Winding down your China-based subsidiary requires thorough preparation for, and execution of, a very particular sequence, with significant involvement from various third party actors. This CS Alert outlines key steps to liquidate your China wholly foreign owned subsidiary.
Why Liquidate?
Liquidation is the process by which investors terminate a company, use the company’s assets to discharge any remaining liabilities, then repatriate any remaining assets to investor(s). Liquidation should not be confused with bankruptcy: Liquidation is applicable to a solvent company, while bankruptcy occurs when a company’s liabilities exceeds its assets.
Chinese law mandates that liquidation must occur when the company’s term of operation expires, the company’s board of directors (the “Board”) requires liquidation due to financial difficulties, the authorities require termination (e.g. for committing illegal acts), the company is subject to a merger, or for other reasons set out in the company’s articles of association. Liquidation may also be elected per resolution by the Board.
If liquidation is mandated but the company fails to do so (e.g., the investors abandon the company), the company’s tax liabilities and existing debts may go unpaid, resulting in the accrual of fines and other penalties, as well as civil judgments against the company and the investors. The company’s legal representative, who is often held legally accountable for the actions of the company, may have his personal assets in China frozen or seized, be unable to obtain or renew his visa or work permit, be prohibited from exiting China’s borders, and may even be blacklisted (along with the shareholders) from holding similar positions in China.
Key Steps
The chart below outlines the sequence to liquidate your wholly foreign owned enterprise (hereafter referred to as “Company”).
Pre-Liquidation
The below steps prepare for liquidation.
Board Resolution
The Board must unanimously pass a resolution agreeing to liquidate, and establish the liquidation committee (the “LC”). The composition of the LC is determined by the Board, and at least three members must be natural persons. The LC is tasked with issuing a public notice of liquidation, formulating a liquidation plan for review and approval by the relevant authorities, and generally overseeing various steps of the liquidation process.
Notice of Liquidation
Notice of Liquidation is the process by which notice is given to creditors and the public about the impending liquidation. Major creditors of your company need to be notified within 10 days of the LC being formed; thereafter, the creditors have 30 working days to submit their claims. Note that, unlike major creditors, the general public must be informed through a newspaper within 60 working days of the formation of the LC.
Pre-Liquidation Audit Report
The LC also handles the Pre-Liquidation Audit Report, which summarizes your company accounts for the prior three years and provides a summary of the liquidation process (for example, itemizing the debts, claims, payments, assets, and taxes to be paid during the liquidation process). The tax authorities will scrutinize the report to ensure that your company’s accounts are in proper order prior to approving the liquidation (and effectively agreeing that your company does not owe any unpaid taxes, and is therefore beyond the reach of additional tax collection by the tax authorities).
Approval Letter
The LC must obtain an Approval Letter for Enterprises’ Early Termination. Obtaining such a letter requires an application to the authority that originally approved establishment of your company. Before issuing the letter, the authority will want to review your company’s business license, the Board resolution approving the liquidation, a list of shareholders and other documents relating to your company’s establishment and your company’s decision for liquidation.
AIC Submission
You must also submit liquidation documents to the Administration of Industry and Commerce (the “AIC”), the authority which registered the approval and establishment of your company. The AIC will record the liquidation once the liquidation is approved.
Liquidation
The LC’s responsibilities during the liquidation process include creating an inventory of company assets and creating a Liquidation Plan, which is submitted to shareholders. Upon approval of the Liquidation Plan, the LC may liquidate or dispose of your company’s unfinished business. Using the proceeds, it must pay off major debts, expenses incurred preparing for liquidation, employees’ wages and labor insurance fees, taxes owed and minor debts (in that order). Any remaining assets may be distributed to the investor(s).
Post-Liquidation
Post Liquidation Audit Report
After completing this process, the LC must prepare the Liquidation Audit Report, which focuses on the assets, distribution of proceeds, and expenses of the liquidation. It also serves as proof of the liquidation. After being finalized, it is issued to the original approval authority and to shareholders.
Cancel Registrations
After liquidation, your company must cancel its registrations with the relevant authorities. These include various bureaus such as the Tax Bureau, Customs, and the State Administration of Foreign Exchange.
The Approval Certificate must be cancelled by the original approval authority, which may be done promptly after the complete application is submitted. Finally, a similar set of materials must be submitted to the AIC to cancel the registration of your company with the AIC.
Challenges to Liquidation
Liquidation can be time consuming, and requires the ongoing attention of either a trusted service provider familiar with the procedure, or a manager who can dedicate the time to overseeing external service providers. The above is true when the liquidation procedure is smooth (meaning, your company’s accounts and records are in good order). Deficient or defective accounts or tax records can significantly increase the resources needed to complete the liquidation.
There are significant penalties for improper activities during liquidation. Examples of such improper activities include bad faith asset disposal, failure of the LC to file the Liquidation Audit Report, and failure to properly notify creditors of the liquidation proceedings. Penalties include fines, criminal liability, and asset confiscation.
Additionally, if your company’s assets cannot satisfy its liabilities, then your company is insolvent and must refer the matter to bankruptcy. A single unsatisfied creditor can initiate bankruptcy. An important dynamic of bankruptcy is the lack of procedural control of the investor(s) and Board; the process relies heavily on an independently appointed administrator who acts much like a bankruptcy trustee, assisting the creditors to equitably satisfy their debts with the limited company assets still available.
©2013 All content of this article is the property and copyright of China Solutions Inc and may not be reproduced in any format without prior express written permission. The content of this article is intended to provide a general guide to the subject matter and should not be treated as a substitute for specific advice concerning individual situations. Readers should seek legal advice before taking any action with respect to the matters discussed herein.
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