Key Points on Early Dissolution and Liquidation of WFOEs

(By Lisa Li)In accordance with the PRC Company Law (hereinafter referred to as the “Company Law”), the Regulations of PRC on Administration of Company Registration (hereinafter referred to as “Company Registration Administration Regulations”) as well as the Law of PRC on Foreign Invested Enterprises (hereinafter referred to as “Foreign Invested Enterprises Law”) etc and based on the author’s prior experience in handling cases of early dissolution and liquidation of companies, we summarized key points and practical experience regarding the early dissolution and liquidation process of wholly foreign invested companies, including foreign invested enterprises owned by one sole foreign investor and those jointly owned by foreign investors (hereinafter collectively referred to as the “WFOE”) prior to expiration of the registered operation term.

1. Dissolution conditions

To conduct liquidation of the WFOE is conditional upon the dissolution of the WFOE.

(1) In accordance with the Company Law, a company is dissolved due to the following reasons:

  • The term of operation specified in the articles of association of the company expires, or a dissolution event stipulated in the articles of association of the company occurs;
  • The shareholders’meeting makes a resolution to dissolve the company;
  • Dissolution is required due to merger or split-up of the company;
  • The company’s business licence is revoked, the company has been ordered to be closed down or is revoked according to the law;
  • The people’s court orders the company to be dissolved in accordance with Article 182 of the Company Law (where shareholder(s) on its own or jointly holding 10% or more of the voting rights launch a company dissolution lawsuit with the court).

(2) In addition, WFOEs shall refer to the special provisions on dissolution and liquidation of companies under special laws and regulations governing WFOEs, e.g., Foreign Invested Enterprises Law and the Implementation Rules on the Law of PRC on Foreign Invested Enterprises (hereinafter referred to as “Implementation Rules”). Same as WFOEs, those Sino – Foreign Joint Ventures and Sino – Foreign Contractual Joint Ventures shall refer to the special laws and regulations governing the dissolution and liquidation accordingly – we hereby do not deliberate on this as we focus on the early dissolution and liquidation of WFOEs in this article.

Article 70 of the Implementation Rules stipulates the following circumstances triggering dissolution of WFOEs:

  • The WFOE’s registered term of operation expires;
  • The foreign investors decide to dissolve the WFOE due to severe economic losses of the WFOE;
  • The WFOE is not possible to continue its operation due to force majeure (such as natural disasters and wars etc);
  • The WFOE enters bankruptcy process;
  • The WFOE is revoked according to the law because of its violation of Chinese laws and regulations causing damage to the public interest;
  • Occurrence of other dissolution circumstances as stipulated in the articles of association of the WFOE.

In case of any of the circumstances stated in above b., c., or d., the WFOE shall submit its dissolution application to the approval authority for approval and the date of approval shall be deemed as the date of terminating the operation according to the Implementation Rules.

The Company Law provides for that the Company Law shall be applicable to foreign invested limited liability companies and foreign invested companies limited by shares; however, if other laws governing foreign investment have different provisions, such provisions shall prevail. Since the above Implementation Rules are not laws but administrative regulations, WFOEs therefore shall refer to the Company Law as well as the relevant provisions of their articles of association to determine if the conditions for dissolution have been satisfied in case the provisions of the Implementation Rules on dissolution and liquidation were not incorporated into their articles of association. However, from perspectives of safety and efficiency, it is advised to communicate with the local competent authorities in this regard in case of early dissolution.

Based on the above, in general, if a WFOE is dissolved prior to expiration of its registered term of operation without involvement of external factors (such as business license being revoked, being ordered to be closed down or being revoked), it shall satisfy the following conditions: either the events triggering the dissolution occur, or the shareholders’ meeting resolves to dissolve the company. For a WFOE held by one sole investor, it is certainly quite easy for the sole shareholder to pass a dissolution resolution if it intends to dissolve the company. For a WFOE held by several investors, generally a dissolution resolution is required to be passed by shareholders representing over 2/3 voting rights – where there is higher requirement on the proportion of voting rights for passing such dissolution resolution as specified in the articles of association, such provisions of the articles of association shall be followed. Consequently, it is very necessary to review the relevant provisions specified in the articles of association before commencing the dissolution and liquidation process. If there are conditions or restrictive requirements therein, the shareholders may consider clearing the barriers set in the articles of association by amending the same accordingly where necessary and feasible. Otherwise, it will have to refer to other applicable laws to initiate the dissolution (e.g., where the relevant laws and judicial interpretations are applicable, the shareholders may apply to the court for compulsory dissolution of the company, which we will not elaborate on as it is not the focus of this article).

