Analysis on the probative power of audit report in one-person company shareholders' joint and several liability disputes

Authors: Attorney Deng Minmin, Attorney Wang Jixian

Introduction

ZHIHENG

Article 63 of the Company Law (as amended in 2018) (hereinafter referred to as the “Original Company Law”) provides: “If a shareholder of a single‑member 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 “Draft Amendment to the Company Law (First Deliberation Draft)” has removed the provision in the Company Law that reversed the burden of proof regarding the commingling of assets between a one-person company and its shareholder, thereby creating the possibility that the burden of proof for disregarding the corporate veil in one-person companies may be adjusted to the general rule of “he who asserts must prove.”

However, in the Company Law (Revised in 2023), which officially came into effect on July 1, 2024 (hereinafter referred to as the “New Company Law”), the special provision regarding the reversal of the burden of proof for the commingling of assets between a single‑member company and its shareholder has been retained and elevated from the specific provisions of the original Company Law to the general provisions.（Article 23, paragraph 3 of the Company Law (as amended in 2023) provides: “In a company with a single shareholder, if the shareholder fails to prove that the company’s assets are independent of the shareholder’s own assets, the shareholder shall be jointly and severally liable for the company’s debts.”

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Therefore, in disputes concerning the commingling of assets involving shareholders of single‑member companies in China, the reversal of the burden of proof remains applicable, requiring the shareholder to bear the corresponding evidentiary burden. However, current laws do not explicitly specify under what circumstances a shareholder of a single‑member company may be deemed to have discharged this burden, thereby granting courts considerable discretion in adjudicating such cases and increasing the uncertainty of related litigation.

Submitting an audit report is a common method by which shareholders of a one-person company in litigation demonstrate the financial independence of the company and themselves; however, judicial practice has yet to establish a fully uniform standard regarding whether such an audit report constitutes necessary evidence and the extent of its probative force. This article attempts to provide a preliminary analysis of the relevant issues through a review of case law.

[Case Search Results]

1. Regarding whether the annual audit report constitutes necessary evidence.

According to the relevant cases retrieved, some courts have held that the annual audit report constitutes necessary evidence.(See, for example, Case No. (2020) Supreme People’s Court Min Shen 2827 and Case No. (2020) Guangdong Provincial Higher People’s Court Min Zhong 1209.)The primary reason is that, pursuant to Articles 62 and 63 of the original Company Law,When a company’s creditors seek to hold shareholders jointly and severally liable, the shareholders bear the burden of proving that the company’s assets are separate from their own. This burden requires, first, demonstrating that the financial statements for each fiscal year have been audited by an accounting firm, and second, proving that the shareholders’ personal assets have not been commingled with the company’s assets.

At the same time, some also argue that the annual audit report is not necessarily required evidence for shareholders seeking to demonstrate that their personal assets are separate from those of the company. As stated in the “Legal Issues Concerning the Application of Law to Sole-Proprietorship Companies” presented by the Commercial Adjudication Division of the No. 1 Intermediate People’s Court of Shanghai at a district-wide conference on commercial adjudication: “Although the shareholder of a sole-proprietorship company has not submitted the financial accounting reports for each fiscal year that have been audited by an accounting firm,However, if other evidence, such as a judicial audit report, is provided and can demonstrate the operational status of the company’s assets, including the disposition of such assets and their use for the company’s normal and reasonable expenses, it may be deemed that the burden of proof prescribed in Article 63 of the Company Law has been fulfilled.

Additionally, in case No. (2017) Zhe Min Shen 2570, the court held thatBased on a comprehensive review of the company’s and shareholder’s business registration information, articles of association, internal financial management system, bank account opening certificates, tax registration certificates, and other relevant documents, it is determined that no confusion of legal personality exists between the company and its shareholder.

