Why liquidating your company is essential for foreign investors?

Foreign investors may decide to close their China operations for various reasons. According to the relevant laws, rules, and regulations, closing operations in China involves dissolving and liquidating the company. Abandoning a company without completing the legal requirements can result in serious penalties for both personnel of the company and the company. Specifically, the personnel of the company and company can be blacklisted, and individuals may not re-enter China or face visa difficulties. We strongly recommend that liquidation is correctly proceeded to reduce risks afterwards. Below, we provide a Q&A for foreign investors to understand their liabilities and penalties when closing operations in China.

Q. What are the legal terms for closing a company in China
A. There are two terms defined in the Company Law of the People’s Republic of China (“Company Law”) dissolution and liquidation. Dissolution refers to the legal act of any established company in China ceasing corporate operating activities under any conditions provisioned in the Articles of the Association (“AoA”) or legally permitted condition. Liquidation is a compulsory procedure for corporate termination and protects the interest of the shareholders and creditors. Dissolution and liquidation usually occur simultaneously and involves settling creditors’ rights and debts, distributing the remaining properties to shareholders, handling formalities of corporate deregistration and business license revocation. When liquidating a company, investors should review the company, determine a plan, and ensure ample time is designated. The termination process can be lengthy and costly, especially if it involves terminating employees and settling debts with third parties. Investors should comprehend all aspects of the company and overlooking aspects can result in legal liabilities for the company and individuals.

Q. Can investors terminate a company under any circumstances?
A. In the Company Law, the company can be dissolved under the following conditions:

  • Term of business operation as prescribed in the Articles of Association (“AoA”) expires or dissolution event as prescribed in the AoA of the company occurs.
  • The board of shareholders or the general meeting resolves to dissolve the company;
  • Dissolution of the company is necessary due to any combination or division to which the company is a party;
  • The business license is revoked, or it is ordered to close down or be dissolved in accordance with the law;
  • The company encounters serious difficulties in its operations or management, causing significant shareholder losses if they persist and the situation cannot be resolved by any other means, shareholders representing 10% more of the shareholders’ voting rights may petition the people’s court to dissolve the company.

In practice, where the investors close the company, the resolution of the shareholders to dissolve the company is required to initiate the legal procedures. Where the shareholders do not unanimously agree to dissolve the company, the Company Law permits shareholders representing 10% or more of the voting rights of the shareholders may petition the people’s court to dissolve the company. However, such circumstances should satisfy the conditions abovementioned (last bullet point).

Q. Can the business still operate during the termination process?
A. During the period, the legal status of the company still exists. The company is existing for liquidation. Therefore, the company is forbidden from business operations other than the activities related to liquidation.

If the company continues to operate as a normal business, the company shall be reprimanded by the company registration authority, and such profits shall be confiscated.

Q. What is the liquidation committee?
A. Under the Company Law, the liquidation committee must be formed within 15 days from the shareholders’ resolution to dissolve the company. The liquidation committee is permitted to perform the following functions and powers:

  • Liquidate the company’s assets and produce a balance sheet and schedule of assets;
  • Notify the company’s creditors with a notice or public announcement;
  • Manage and clear the remaining business of the company;
  • Pay outstanding taxes and any tax liability incurred in the course of the liquidation;
  • Pay the company’s accounts payable and recover its accounts receivable;
  • Dispose of the company’s residual assets; and
  • Represent the company in any civil litigation to which it is a party.

Members of the liquidation group owe an obligation to conduct the liquidation procedure in accordance with the Law. In other words, the members shall not take advantage of their position and receive unlawful payments from such duties. Violations can face monetary penalties, which are calculated based on the illegal earnings received.

We recommend that the liquidation committee formulates a clear schedule of the liquidation procedure – especially in matters related to employment, contractual obligations, and outstanding balances related to third parties (such as suppliers) and payable taxes. In this manner, each step of the liquidation is clearly outlined and reduces risks.

Q. When can shareholders receive the remaining assets of the company?
A. The company shall only distribute company assets to the shareholders once completing the following payments:

  • Liquidation expenses
  • Employee salaries, including social insurance premiums and statutory indemnity premiums
  • Outstanding payable taxes and taxes incurred during liquidations
  • Outstanding debts

Company assets must be distributed to the shareholder according to the proportion of capital contributed by each shareholder. Where the liquidated company assets are insufficient to pay the obligations, the company may file for bankruptcy with the People’s Court. Once a company is declared bankrupt by the People’s Court, the liquidation committee shall hand over the administration to the People’s Court.

The duration of dissolving and liquidating a company in China depends on various factors such as employee terminations, pending legal lawsuits, outstanding debts, and the location of the company in China. Companies are required to settle all matters before the company can be deregistered, and the legal status of the company can be inactivated. Companies are forbidden from becoming a non-operating business (shell company). Such activities can be evidenced by the lack of business transactions such as issuing fapiaos (invoices), bank account activity, and employed personnel. For foreign investors residing outside of China or who cannot return to China due to the temporary COVID-19 visa restrictions, appointing professionals in China who can conduct the liquidation procedure on behalf of you is essential. Without complying with the liquidation procedures, foreign investors and legal representatives of the company may be permanently prohibited from entering and working in China.