2.Necessity to conduct liquidation and de-registration of company lawfully

 In practice, certain WFOEs have difficulties in their operations and have de facto stopped their business operation. However the WFOE or the shareholders do not initiate the liquidation procedure. In other cases, we received inquiries whether WFOEs could be kept “dormant” – the company does not conduct operational activities while the shareholders will not initiate the dissolution and liquidation process.

The above mentioned practice is not advised as it is not allowed under Chinese law: firstly, we have no such legal or system arrangement equivalent to or similar to “dormancy” permitted under foreign laws; secondly, where there is a statutory event triggering the dissolution of the company, the company shall conduct the liquidation and the company shall be de-registered after completing liquidation according to law. In addition, the foregoing “dormancy” status may expose the shareholder(s) or the legal representative of the company to legal risks as follows:

In accordance with the Company Registration Administration Regulations, if the company does not open its business for more than 6 months as of its establishment, or stops its business operation for a consecutive period of more than 6 months, the company registration authority may revoke its business license. Moreover, in accordance with Article 146 of the Company Law, if an individual acted on the position of legal representative of companies of which the business license was revoked or which was ordered to be closed down due to its violation of laws and who are responsible for revoking of the business license or being ordered to be closed down, s/he is not allowed to act as directors, supervisors or other senior management staff of other companies for a period of 3 years as of revoking business license or ordering the company to be closed down. Due to establishment of joint information sharing system amongst the relevant government authorities, this may also impact such foreign legal representatives’ future employment in China by obtaining the foreigner’s work permit.

In addition, in accordance with the Provisions of the Supreme People’s Court of PRC on Several Issues of Application of the PRC Company Law (II), Revised by 2014 (hereinafter referred to as “Company Law Judicial Interpretations II”), under the circumstances that a company shall conduct liquidation according to law, if the shareholders delay in setting up the liquidation committee or the liquidation committee delays in conducting liquidation after its establishment, the creditors of the company may file a compulsory liquidation case with the court. If the compulsory liquidation case is accepted, the court shall designate members of the liquidation committee to conduct the liquidation and de-registration activities. In accordance with Article 18 of Company Law Judicial Interpretations II, (a) the company’s creditors shall be entitled to request the company’s shareholders to pay off the company’s debts to the extent of the losses incurred by the creditor due to the depreciation, loss or destruction of corporate property resulted from the shareholders’ failure to establish the liquidation committee within the statutory timeframe; (b) the company’s creditors shall be entitled to request the company’s shareholders to bear joint liabilities for the debts owed to the creditors if the shareholders’ delay in performing their obligations results in loss of the major corporate property, accounting books and important documents, etc.

Moreover, if the company is de-registered without liquidation or the business license is revoked due to stop of business for over consecutive 6 months, there will be records recorded in the relevant authorities’ system, which may affect the investors’ future re-entry into China market.

3.Initiating liquidation process

In case of occurrence of dissolution events or passing dissolution resolution by shareholder(s), WFOEs do not necessarily enter the liquidation process.

Depending on whether the WFOE is subject to the market-entry special administration measures by the State (“Special Administration Measures”), the WFOE’s establishment and major modifications (including early dissolution before expiration of registered term of operation) shall be classified into two categories: those WFOEs subject to the Special Administration Measures shall seek approval of the competent commercial authority, i.e., the approval authority; and those WFOEs not subject to the Special Administration Measures just need to file with the approval authority accordingly. Thus, in case of shareholder(s) passing a dissolution resolution, the WFOEs subject to the Special Administration Measures shall be dissolved and enter the liquidation process after the approval authority approves the dissolution application. Those WFOEs not subject to the Special Administration Measures shall enter the dissolution and liquidation process at the timing as resolved in the shareholder(s)’ resolution.

