ENTITY SHIELDING AND THE RULE OF “DEBT-FOLLOW-ASSET” IN CHINA : AN EMPIRICAL LAW AND ECONOMICS ANALYSIS

Legal personality has been regarded as one of the essential characteristics of modern corporations. Since a corporation is a legal entity separated from its shareholders, its assets are usually shielded from the creditors of its shareholders. Scholars refer to this arrangement as “entity shielding” and generally consider it as an efficient arrangement. China, however, has explicitly adopted the controversial rule of “debts-follow-assets” (the DFA rule), with which courts may hold a corporation liable for the debt of its shareholder under certain circumstances. This article presents an empirical study of how this rule is enforced in practice. It finds that courts often consider two important factors that are not stipulated in the DFA rule – the identity of the creditor raising the lawsuit and the number of outside investors in the corporation. These patterns can be explained with the theory of asset partitioning. China’s experience contributes to the literature of the law and economics of business forms and organizational law by showing for the first time that economic concerns shape the legal restrictions of entity shielding within a specific jurisdiction. The factors identified in this article as important may also be considered by policymakers in the legal design of rules that restrict entity shielding in other jurisdictions