In international sales of goods, it’s common that a group of afflicted companies may be involved in a series of transactions, involving an increasing number of legal issues of affiliated companies. In China, the phenomenon of "a group of same people, a number of different companies" has become more common in international trade industry. Under Chinese law, in case of any dispute over confusion of corporate personality of affiliated companies in the international trade, the main issues to be considered shall include but not be limited to: identification of affiliated companies, identification of the corporate personality of affiliated corporate entities, risk prevention, etc. To this extent, a recent case may be worth noting.

Facts

The appellant Rongchang Co., Ltd. (the plaintiff of first instance, hereinafter referred to as “Rongchang”) and the appellee Koko International Holdings (Hunan) Co., Ltd. (the defendant of first instance, hereinafter referred to as “Koko Company”) entered into an Agreement on Payment Remittance Plan. The parties acknowledge that there was no transaction between them, and the payment involved in the Agreement on Payment Remittance Plan was from transaction between Rongchang and Hunan Koko Import and Export Co., Ltd. (hereinafter referred to as "Koko Import and Export Company") — the 31 Contracts for the International Sale of Goods and Contracts for Import Goods which signed by Koko Import and Export Company and Rongchang. However, in order to reduce the customs duties, the price as stipulated in the Contracts for the International Sale of Goods and the Contracts for Import Goods was much lower than that of stipulated in the Agreement on Payment Remittance Plan.

Although the legal representatives of Koko Company and Koko Import and Export Company were the same person, no tripartite agreement had been entered into among Rongchang, Koko Company, and Koko Import and Export Company on the repayment matters. Also, there was no mutual agreement between Rongchang and Koko Import and Export Company or between Koko Company and Koko Import and Export Company on the repayment matters.

Thereafter, Koko Company did not make payment in accordance with the Agreement on Payment Remittance Plan, so Rongchang filed a lawsuit. The court of first instance ruled that there was no authentic sale contract between Rongchang and Koko Company, so there was no factual and legal basis for Rongchang to request for repayment, so the court rejected the Rongchang 's claim. Rongchang then appealed to the Intermediate People's Court of Xiangtan City, Hunan Province. The court of second instance upheld Rong Chang's claim for repayment.

Issues

1. Whether Koko Company had been assigned all the indebtedness from Koko Import and Export Company pursuant to the Agreement on Payment Remittance Plan and shall be obliged to pay Rongchang.

2. Whether the payment amount of Koko Company shall be subject to the Agreement on Payment Remittance Plan, or the Contracts for the International Sale of Goods and the Contracts for Import Goods.

Judgment

1. Whether Koko Company had been assigned all the indebtedness from Koko Import and Export Company pursuant to the Agreement on Payment Remittance Plan and shall be obliged to pay Rongchang.

The court of first instance held that it was Koko Import and Export Company who had transaction with Rongchang. Koko Company and Koko Import and Export Company were both independent legal persons and thus different legal subjects. Although the legal representatives of the two companies were the same, this shall not affect the principle that the two companies shall assume civil liabilities separately. Article 84 of the Contract Law stipulates that "where the obligor assigns its contractual obligations in whole or in part to a third party, the consent of the obligee must be obtained". It was confirmed that the assignment of debts shall be subject to the agreement between a third party and the debtor, plus with the consent of the creditor. Since no bilateral agreement had been entered into by and among Koko Company and Koko Import and Export Company, and no tripartite agreement had been entered into by and among the three companies, there was no valid assignment of debts.

The court of second instance held that the legal representatives of Koko Company and Koko Company were the same, i.e. Ye Wei. Although the two companies were legal persons that independently assume external civil legal liabilities, they could be proved to be affiliated companies according to some obvious facts, such as the shareholders, capital contribution and enterprise names of the two companies. Their legal representative knew and had partially performed the Agreement on Payment Remittance Plan so it was obvious that Koko Company had fully recognized the Agreement on Payment Remittance Plan. The Wechat messages between the legal representative of Rongchang and Ye Wei or the relevant personnel of Koko Company involved discussion regarding trading practice between the two parties, and Ye Wei did not clarify whether the trading party was Koko Company or Koko Import and Export Company. The company’s address involved in Wechat was also the address of Koko Company whereas the behavior that Rongchang and Koko Company affixed its official seal on the Agreement on Payment Remittance Plan all indicated that the creditor had agreed on the transfer of debts in this case. It shall be recognized that the three companies had reached an agreement on the transfer of debts and the assignment of debts was complied with the relevant provisions in the Contract Law.

2. Whether the payment amount of the Koko Company shall be subject to the Agreement on Payment Remittance Plan, or the Contracts for the International Sale of Goods and the Contracts for Import Goods.

The Agreement on Payment Remittance Plan was signed after the Contracts for the International Sale of Goods involved in the case. The Agreement on Payment Remittance Plan was signed by the parties based on equal and voluntary negotiation and reflected parties true intention. Therefore, the payment amount shall be based on the subsequent contract, i.e. the Agreement on Payment Remittance Plan.