In practice, for those WFOEs subject to approval of the approval authority, it is advised to communicate with the competent approval authority if they require submission of written consent on early dissolution by the local government department in charge, e.g., the administrative committee of the industry park. If so, such written consent on early dissolution must be obtained from local government department in charge. 

4. Basic dissolution and liquidation process

 As for WFOEs, the general steps of the early dissolution and liquidation process will be as follows (which are subject to minor adjustments depending on the specific circumstances):

  • Preliminary preparations such as preparing the shareholder resolutions, employee termination and compensation plan, appointment of liquidation committee members;
  • Obtaining the approval of the approval authority or filing with the approval authority;
  • Establishing the liquidation committee and filing with the company registration authority;
  • Notifying the creditors to declare their creditors’rights and publish announcement on early termination and entry into liquidation process;
  • Creditors declaring their creditors’rights;
  • Examining assets of the company and preparing the list of assets;
  • Preparing the liquidation plan and obtaining the shareholders’confirmation on the same;
  • Claiming creditor’s rights and paying off liquidation expenses and employees’remuneration/severance/social insurance contributions etc, paying off taxes and debts;
  • Preparing the liquidation report and submitting the same for the shareholders to confirm;
  • Allocating the remaining company assets;
  • Tax de-registration;
  • Customs de-registration;
  • Cancellation of the approval certificate;
  • De-registration with the company registration authority and conducting various other de-registrations (foreign exchange, social insurance, public housing fund etc);
  • De-registration of bank account(s).

5.Establishing liquidation committee

The liquidating company shall establish its liquidation committee within 15 days as of occurrence of events triggering dissolution and commence the liquidation activities. If the liquidating company fails to establish the liquidation committee within the specified timeframe, the creditors may apply to the court for designating the liquidation committee members to conduct the liquidation activities. As the liquidation activities involve claiming creditors’ rights and disposal of the liquidating company’s assets, the shareholders shall establish the liquidation committee and file with the company registration authorities in a timely manner from perspective of protecting their rights and interests as shareholders of the WFOEs.

As for constituent of the liquidation committee, the Company Law does not provide for the number of the liquidation committee, in particular where the shareholders are individuals. From our experience, the approval authority and the company registration authority generally require a sole entity shareholder to designate an odd number of individuals to sit on the liquidation committee, which shall not be less than 3; the authorities do not prefer all foreign individuals to sit on the liquidation committee, as they may require frequent communications in respect of various issues emerging during the entire process, which may be a lengthy process. If there is a Chinese national sitting on the liquidation committee, it will facilitate the communications with the authorities.

If there are professionals from law firms or accounting firms acting as members of the liquidation committee, or the liquidating company has several shareholders to sit on the liquidation committee, it will be necessary to set out basic rules on deliberation of liquidation matters so as to prevent disputes or dilemma over major liquidation matters. Clear deliberation rules and decision-making mechanism may also be helpful to prevent or mitigate risks for members of the liquidation committee. In case of violation of laws, regulations or the articles of association of the liquidating company which damaged the liquidating company’s interest and that of the creditors, members of the liquidation committee may have to bear liabilities for compensating the liquidating company or the creditors. Where there are no such existing deliberation rules or decision-making rules for the liquidation committee set out in the articles of association and in case of any dispute over the liabilities amongst the liquidation committee members, it might be difficult for the members to prove that they did not breach relevant rules.

6.Termination of employees in case of company closure

In case of the WFOE being dissolved prior to expiration of its registered term of operation, in accordance with PRC Labour Contract Law (hereinafter referred to as “LCL”), the employment contract ends if the employer decides to dissolve itself. This provision under the LCL is not very clear with regard to the timing of ending the employment contract. In practice, there have been various different opinions on the timing for ending the employment contract, such as (a) when the authorized authority of the employer issues the dissolution resolution, (b) when the dissolution resolution is submitted to the approval authority, (c) when the dissolution resolution is approved by the approval authority, (d) the dissolution date as approved by the approval authority, or (e) the date of completing the liquidation, etc. There have been plenty of labour disputes in this regard.