2. On the probative force of the annual audit report

With regard to whether the mere submission of an annual audit report can suffice to demonstrate that a shareholder’s assets are separate from those of a single-member company, judicial rulings have also adopted differing views:

One view holds that when a shareholder of a single-member company submits the audited financial statements for each fiscal year prepared by an accounting firm, this satisfies the evidentiary requirements under corporate law. In the absence of contrary evidence presented by the creditor to rebut such claims, the relevant audit report should be deemed sufficient to establish the independence of the parties’ respective assets.

For instance, in the “Legal Issues Concerning the Application of Law to Single-Member Companies” presented at the district-wide commercial adjudication work conference by the Commercial Adjudication Division of the No. 1 Intermediate People’s Court of Shanghai, it was held that, with respect to the standard of proof for demonstrating the financial independence of a single-member company from its shareholder:“Where a shareholder of a single-member company submits the audited financial statements for each fiscal year prepared by an accounting firm, it is generally deemed that the company has satisfied the evidentiary requirements set forth in Article 63 of the Company Law.

If a creditor contends that the financial statements for each fiscal year, as audited by an accounting firm, lack evidentiary force, the creditor shall provide contrary evidence or furnish a sufficient explanation. This judicial stance has also been adopted in judicial practice.(As in Case No. (2021) Supreme People’s Court Min Zhong 435.)

Another view holds that merely submitting an annual audit report is insufficient to demonstrate the financial independence of a shareholder from a single-member company. For example, in Case No. (2020) Sup. Ct. Min. Term. 727, the court determined that the relevant audit report only reflects the company’s liabilities and profitability, but does not disclose the flow of assets between the shareholder and the company, and therefore fails to establish the financial independence of the sole shareholder from the company.

3. On the probative force of special audit reports

Based on case‑law research, some courts have held that such reports are prepared unilaterally and do not constitute the statutory annual audit reports prescribed by the Company Law; moreover, the basis for the audit has not been confirmed by the opposing party. Consequently, the audit findings cannot be deemed objectively authentic and may not be admitted as evidence to establish the independence of a shareholder’s assets from the company’s assets, or their evidentiary force is insufficient. For example, in cases (2023) Hu 01 Min Zhong 13599 and (2023) Hu Min Zhong 214, the courts adopted this view.

Some courts have accepted the special audit report and confirmed that no confusion of legal personality exists between the shareholder and the single-member company. In case No. (2023) Hu 0110 Min Chu 2192, the court held that “in the absence of any factual evidence demonstrating a conflict of interest between the auditing firm and the two defendants, [Name of Firm] (a general partnership), as a qualified appraisal entity licensed by the state, conducted all necessary and comprehensive audit procedures in accordance with the Chinese Standards on Auditing and relevant regulations, based on the actual circumstances.”

During the trial of this case, both defendants also provided all financial materials required for the audit. The plaintiff did not raise any objections regarding whether the specific audit conclusions were consistent with the audit materials; therefore, this Court accepts the Special Audit Report… The Special Audit Report prepared by a certain accounting firm and the financial records submitted by the two defendants demonstrate that Company 3 has already made its capital contribution in full, and do not indicate any instances of excessive exercise of control leading to a commingling of business operations between Company 3 and Company 2, or of reciprocal transfers of benefits. Consequently, the mere overlap of personnel is insufficient to establish a confusion of legal personalities between the two defendants.

[Case Retrieval and Summarization]

Based on our review of relevant case law, for cases in which an audit report (including annual and special-purpose audit reports) was submitted but its evidentiary value was not recognized by the court, we have identified the following primary grounds:

1. The audit report itself contains defects in content or form,Includes:

The audit report contains obvious audit deficiencies or constitutes an audit failure.In case No. (2021) Supreme People's Court Min Shen 3711, the court held that “after Huayang Company became a single-member limited liability company, it violated the provisions of Article 62 of the Company Law of the People's Republic of China by failing to prepare financial accounting reports at the end of each fiscal year and have them audited by an accounting firm.”