Comments

Under Chinese law, in case of any dispute over confusion of corporate personality of affiliated companies in the international trade, the main issues to be considered shall include but not be limited to: identification of affiliated companies, identification of the corporate personality of affiliated corporate entities, risk prevention, etc.

1. Identification of Affiliated Companies

Although the Company Law of the People's Republic of China (hereinafter referred to as “Company Law”) does not specify the definition of affiliated companies, Article 109 of the Regulations on the Implementation of Enterprise Income Tax Law of the People's Republic of China (hereinafter referred to as “Regulations on the Implementation of Enterprise Income Tax Law”)  provides that "affiliated parties", as referred to in Article 41 of the Enterprise Income Tax Law of the People's Republic of China, shall mean enterprises, other organizations or individuals that have any of the following relations with an enterprise: (1) a direct or indirect relationship in respect of, among other things, the capital, management, purchase and sale; (2) under the common control of a third party directly or indirectly; or (3) other relations of interest. Similar provisions are set out in Article 51 of the Rules for the Implementation of the Law of the People's Republic of China on the Administration of Tax Collectio revised in 2012, and Article 9 of the Implementing Measures for Special Tax Adjustment (hereinafter referred to as “TRIAL”) promulgated by the STA lists eight circumstances which constitute an affiliated company relationship, refining the provisions on three types of affiliated company relationships stipulated in the Regulations on the Implementation of Enterprise Income Tax Law to be more operational. Therefore, if the Company Law has not yet given a clear legal definition of affiliated company, the above provisions may be referred to in identifying affiliated companies.

No direct definition of affiliated companies has been made in any international convention, it is generally with reference to the definition of affiliated companies in the Articles of United Nations Model Double Taxation Convention Between Developed and Developing Countries and the Articles of OECD Articles of the Model Convention with Respect to Taxes on Income and on Capital. The two documents also emphasize that if enterprises have a direct or indirect relationship in management, control, capital and personnel, they may be considered as affiliated companies.

2. Identification of Corporate Personality of Affiliated Companies

The confusion of corporate personality regarding affiliated companies reflects a high degree of mixture between the personalities of corporate entities and their legal representatives, which is mainly manifested in the confusion of personnel and organizational structure as well as financial and business operation. The confusion of personnel and organizational structure is generally reflected as cross appointment, shared business address and actual offices among affiliated companies. The confusion of business operation refers to the confusion in the business scope, transaction mode, pricing, etc., which can be reflected in the sharing of sales manuals and templates of distribution agreements in practice. Financial confusion generally reflects the use of a same business account and a same approval signatory.

The confusion of personalities between company and its shareholders is covered in Paragraph 3 of Article 20 of the Company Law, but the confusion of personalities regarding affiliated companies has not been regulated directly. Although there is no direct provision of the liability of affiliated companies in the existing legislation, the reported cases issued by the Supreme People's Court of the People’s Republic of China (hereinafter referred to as “the Supreme People’s Court”) give an authoritative interpretation of the problem. The Supreme People's Court emphasizes that the independent property of a company is the material guarantee for the company to undertake its legal liability independently, the company’s independent entity is also prominently manifested in the independence of property. If the property of affiliated companies cannot be distinguished, they lose the basis of independent corporate entity and legal liability. Where affiliated companies have blurred boundaries and confused personalities and try to evaded debts by taking advantage of the affiliated relationship, they violate the purpose of the establishment of legal person system and the principle of good faith. Since the nature of such activities and harmful consequences are equivalent to those specified in Paragraph 3 of Article 20 of the Company Law (the confusion of personalities between company and its shareholders), such affiliated companies shall assume joint and several liabilities for any debt as per such provision.

3.Risk Management

In contracts for the international sale of goods, a series of disputes caused by affiliated companies are quite common. For example, in the process of contract signing, some companies try to evade contractual obligations by using the names of other afflicted companies which are close yet different from their own names.  In order to avoid any dispute caused by affiliated companies, companies should pay special attention to the following issues.

Correctly identify the subject of contract. Before signing a contract, due diligence should be done regarding the opposite party and its affiliated companies in order to correctly identify the Chinese and English names, financial capacity and personnel composition of the opposite party, and to prevent potential fraud.

Correctly identify the subject of communication. After the contract being signed, one should pay special attention to the process of the communication during the performance of the contract and ensure that the individual contacts are formally authorized by the opposite party. Also, it is imperative that any communication should be within the scope of authority.

Correctly identify the subject of liability. When a dispute arises, affiliated companies of the opposite party to the dispute shall be sorted out in an all-round way so as to identify those affiliated companies which may assume liabilities, One can prove the relationship between the opposite party and its affiliated companies by mixture of personnel and organizational structure, companies' financial affairs and their business operations etc., and it may further claim that the relevant affiliated companies should assume joint and several liabilities in accordance with Paragraph 3 of Article 20 of the Company Law.

This article is mainly excerpted from the authors’ article in China Commercial Dispute Resolution Annual Report (2019). The report is edited by Beijing Arbitration Commission / Beijing International Arbitration Center (BAC/BIAC) and will be officially published by Wolters Kluwer soon.