As for the timing of ending the employment contract under the situation of early dissolution, in general, the author’s opinion is that the time points of dissolution as approved by the approval authority may be applicable to those WFOEs subject to Special Administration Measures; as for those WFOEs not subject to Special Administration Measures, the timing of early dissolution set out in the WFOE’s dissolution resolution should be applicable. Notwithstanding this, from a prudential perspective, WFOEs are advised to check the precedent cases of the region/area where itself is located and know the opinions of the local competent courts. In addition, regardless of whether the WFOE is subject to Special Administration Measures, WFOEs shall timely perform the obligations of performing the dissolution and liquidation activities according to law, otherwise this may trigger labour disputes, in particular under the situation that the WFOE is not finally de-registered.

Actually, we in practice were required by the approval authority to provide the employee termination and compensation plan before the approval authority accepted the early dissolution application. Certain approval authority even required the WFOE to provide the written termination agreements concluded with the employees. This actually set higher requirement for the employers to terminate the employees, where WFOEs shall seek to reach a written agreement with the employees on the termination date, severance and/or compensations.

In addition, in practice, WFOEs still need to consider the impact of labour disputes on the liquidation process. Thus WFOEs is advised to conduct communications with the employees clarifying the laws and regulations in this regard and pursue an “amicable” termination approach as the liquidation process is not possible to be accomplished and the company is not possible to be closed down if there are any pending arbitration or litigation processes.

7.Transfer of real estate

Most of those manufacturing WFOEs may have ownership of factories or office buildings as well as the land use right. For those WFOEs to be dissolved, they may have been looking for the potential buyers or negotiating with them on contractual terms before officially entering the liquidation process. They are advised to pay attention to the Implementation Rules, Article 33 of which stipulates that during the WFOE’s term of operation, the land use right shall not be transferred without prior approval. The said approval may probably refer to that of the approval authority approving the establishment of the company, in particular for the situation that the registered domicile address of the company is located at the factory or office building thereon.

For transfer of real estate whose address is registered as domicile address of the WFOE subject to Special Administration Measures, it is advised to pay special attention to the transfer and consider the possibility of obtaining the approval authority’s approval on early dissolution. It is also advised to include proper clauses on effectiveness of the transfer contract, otherwise the WFOE may have to be liable for the buyer in case that the transfer contract cannot be performed or in case of unexpected situations of breaching the transfer contract. 

8.What to do if whereabouts of creditors are unclear

In the author’s opinion, generally the “known creditors” refers to those creditors whose name and contact information are clear and that it is confirmed that the WFOE owes money to them and the amount is clear. In practice, certain creditors’ information is not so clear, e.g., the trade name is clear without the full company name and there is no other contact information. What the liquidation committee must do is trying its best to locate the creditors in order to deliver them the dissolution and liquidation notice.

However, depending on the specific circumstances, certain creditors whose whareabouts are not clear may not be possible to be located, although the liquidating company has published the dissolution and liquidation announcement. This creates obstacle for the liquidation committee to pay off the liquidating company’s debts (actually the notary public office may not accept application and provide services for keeping the equivalent money for purpose of paying off debts later as they are not possible to review the authenticity of the creditor-debtor relationship and the identity of the counterparty creditor). In practice, this requires the shareholders to make a final decision of writing off the debts and the accounting firm needs to make proper financial arrangements accordingly – for which of course the company registration authority will require shareholders of the liquidating company to make commitment to paying off debts which occurred before the completion of the liquidation process as requested by the creditors later.

9.Conversion of liquidation process to bankruptcy process

The liquidation committee shall file a bankruptcy case with the court if it discovers that the liquidating company’s assets are not sufficient to cover the its debts after examining the company’s assets, preparing the balance sheet and list of assets. Regardless of the liquidating WFOE or the intermediaries such as law firms or accounting firms providing the liquidation services, they are advised to examine the balance sheet of the WFOE prior to commencement of the relevant procedures so as to assess if the company is insolvent. It is necessary to conduct a preliminary assessment if the company is insolvent before assessing and determining the applicable procedure or next steps for closing the company.

Disclaimer: This article does not constitute legal advice or suggestion on specific legal matters, nor does it constitute full interpretation of laws and regulations; it shall also not be deemed as the opinion of the law firm under which the author is registered as a lawyer.  

Lawyer Contacts

Lisa Li

E-mail: lisa.li@debund.com

Tel: +86 158 0196 9276 /+ 86 21 5213 4257

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