Every so often, someone about to have their Chinese company shut down by the Chinese government contacts us. These sorts of contacts accelerate during economic slowdowns and times of tension and that has been the case of late as well. The following is a composite of some of the emails we have received relating to a business shut down:
We set up our company in China three years ago and started a small widget manufacturing business inside a residential compound in [China city]. The local authorities came by the other day to tell us that because it would be impossible to license our venue for any sort of business (our company legal address is necessarily elsewhere) they would be shutting us down. Apparently there is only a title deed for the entire complex, which was built around 4 years ago. The property management company is completely on our side, but they seem unable to do anything or don’t know what to do. We registered as a consulting company, not a manufacturing business.
We would really like to have this resolved ASAP, as we will otherwise need to lay off our staff. Is there anything you can do?
We usually very nicely write back with the name of a local Chinese business lawyer because it usually does not make sense for a small company to pay a large amount of money on what will almost certainly be a losing cause. But the following is what I really want to say:
You have a big, probably insurmountable problem entirely of your own making. I am guessing you used a cheap company formation agent to form your China legal entity and you went along with what you either knew or should have known to be illegal. Your business is illegal and there is no way we can solve that.
Just to be clear, your business is illegal for the following reasons — and this is just what I am able to glean your five sentence email:
- You registered your business as a consulting company but you are operating as a widget manufacturing business. I’m guessing you did this because your entity formation company told you that doing so would be considerably faster, easier and cheaper than setting up your company as a manufacturing business. But surely you must have known all along that you were and are not a consulting company, right?
- Your registered address is “necessarily elsewhere” because to register your company in China you needed a separate and legitimate address that allows for manufacturing. Your widget business is in an apartment complex, which obviously does not allow manufacturing. You knew you provided the authorities with the wrong address and you knew exactly why you did so so are you surprised now that you’ve been caught for this?
- Your existing address can never qualify as a legitimate business address (much less a manufacturing address) because you need your own separate space/address for your China business entity and where it is located (as you point out by saying there is only one title for the entire complex) constitutes just one business location. Surely you knew this and this is why you did not list this address as the address when you registered, so what exactly are you expecting us to do now that you have been caught for this? Seriously.
- Your lease is illegal and that is why your landlord cannot help you. It sounds like your landlord is not authorized to lease out a part of the property for a business, which makes sense because the area in which the building is located is almost certainly not zoned for business. It’s an apartment, isn’t it? Again, did you really think you would get away with this?
I really don’t know what else to tell you other than that your people in China are at personal risk and if it is not too late they should consider leaving China immediately.
Our China company formation lawyers typically see the following two fairly different business scope problems:
1. The current scope of business applies to the basic type of business conducted, but the scope is too narrow. An example of this would be where the scope is for a service business, but the company now wants to do a service business that is not strictly within its original scope. In this case, making the scope broader can be done, but doing so is can be time consuming and complex. It is therefore always better to get your business scope correct at the time of company formation, rather than afterwards.
2. The company wants to go into an entirely different type of business. Take for example: service businesses, manufacturing businesses, trading companies, and retail businesses. These are all different forms of business in China. In this sort of case, the company often cannot simply change its scope of business; it must instead form an entirely new company that is then qualified to do the other type of business at a new location. Thus, shifting from service to manufacturing can be a lot more complicated than just changing the business scope. It means starting over from the ground up with an entirely new business entity.
In other words, scope of business has two different functions in China. It is used to set out the basic business type and it is also used to set out what a company is authorized to do within that business type.
Our China company formation attorneys rarely confront a situation where the scope of the business is too narrow. What we mostly see is the situation where someone wants to do a business of a different type than that for which they were authorized. For example, it is common for manufacturers to want to operate as a general trading company or to do basic retail. We also frequently have service companies that decide they want to start manufacturing or engaging in general trading or in retail. The issue in these cases is not that their scope of business is too narrow; it is that they want to go into an entirely different type of business for which they have not been approved.
We see this a lot in software as well. The company starts its China company planning to sell its software into China as a download from its home country server. Then after they have formed their China business entity, they decide they want to sell their software as a service (SaaS) via the cloud or set up a retail operation in China. They think this is natural, but they are not authorized to do either. They have to start over and determine how to do what they now want to do and sometimes, what they want to do cannot be done by any foreign-owned company in China.
Thus, even though company formation companies often convince people to improperly form a Chinese company by saying that “this scope will make things easier,” what the formation agent sometimes really means is that “what you want to do is illegal or impossible so I suggest you form your company this way and just operate illegally and hope for the best.” The point is that in these situations the matter cannot be “fixed” by manipulating the scope of business. Before forming a China company, the foreign investor must determine whether it can do business in China legally at all and, if so, how.
But what if you right now have a China business that is “out of scope” or located in an improper location? What should you do beyond just sticking your head in the sand and hoping that the next knock on your door is not the government? If your location is improper, hunt down a proper one and then seek permission from the appropriate authorities to have your address changed. This usually is not so difficult and it usually works.
The same general advice applies to broadening the scope of your Chinese company’s business so long as your type of business does not change. The first thing you should do is secure shareholder approval to broaden your China company’s scope. Once you have that approval, you should revise the company’s Articles of Association to reflect its new broadened scope. You then should go to China’s State Administration of Industry and Commerce where your China entity was originally registered and submit the applicable change in scope application form. This application requires the original and a copy of your business license, your company seal and your legal representative seal, written proof of the shareholders’ decision to broaden the company’s business scope, and the business’s newly revised Articles of Association. Once SAIC grants you the business scope change, you should then update your company’s tax registration to reflect that change. This too can be relatively complicated. Nonetheless, doing these things will always beat having your business shut down because you failed to do so
The Bottom Line: Form your Chinese business correctly or don’t bother forming one at all. China views foreign companies operating illegally as easy pickings and if your Chinese legal entity is not living up to its registration requirements, you are at risk and you should act now to clean up now. If you can.