Forming a China WFOE: The Method and the Madness

One of the more challenging things about our work as China lawyers is making peace with how often the written law in China has no relation to what happens in the real world. Such disconnects fit into one of two broad categories: (1) routinely ignored laws and regulations and (2) rules imposed without any basis in law or regulation. Even old China hands can have trouble predicting which laws or regulations will actually be enforced, or how.

I was thinking about this the other day, as I was finishing up one WFOE formation and getting ready to start another. We always counsel our WFOE clients to be prepared for a long and at times frustrating process that will likely contain an unanticipated obstacle that will delay their WFOE formation by weeks, if not months. To say nothing of the minor annoyances that we already know about, such as the following:

  1. The identity of the legal representative. Pursuant to China’s Company Law, the legal representative of a WFOE can be either (1) the chairman of the board of directors, (2) the executive director (for companies with only one director), or (3) the general manager. But in many cities, the legal representative can only be the chairman of the board or the executive director. The only way a WFOE’s general manager can be the legal representative is if the general manager is also the WFOE’s chairman of the board or executive director. If you try to tell the local SAIC that it should allow a general manager to be the legal representative because the law says so, they will just laugh at you. (It’s ironic that our clients sometimes want to press this point, because it’s usually a terrible idea for the general manager to be the legal representative, and China’s disregard for its own laws effectively saves our clients from themselves.) Yes, the Chinese authorities aren’t following their own laws. What do you want to do about it? Accept that the chairman of the board will also be the legal representative and move on.
  1. Forming a pre-capital account. Before a WFOE receives its business license, it is not a legal entity and it cannot open a bank account, let alone enter into contracts or pay bills. However, the WFOE’s foreign investors often incur costs during the WFOE formation process (in particular, with regard to leasing office space and paying for utilities), and as a result China has made an exception that allows a WFOE to open a bank account before formation to pay such costs. The money in this bank account is essentially a down payment of the WFOE’s registered capital, and is not treated as taxable income. After the WFOE is formed, the pre-capital account is merged with the WFOE’s actual bank account. Sounds great, right? Except that these accounts are so difficult to open and administer that hardly anyone does it, and when they do, they usually wish they hadn’t. Did I forget to mention that the account can only be denominated in foreign currency and that you need explicit approval from the State Administration of Foreign Exchange (SAFE) not just to open the account but also for every single payment? No wonder most people have never heard of this type of account.
  1. The minimum amount of registered capital. When China revised its Company Law in 2013, one of the major announced changes was the abolition of the minimum capital requirement. But as we observed shortly thereafter, this didn’t alter much on the ground. The local bureaucrats in charge of approving WFOEs still think they can and should determine the minimum amount of capital for each proposed WFOE. This comes as a rude awakening for those who think they can get away with a few thousand dollars in capital.
  1. Signing with the proper kind of pen. If you are ever signing an official document that needs to be filed with a Chinese agency – in particular, with the State Administration of Industry and Commerce – you had better sign the document in black ink and you had better use a pen that uses water-based ink like a fountain pen or a Uniball. This requirement is not codified in any law or regulation, but it is all too real. We give our clients scrupulously detailed instructions on how to sign documents, and even then we still occasionally get grief from the SAIC. You’d think Chinese bureaucrats would have eased up after Chinese Premier Li Keqiang lamented China’s inability to make a quality ballpoint pen – people in glass houses – but not so much.

If you’re forming a WFOE, each of the above may seem like a small thing, but when you put them all together it can sometimes seem like the sky is falling. On the other hand, if you’re expecting these problems (and more), you can take them in stride, fix what you can, and move on. It’s not like things are magically going to get easier once your WFOE is formed, so the sooner you get used to the way things work in China, the better.