Every few months we get an email from someone requesting our China business lawyers prevent the Chinese government from shutting down their business. Something is definitely afoot in China right now as we received three such emails just this week.
The following is a composite of these three emails:
We set up a WFOE and started a small XYZ business inside a residential compound in ______. The local authorities came knocking the other day, pointing out that it is impossible to license our venue for any sort of business — “our company legal address is necessarily elsewhere.” Apparently there is only a title deed for the entire complex, which was built some 5 years ago. We have the property management company fully on our side, but they seem unable to do anything, or don’t know what to do. They have said that they intend to close us down. Just so you know, we are registered as a consulting company, not an XYZ 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 write back suggesting their various options, but what we really want to say is the following:
Dude, you have a big, probably insurmountable problem. And it is of your own making. You used a cheap entity formation company to form your WFOE and they went along with what you knew was illegal. Your business is illegal in four ways and there is no way we can quickly or cheaply solve a problem like that.
Not that I need to tell you this, but just to be clear, your business is illegal for the following four reasons (and this is just what I am able to glean from your five sentence email:
- You registered your business as a consulting company but you are operating as an XYZ business. I’m guessing you did this because you wanted to keep your required minimum registered capital low.
- Your registered address is “necessarily elsewhere” because to register as a consulting business, you needed an office and your XYZ business is not an office.
- Your XYZ business location can never qualify as a legitimate WFOE because to do so you need your own separate space 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.
- 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. The area in which the building is located is almost certainly not zoned for business.
If you under or overreach on the description of your business scope, you likely will eventually find yourself in big trouble. Foreign companies that do things with their China business that were not mentioned in the business scope section of their initial WFOE get in trouble.
In some cases, the companies have admitted to us that they were never “really comfortable” with the business scope mentioned in their applications, but the company they had used to form their WFOE had “pushed” them into it as it would “make things much easier.” In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the company probably would never have been approved at all had it been upfront and honest in its application. In nearly all instances, the foreign companies had managed to secure local approval but were now in trouble with Beijing, which constantly is auditing these applications. In one instance, the local government went back and changed its mind, probably after conducting an audit of its own.
I cannot go into any more detail on these matters, but I can give this advice: applying for a WFOE in China involves a heck of a lot more than just filling out a form and getting approval. It matters for what you get approved and you (or whomever you are using for your WFOE application) need to know China’s foreign investment catalog inside and out before applying. You then must tailor your China WFOE application to meet both the requirements of the foreign investment catalog AND the reality of what your WFOE will be doing in China. A failure to comply on either front will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.
If you take away nothing from this post, please at least understand that getting local government approval for your WFOE does not mean you are out of the woods. There is little to no benefit in getting approval for a non-conforming WFOE.
It is also of critical importance that you have valid lease for your WFOE. If you are not going to get the right space for a WFOE, you are probably better off not getting a WFOE at all. Registering a WFOE and then not complying with ALL the requirements for having a legally operating WFOE is a classic example of trying to operate quasi-legally in China, which is virtually always worse even than operating 100% illegally.
The Bottom Line: We have said it before and we will no doubt say it again. Form your WFOE correctly or do not bother forming one at all. China’s economy is on the decline and the Chinese government is very actively seeking to get rid of foreign companies operating illegally. If your WFOE is not living up to its registration requirements/promises, you are at great risk.
What are you seeing out there?