In talking with a China lawyer friend recently, we got to talking about some common mistakes we see foreign companies making in their China deals. Among other things, we talked about how foreign companies too often fail to understand the need to conduct due diligence on their China counter-party, or have no clue how to do so.
Two of the more common misunderstandings stem from China’s registered capital and personal liability rules and foreign companies oftentimes wrongly believe the following:
- The amount of a Chinese company’s registered capital is the minimum amount of funds that company has in the bank at any given time.
- Shareholders of Chinese companies are personally liable for the debts of their company.
Nearly all Chinese companies are limited liability entities. And though each Chinese limited liability company is required to initially put up a certain amount in registered capital, that amount very quickly becomes relatively meaningless for determining the company’s financial viability. The amount of a company’s registered capital can, with varying degrees of difficulty, be determined and that number can be at least somewhat helpful in giving you some read on the size of the company with which you are dealing. But once a Chinese company has been capitalized, there is no way to know what will happen or has happened to the capital. Even if all the registered capital was actually put into the business, it may or may not still be there. And even if the Chinese company still has all of its registered capital in a Chinese bank somewhere, the company might owe fifty times that amount in debt.
Shareholders are required to contribute to the company the amount of capital stated in the company’s registered capital and their failure to do that is a crime. However, there is still no way for a creditor to do anything with that in terms of pursuing an action against a shareholder. The limited liability designation in China means what it says and means what it means outside China: except maybe in extreme situations, the shareholders of Chinese companies are not liable for the debts of the Chinese company.
There is no infallible way to determine the credit-worthiness of any company with which you are looking to do a deal, much less one in China. But in China, like just about everywhere else, the best way is to conduct a full-on due diligence review of the company. That due diligence can and should include a review of the company’s registered capital, but that information should be just one small factor in any risk analysis you do on the company.
Be careful out there.