Although Pang Hua submitted evidentiary materials, including the audit report of Huayang Company issued by an accounting firm, to demonstrate the company’s property independence, according to the facts ascertained in the original trial,The aforementioned audit report fails to include in Huayang Company’s balance sheet any of the execution debts related to the case that are publicly available through open inquiry.“There are clear instances of audit failure”;

The audit report explicitly expresses a qualified opinion on the scope of the audit, thereby affecting the evidentiary weight of the corresponding audit report.For example, in case No. (2016) Sup. Ct. Min. Reex. 318, the audit reports of a single‑member company over several consecutive years all included qualified opinions; this fact served as one of the grounds for the court to determine that the relevant audit reports could not fully and truthfully substantiate the company’s financial condition, nor could they prove that the company’s assets were separate from those of its individual shareholder.

2. Failure to submit the financial accounting reports prepared for each fiscal year is not in compliance with Article 62 of the former Company Law.(Former Article 62 of the Company Law stipulated: “A single-member limited liability company shall prepare financial accounting reports at the end of each fiscal year, which shall be audited by an accounting firm.”) Article 208 of the new Company Law stipulates: “A company shall prepare financial accounting reports at the end of each fiscal year and have them audited by an accounting firm in accordance with the law.”

”）The provisions do not provide effective proof that the shareholder’s assets are separate from those of the single-member company.In cases such as (2020) Yue 0304 Min Chu 54245, (2021) Yue 03 Min Zhong 19089, and (2021) Yue 03 Min Zhong 19089, the courts’ reasoning in their judgments all refer to the issue of “failure to submit the financial accounting reports prepared for each fiscal year.”

3. The annual audit report reflects the company’s financial position as of a specific date, as well as its operating results and cash flows for a particular accounting year—key aspects of the company’s overall financial condition—but it cannot prove that the assets of a single-member company are entirely separate from those of the shareholder.

4. The audit report was prepared on the basis of a unilateral engagement and therefore cannot objectively reflect the company’s financial condition.As in case No. (2018) Sup. Ct. Min. Shen 6124, the court held that “...the Special Audit Report on the Financial Transactions between Mr. Yang Yue, a shareholder of Beijing Fuyue Investment Co., Ltd., and the Company, which was commissioned unilaterally by Beijing Fuyue, cannot be taken as evidence to establish that the assets of Beijing Fuyue and those of Mr. Yang Yue are mutually independent.”

[Conclusion and Recommendations]

Based on the review of case law, there is no universally consistent judicial view as to whether relevant audit reports can substantiate financial independence. It is recommended that a single-member limited liability company and its shareholder, if required to demonstrate the independence of their respective assets, should, in their day-to-day business operations, strictly comply with the provisions of the Company Law, prepare financial accounting reports at the end of each fiscal year, and, in accordance with the law, engage a qualified accounting firm to conduct an audit.

In addition to reflecting basic financial conditions such as cash flows, the annual audit report shall specify the amounts and details of fund transactions between shareholders and the company, and shall be accompanied by relevant supporting documentation, including accounting vouchers, accounting ledgers, and financial statements, to ensure clear and transparent accounting records, independent financial accounting, and the demonstration of the mutual independence of assets.

At the same time, in day-to-day operations, it is essential to remember that, as an independent legal entity, one must avoid creating external appearances—such as signing contracts or making payments on behalf of others—that could be construed as a blurring of corporate identities.

Author

Introduction

Deng Minmin

Zhiheng General OfficePartner

Throughout her more than ten-year legal career, Attorney Deng Minmin has consistently focused on case research, representing a large number of civil and commercial litigation and arbitration matters. She has also provided ongoing, long-term legal services as well as specialized investment and financing services to dozens of enterprises, institutions, and government agencies in sectors such as new energy, healthcare, education, and real estate, demonstrating clear logical thinking, keen risk awareness, and strong dispute-resolution capabilities.

Wang Jixian

Lawyer at

Attorney Wang Jixian graduated from China University of Political Science and Law. Since 2021, she has been providing legal services at a law firm. Throughout her career, she has served as long-term legal counsel to numerous enterprises and institutions across industries such as telecommunications, real estate, food, and certification services, and has handled a variety of civil and commercial litigation cases as well as labor arbitration matters.

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