Can a husband and wife company be jointly and severally liable for company debts? How to avoid it?
Author | Attorney Jia Xiaoya
Introduction
Mr. Hu manages and operates a company that leases and runs a shopping mall. Recently, the tenant was sued by the landlord for unpaid rent, with the amount in dispute totaling approximately RMB 2 million. In addition to seeking compensation for rental losses from the company, the property owner also simultaneously demands that Mr. Hu and his wife, Ms. Zhang, be held jointly and severally liable for the company’s debts.
Furthermore, it is understood that the company managed by Mr. Hu has two shareholders: Mr. Hu and his wife.
1
What is a husband-and-wife company?
In short, it is a company established during the subsistence of a marital relationship, with only the husband and wife as shareholders.
From a formal perspective, a company operated by a married couple is not a single-member company and, therefore, is not subject to liability doctrines such as the piercing of the corporate veil. But why, once a dispute arises, do courts so often rule that both spouses must bear joint and several liability for the company’s debts?
Court adjudication rules generally fall into two categories.
2
Court Judgment Rules
(I) Due to factors such as the special nature of the shareholders' status and the commingling of company assets with shareholders' personal assets, courts often recognize "husband-and-wife" companies as de facto single-member companies.
For example, in Case No. (2019) Supreme People’s Court Min Re 372, this case is a typical case that is frequently cited and applied in similar matters.
The Supreme People’s Court reached this determination primarily based on the following considerations:
1. The company was established during the subsistence of the marital relationship, and the company’s industrial and commercial registration records do not contain any written proof or agreement regarding the division of the couple’s property; in other words, the creditor was unaware of such arrangements. Article 1065, paragraph 3, of the Civil Code provides that, where a couple has agreed to a system of separate property, if a third party is aware that one spouse has incurred a debt, such debt may be discharged from the personal property of that spouse.
The key point here is that the third party must be aware that the couple is under a regime of separate property. However, in reality, there are few cases that can be fully substantiated with evidence.
2. The company’s registered capital is derived from the couple’s joint property; therefore, the company’s equity constitutes marital property.
3. All of the company’s equity is essentially derived from a single property right, which is jointly owned and controlled by one entity, resulting in a high degree of alignment of interests among the parties and substantive unity, making it difficult to establish effective internal oversight.
4. Shareholders are both owners and managers, leading to a commingling of personal and corporate assets.
(II) Adhere strictly to the legal form of a one-person company and refrain from broad interpretations.
In case No. (2020) Sup. Ct. Min Shen 6688, the Supreme People’s Court held that, pursuant to Article 57, paragraph 2, of the Company Law, a single-member limited liability company refers to a limited liability company with only one natural person shareholder or one corporate shareholder. Although the shareholders in the case established the company by contributing jointly owned marital property, characterizing it as a “single-member limited liability company” still lacks a legal basis.
In case No. (2020) Hu 01 Min Zhong 2552, the second-instance court upheld the first-instance court’s determination on this issue. The court held that family members, including spouses, are all independent legal entities and cannot be entirely equated to a single person. Therefore, the provisions applicable to single-member companies do not apply to such “husband-and-wife” companies. In the absence of evidence demonstrating commingling of assets between the spouses as shareholders and the company’s assets, the spouses should not bear joint and several liability for the company’s debts.
The aforementioned court rulings demonstrate that a company operated by a married couple is not necessarily deemed to be a one-person company and, therefore, is not automatically held jointly and severally liable for the company’s debts. However, the key issue ultimately hinges on whether there is evidence demonstrating a commingling of shareholders’ assets with the company’s assets. According to Article 63 of the Company Law, the burden of proof regarding the separation of a shareholder’s personal assets from the company’s assets is reversed; that is, the shareholder must prove the independence of its assets from those of the company.
Therefore, in actual case law, there are frequent instances where parties are held jointly and severally liable due to difficulties in producing evidence.
Returning to the case in the introduction, Mr. Hu and his wife are both shareholders of the company. Mr. Hu serves as the executive director and general manager, while Mrs. Hu is the supervisor but does not participate in the day-to-day operations. Furthermore, during the course of operations, particularly in dealings with property owners and small merchants, Mr. Hu often uses his personal account to collect rent from the small merchants, while using the company’s account to pay rent, property management fees, and other expenses to the property owners.
For the owner, obtaining the aforementioned evidence is relatively straightforward; therefore, it is highly likely that this case will be deemed a case of commingling between personal and corporate assets. This scenario is also commonly observed in many companies run by married couples. So, for such companies, how should they avoid risks?
3
Recommendations for Avoiding Joint and Several Liability for Company Debts
1. Regarding the equity structure
For companies run by a married couple, particularly those still in the early stages of development with immature corporate governance, non-compliance is all too common; therefore, it is advisable to restructure the equity ownership. It is recommended that a third party, other than the spouses, hold one spouse’s equity on their behalf, with the holding ratio kept within a relatively small range; alternatively, a third-party shareholder may be introduced through share transfers or capital increases.
2. Avoid substantive financial confusion.
(1) Ensure that shareholders’ assets and the company’s assets are accounted for and recorded separately, with profits distributed and held in separate accounts, and risks borne independently.
For example, company assets should be registered in the company’s name; however, the company has registered assets used in its production and operations under the names of its shareholders. For example, where shareholders contribute capital in the form of intellectual property or other assets but fail to promptly update the relevant registration, and continue to possess and use such assets; or where shareholders use the company’s funds to repay their own debts.
(2) Avoid commingling company accounts with personal accounts.
For example, using a shareholder’s or employee’s personal account to collect and disburse company funds. Another common scenario involves transaction agreements signed by a company with external parties, where the agreed-upon collection account is actually that of a shareholder. Without a reasonable explanation, this may be deemed as financial confusion.
(3) The company shall establish standardized financial procedures and maintain separate accounting records. Where feasible, it is recommended that the company prepare annual financial reports and have them audited by a certified public accounting firm.
4
Legal provisions
Company Law (as amended in 2018)
Article 57 The establishment and organizational structure of a single-member limited liability company shall be governed by the provisions of this Section; where not otherwise provided for in this Section, the provisions of Sections One and Two of this Chapter shall apply.
For the purposes of this Law, a single-member limited liability company refers to a limited liability company that has only one natural person shareholder or one corporate shareholder.
Article 63: Where a shareholder of a single-shareholder limited liability company fails to prove that the company’s assets are independent of the shareholder’s own assets, such shareholder shall bear joint and several liability for the company’s debts.
The Civil Code
Article 1065 [Property Regime Agreed Upon by Spouses]
Both parties may agree that the property acquired during the marriage, as well as the property owned prior to marriage, shall be owned by each party individually, jointly, or partly by each party and partly jointly. The agreement shall be in writing. In the absence of an agreement, or where the agreement is unclear, the provisions of Articles 1,0
62and 1,063 of this Law shall apply.
Any agreement between spouses regarding property acquired during the marriage as well as premarital property shall be legally binding on both parties.
If a couple agrees during the marriage that any property acquired during the marriage shall belong to each of them individually, and a third party is aware of such agreement, any debt incurred by one spouse shall be discharged from the individual property of that spouse.
lawyer Introduction
Attorney Jia Xiaoya
Full-time lawyer at
Legal and business professional lawyer
Attorney Jia Xiaoya specializes in legal services in the areas of corporate law, investment and financing, and insurance law, including, but not limited to, corporate legal advisory, equity investment, commercial contract disputes, insurance dispute resolution, and family (corporate) governance and wealth management, with extensive practical experience.
Phone: 13612973385
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