As foreign companies tire of China’s increasing randomness and expenses, and as the COVID vaccines begin rolling out, our China lawyers are getting an increasing number of calls about China WFOE closures. These calls are not coming from companies that have their WFOEs in China to make product or service sales in China; they are mostly coming from companies that have WFOEs in China to aid in their manufacturing in China.
Some of these companies are looking to shut down their WFOEs because they plan to leave China entirely, but most want to shut down their WFOE simply because it has become too difficult and expensive to operate. These companies plan to contract with Chinese domestic companies or WFOEs to do for them what their WFOEs previously did for them. This shift makes sense for so many.
The below are composites of various recent emails we have sent to clients regarding the closing of their WFOEs. To preserve confidentially, we have removed any identifiers and shortened and simplified them for purposes of this post.
The first email is to a client whose WFOE (we will call it Beijing XYZ WFOE) has already had its license revoked.
We were asked to review your situation with respect to your Beijing XYZ WFOE in China.
Your questions concern the current status of your WFOE and the issues of formally closing it under Chinese law. You have also asked us to explain the impact of failing to close this WFOE.
As will be fully described below, the Chinese government has already revoked the business license of Beijing XYZ WFOE. As the legal representative of XYZ WFOE, you are required to carry out a proper liquidation of the company. Such liquidation requires payment of taxes, payment of salary to employees and payment of all major debts of the company. This has not been done. In this situation, you will be held personally liable for damages caused by nonpayment. This means that your entry into the PRC may be barred. More seriously, it could mean that you could be arrested after entry into the PRC. For this reason, you should not enter the PRC until after a proper liquidation of Beijing XYZ WFOE is completed. If such liquidation is not possible or if the shareholders choose not to liquidate, you should not enter into the PRC for at least the next three years, if ever.
When a license is revoked, the following is required:
1. The company must immediately cease doing business. This means, for example, that all websites and other public announcements where the company offers to do business in China must be taken down.
2. The official company seals must be collected and deposited with the licensing authority.
3. All taxes and fees owed to the national and local governments must be paid.
4. All salary owed to employees must be paid.
5. The legal representative (you) and the directors of the company must immediately liquidate the company in accordance with the China Company Law and local procedure. All company assets must be used to pay creditors in accordance with the liquidation procedure. Use of the company assets for any other purpose is a crime.
You as the legal representative and the other directors are personally liable for any damages caused to creditors for failing to strictly comply with the above requirements. In this case, since the amount of tax owed is significant, the risk for failure to follow these rules is high.
When a proper liquidation is not completed, the names of the legal representative and the company directors (and sometimes others tied to the company) are placed on a black list. Failure to pay taxes, failure to pay employees and failure to pay a major creditor are normally noted on the black list. The black list is shared with the PRC border control authority and those on the list are usually denied entry into China. This is particularly common in Shenzhen for persons entering the PRC from Hong Kong. Though not common, persons named on this list are sometimes allowed to enter China and then immediately arrested. Entrance and arrest is more likely if the monetary amounts are large or if a government agency is involved (taxes and fees). For this reason, you should not to enter into the PRC until after a proper liquidation of Beijing XYZ WFOE has been completed.
The following are the major legal consequences resulting from revoking the Beijing XYZ WFOE business license:
1. As legal representative, you will not be permitted to act as a director, manager or supervisor of a Chinese company for at least three years from the date of revocation.
2. The shareholders of Beijing XYZ WFOE will not be permitted to invest in another Chinese company for at least three years from the date of revocation.
3. The name of the company cannot be used for at least three years from the date of revocation.
4. The name of the company, the representative director, the shareholder and the directors (and perhaps others tied to the company) will be placed on a national “black list” maintained by the Chinese police, border control authorities and State Administration for Industry and Commerce (SAIC). The black list period is normally for three years. However, some local authorities will maintain the black list for five years. During the black list period, it is difficult or impossible for any person or entity named on the list to engage in investment or company management in China. Though not common, such persons may also be denied entry into China. Normally, however, if proper liquidation is completed there is no risk that such persons will be arrested after entry into China. Note though that unless and until your company pays its taxes, employees and major creditors in full, the consequences for you could be much worse and the time frames much longer.
The below email relates to a company whose business license has not been revoked, but is looking to close down its China WFOE.
We reviewed the status of Shanghai ABC WFOE with the Shanghai/Jingan office of the SAIC [now known as SAMR –State Administration for Market Regulation (国家市场监督管理总局)], which has authority over the company. The SAIC informed us that there are no current legal or administrative actions being taken against Shanghai ABC WFOE. This is confirmed by the Shanghai SAIC website. This means that the Shanghai ABC WFOE business license is currently valid and that the company is fully authorized to do business.
I must caution you that failing to properly maintain the company registration status will eventually result in a revocation of the business license. [Such a revocation would have the same consequences as reported above for Beijing XYZ WFOE].
With respect to Shanghai ABC WFOE, the shareholders have the following two options:
1. Maintain the legal status of the company. This requires 1) filing all annual reports and the annual audit, 2) filing the annual tax return and paying all taxes, 3) maintaining a legal office.
2. Liquidate the company in accordance with PRC law. With respect to liquidation, the process is complex and time consuming. Though you indicate you believe no taxes are due and there are no company debts, this cannot be confirmed without a proper liquidation. The Jingan authorities are quite creative in finding taxes and fees that have not been paid and sometimes even in finding taxes and fees that probably were never previously owed but for which they are now seeking payment. It is also not uncommon for alleged debtors to come out of the woodwork when a WFOE is being liquidated.
Please note that some of what is required to close a WFOE is local — very local.