The Risks of Shutting Down Your China WFOE

Not sure why, but my law firm has done more business shutting down WFOEs (a/k/a WOFEs) over the last three months than in any other 12 month (not three month) period. We also have been getting a whole slew of questions regarding the logistics in shutting down China operations. I know the recession has something to do with this increase, but why did it not pick up its full force until around three months ago?

China has very clear rules about what must be done to shut down a WFOE and failing to follow these rules (which mostly involve paying all back wages and taxes) can lead to all sorts of problems, ranging from the Chinese government keeping your equipment to a local government locking you in a room (I am NOT kidding here) until money gets wired from home.

Our China lawyers have dealt with more than a few locked room cases and we have learned that negotiating on the dollar amount leads to a much faster resolution than trying to explain the niceties of corporate entity protection.

Got an interesting email today from someone who apparently was able to leave China before his improper WFOE shutdown was discovered, but is now wanting to test his “luck” by returning to China. The email (modified slightly to strip it of any identifiers) was as follows:

I’m John Smith.  I have a question regarding failed WFOE’s [wholly foreign owned entities] in China. Here’s the situation:

We set up a BVI (British Virgin Islands) corporation in 2005, and a Beijing-registered WFOE in 2006.  We paid in the initial capitalization requirement, received our license, and had a corporate “office” in Chaoyong. We used a run-of-the-mill agent to make it happen at the WFOE level and within two quarters, a bloody and nasty board fight led to the Board deciding to wind down the venture.

I lost my shirt and then some, as I was the bank the others contributed IP [intellectual property]. Our lack of a good agreement between we owners precipitated our downfall.

We never took formal steps to dissolve the WFOE. We never achieved break-even, or even generated material income, and we also never fulfilled the full capitalization requirements. We basically abandoned ship (we dissolved at the BVI level only), and I am worried that might come back to bite me.

I understand that the authorities can, will, or have already, revoke(d) our business license — that much is obvious. My question is whether or not the authorities would go after me (as the CEO) for fines, penalties or worse, should I return to China for business or pleasure.

Since the “wind-down” of the WFOE I’ve been back three times on tourist visas, with no issues. Now, a United States company is courting me to help them set up distribution in China and APAC. I would not be opening a WFOE, but I would be there a lot for a 6-12 month period and would perhaps help them set up a Rep Office. I’d be getting invitation letters from a China business for a business visa, but I could also do tourist visas and shuttle to HK. I’ve been working and traveling in China since 2000, so my passport data is a known entity to China.

I don’t want to accept an offer here if there is a realistic possibility that my exposure could be problematic to either myself or to the US firm. My sense (or hope) is that because we were a small fish, and because there is a lack of tightly integrated e-records between various authorities, I should be okay.

Though I am most interested in my specific situation, if you see more value in a general post on failed WFOE ramifications, that’s fine too, but please redact my specifics.

I responded as follows:

I love your questions and I am going to run them as a blog post, scrubbing it and modifying it to remove any possible identifiers.

The quick answer is that you are definitely taking some risks by going to China, the full extent of which is unknown.

China does go after those involved in WFOEs that have shut down improperly and it does go after those who were involved in those WFOES for taxes and fines and it does block those people from entering the country. This I know from my firm’s own client experiences. Even worse, it often lets those people into China and then does not allow them to leave until all back payments, plus interest and penalties have been paid. This I also know from companies calling my law firm when faced with this situation.

I am actually a bit surprised you have been able to go to China three times without incident and that makes me think you may be home free on this, but then again, there is always the chance you have just gotten lucky and the fourth time will do you in. It is impossible to know. I share your concern that linking your name to a new business will cause someone somewhere to pull up an old file and it will be then that your problems arise. What are the odds this will happen? I do not know and I do not believe anyone else knows either.

What really bothers me though is that what you are proposing for this new company are the exact things China is really cracking down hard on right now. Based on your description of what you are planning for this business, it cannot be a Rep Office; it has to be a WFOE. So you probably will be better off operating either completely off the gird, ready to bolt when caught, or operating completely legally. Operating halfway legally is usually the worst move at all because you are enough on the grid to get caught, yet enough off the grid to get into big trouble.

Opening a Rep Office that should be a WFOE is just going to put a massive target on your back. And you should think of you going back and forth between China every few months as the spotter for the target. Then when you add in your past history. . . . .

If you were to form a WFOE correctly, at least then the Chinese government would have a good reason to cut you a break for your past. With this proposed structure, they have every reason to throw all the books at you and I am pretty convinced they will.

For more on how China disfavors Representative Offices (Rep Offices), check out The Slow Death Of The China Rep Office. For more on how China treats those who try to circumvent the need to secure a work visa, check out Sending Your Employee To China Again And Again. What If The Well Runs Dry?

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