Putting Chinese Companies into Dormancy - Chinese Legislator Provides Alternative to Company Dissolution

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published on 20 October 2022 | reading time approx. 3 minutes


The ongoing Covid 19 pandemic has caused the global economy to falter. China is not exempt from this. Delayed or even interrupted supply chains and the resulting production and delivery stoppages and delays, interruptions to operations due to lockdowns, in some cases lasting weeks, and the very uncertain situation and future due to strict adherence to the 0 Covid strategy and the associated risk that, in principle, the aforementioned restrictions, up to and including a lockdown, could reoccur at any time, has led to difficulties for many companies in continuing to maintain operations - despite numerous stimulating measures by the central government and local governments. In particular, cost pressures from daily operating costs, wages and salaries, rents, etc. often lead to financial hardship and the associated question from investors as to how costs can be reduced and how the Chinese company and its business operations in general should continue.  

   

      

Previously, Chinese law stipulated that a company should generally maintain its business operations and that the competent authority could revoke the business license if the business was interrupted or suspended for more than six months. In plain language, this meant that a company had to be liquidated in the event of significant and long-term financial problems, with the consequence that the company was dissolved completely. If the economic situation improved, the only option left to the original investor was to re-enter the market by establishing a new company.

   

Enactment of new Regulation on the Dormancy of a Company

This situation, which is unsatisfactory for all sides, has now been addressed by the Chinese legislator in the "Administrative Regulation of the People's Republic of China on the Registration of Market Entities" (the "Regulation"), which came into force this year, and has enacted provisions that allow companies to be " dormant" under certain circumstances. This provides the investor with an opportunity to significantly reduce the cost of the company and - within a certain period of time - to reactivate the company when the economic situation improves or, in case of doubt, to close the company permanently. Whether or not to suspend the company is a business decision. Reasons may be to buy time for the Chinese company (to raise new funds) or to embed the company in a longer-term business plan with planned reactivation.

    

Scope of Application and Prerequisites

Article 30 of the Regulation provides that market participants (this includes foreign-invested companies) may apply for temporary suspension of business activities for up to three years in case of business difficulties caused by natural disasters, accidents, public health events, social security events and other reasons. The prerequisites in detail are:

 

Prerequisite

Description

 

Eligibility

Not regulated in principle, however:

  • Not blacklisted for violations of law (e.g., exceeding business license, administrative sanctions);
  • No endangerment of national security, public interests, etc.;
  • Local regulations, if applicable (e.g., at least 1 year of business activity prior to application in Shenzhen).
Reason for suspension of business

Presence of one of the reasons specified in Article 30 of the Regulation:

  • Natural disaster;
  • Accident;
  • Public health incident; or
  • Public safety incident

   

Consequences of Dormancy

If the application for dormancy is granted, the following consequences will arise for the Company:

 

 

Legal situation/obligations

 

Business LicenseRemains in effect
Business activitiesNot possible
Employment relationshipsNegotiations with employees on termination of employment prior to dormancy, but dormancy may be a justifying cause for negotiations, but unclear whether dormancy can constitute grounds for termination (in doubt, no)
Physical business addressAddress for mail delivery may differ from the company's registered office or principal place of business (agent for service of process)
Bank accountMust remain in place
Filing of Annual ReportRequired, but less complex
Filing of tax returnsRequired, but less complex
Term of dormancyMax. 3 years
Publication requirements

Yes, among others:

  • Fact and duration of dormancy; and
  • Indication of the address for service
Resumption of business activitiesIn the event the company wants to resume its operation, it needs to apply with the competent AMR and de-register the dormant status. However, it will be necessary that the company also has its own physical address or premises.

    

Many points relating to the dormancy have not yet been clarified. These include, for example, the termination of ongoing contracts (supply contracts, rental agreements, etc.) and how to deal with claims made by contractual partners due to the termination of contracts (such as possible damages, forfeiture of rental deposits, compensation payments for employees and much more). It is unclear, for example, whether payments can be made during the dormancy period or whether this is considered "operational business activity." It is also unclear whether the dormancy can be renewed after the maximum three years if circumstances have not changed. It is also in question whether work and residence permits of foreign employees remain in force during the dormancy or whether they have to leave China.

   

Outlook and Recommendation

The above points represent only a small selection of possible problems that may be associated with a dormant status. Ultimately, it depends on the specific situation of the individual company. In practice, however, there are initial experiences that confirm that dormancy does indeed work and is a real alternative to liquidating a company. If dormancy is an option for your company in China, we will be happy to assist you. Our services in this area include the provision of an address for service, handling of postal correspondence and assistance with the - temporary - cessation of business operations as well as with the remaining obligations of the dormant company (tax returns and annual financial statements).

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