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Introduction: In recent years, Chinese bankruptcy law has introduced the concept of equitable subordination, also known as the "Equitable Subordination Rule" or "Deep Rock Principle," to classify defective shareholder claims as subordinated claims. However, inconsistencies in the application of standards for identifying flaws in shareholder equity, coupled with arbitrary decisions and broad discretion in bankruptcy courts, have raised concerns about fairness, justice, and overall bankruptcy efficiency. This article explores the issue of whether shareholder claims should be subordinated, using a real case from the Shunping County People's Court, involving the bankruptcy of Tianlong Health Salt Co., Ltd., as a reference.

Case Overview: In September 2006, Wang acquired 49% of Tianlong Company's shares through equity transfer. Subsequently, Tianlong borrowed a total of 17.16 million yuan from Wang for operational needs but failed to repay. In December 2018, the court initiated the "asset-to-debt conversion" process. Wang, as a creditor, claimed the remaining principal and interest of 9.3 million yuan. The court identified a 16 million yuan increase in Tianlong's registered capital in February 2013, of which 2.26 million yuan was attributed to Wang. However, Wang disclaimed signing the capital increase resolution, bank transfers, and business registration records. The management concluded that the 16 million yuan was "bridge financing" with capital diversion, demanding Wang to supplement the 2.26 million yuan and pay corresponding interest. Simultaneously, the management subordinated Wang's entire 9.3 million yuan claim as "subordinated debt" due to alleged capital diversion. Despite Wang's appeal for reconsideration, the decision remained unchanged. In September 2022, Wang filed a lawsuit seeking recognition of his claim as an ordinary debt. The court ruled in July 2023, confirming Wang's claim as an ordinary debt.

Equitable Subordination Principle: The Equitable Subordination Rule originated in the United States, notably established in the 1939 Deep Rock case by the U.S. Supreme Court. It addresses related-party debt issues, emphasizing fairness and subordinating controlling entities' claims when unfair advantages are obtained. The principle encompasses equitable balancing and subordination, allowing courts to adjust the order of bankruptcy claims based on fairness. In the U.S., it has evolved into a mature system, playing a crucial role in achieving bankruptcy fairness.

Chinese Exploration of the Equitable Subordination Principle: Chinese legal experts have debated the adoption of the Equitable Subordination Rule since the 2003 "Draft Provisions on Several Issues Concerning the Trial of Corporate Dispute Cases by the Supreme People's Court." Despite early considerations, subsequent legislation like the Company Law and Enterprise Bankruptcy Law did not officially recognize the principle. Notably, in the 2015 Shagang case, the court acknowledged the improper acquisition of shareholder rights as a basis for subordinated claims.

In 2018, the Chongqing Higher People's Court introduced a guideline allowing the subordination of shareholder claims in specific situations, marking a significant departure. However, inconsistencies emerged across different courts, and the lack of clear legal grounds raised concerns about arbitrary rulings.

Evaluation of Equitable Subordination in Civil and Commercial Law:

1. Legal Basis for Subordination: The distribution order of bankruptcy assets is a statutory system, requiring a legal basis for recognizing subordinated claims. The Equitable Subordination Rule must align with the principles of protecting creditors' interests while avoiding unwarranted infringement on shareholders' limited liability.

2. Judicial Clarification: The "2019 Ninth Conference Minutes" emphasize the protection of creditors' interests without unduly infringing on limited liability principles. Courts must apply the Enterprise Bankruptcy Law rather than exceeding their authority based on Company Law interpretations.

Conclusion: The Equitable Subordination Rule has played a significant role in shaping the nature of ordinary bankruptcy claims and improving distribution efficiency. However, its application should be cautious, focusing on the actual flaws in shareholder claims. Recognized claims, particularly those confirmed through legal proceedings, should not be arbitrarily subordinated. Future amendments to the Enterprise Bankruptcy Law should provide explicit guidelines, ensuring a fair and efficient exit mechanism for market entities and fostering a positive business environment.