the funds are used for the normal business activities, investment projects, debt repayment, etc. of the company. To support their claims, shareholders may be required to produce relevant evidence including contracts, invoices, bank transaction statements, project reports, etc., to prove that the use of the funds is lawful and reasonable.

2. Proof of the Legality of Transactions

Where a shareholder alleges that the outward transfer of funds is based on a lawful transaction, it shall be required to prove the authenticity, legality and reasonableness of the transaction. This includes producing evidence such as original transaction contracts, qualification certificates of transaction counterparties and evaluation reports on transaction prices, to prove that the transaction is conducted on a fair and impartial basis without any circumstance that damages the interests of the company.

(III) The People's Court's Review and Determination of the Burden of Proof

1. Sufficiency of Evidence

The people's court shall conduct a comprehensive and meticulous review of the evidence submitted by both parties, and determine whether the evidence is sufficient and conclusive. Evidence shall have the characteristics of relevance, legality and authenticity, and be capable of forming a complete chain of evidence to support the respective claims of the parties. Where there are defects in the evidence or the evidence is mutually contradictory, the people's court may require both parties to further submit supplementary evidence or provide relevant explanations.

2. Shift of Burden of Proof

In the course of litigation, where the evidence submitted by a party is sufficient to establish a prima facie case for the fact to be proved, the burden of proof may shift accordingly. For example, if the prima facie evidence provided by the bankruptcy administrator is sufficient to prove that a shareholder is suspected of withdrawing capital contributions, the shareholder shall bear the burden of producing contrary evidence to refute such allegation. Where the shareholder fails to provide competent evidence, the people's court may render a judgment unfavorable to the shareholder based on the available evidence.

7. Impacts on Bankrupt Enterprises and Creditors

(I) Increase of Bankruptcy Property

1. Impact on Bankruptcy Liquidation

In bankruptcy liquidation proceedings, the recovered unlawfully withdrawn capital contributions will directly increase the total amount of the bankruptcy estate. This means that the assets available for distribution to creditors will increase, and the repayment ratio for ordinary creditors will be raised accordingly. For example, if the bankruptcy estate could originally only satisfy 30% of the creditors' claims, the repayment ratio may be increased to 50% or even higher after the successful recovery of the withdrawn capital contributions, thus more effectively protecting the interests of creditors.

2. Significance for Bankruptcy Reorganization

In bankruptcy reorganization procedures, adequate funding is the key to the resumption of enterprises' operations. The recovered withdrawn capital contributions can provide necessary financial support for enterprises, which may be used for technological transformation, equipment renewal, market expansion and other purposes, so as to help enterprises regain profitability and market competitiveness. In addition, this sends a positive signal to potential strategic investors and increases the possibility of successful enterprise reorganization.

(II) Upholding Fairness and Justice

1. Regulation of Market Order

The proper handling of such disputes can exert a normative and deterrent effect on the conduct of shareholders in the market. It clarifies the legal bottom line that shareholders are prohibited from withdrawing their capital contributions, curbs the illegal acts of shareholders, safeguards the market order of fair competition, and promotes the sound development of the market economy.

2. Construction of the Social Credit System

Recovering the capital contributions unlawfully withdrawn by shareholders demonstrates the law's adherence to the principle of good faith and strengthens the credit awareness of market entities. This helps foster a social atmosphere of honesty and trustworthiness, advance the construction of China's social credit system, and fundamentally reduce the occurrence of similar illegal acts.