Five Questions to Ask about Company Liquidation in China

Know the liability of shareholders or directors in case of non-performance of liquidation liability.

In the past, company liquidation in China was often a chaotic series of events. There have been frequent reports of bad faith on the part of investors in such situations, with individuals closing down one indebted company in order to start up the same business under a new entity without resolving the liabilities of the former one. Now China's Supreme Court has established new provisions that clarify the obligations of shareholders liquidating businesses. This week, Mr Erex Chen from V&T Law Firm explains the impact of these new provisions.

As China's commercial culture has developed in recent years, one area which has lagged behind is the process of winding up companies. In many cases, shareholders have ignored their responsibilities for resolving company obligations when the companies were shut down, and what is more serious is that we have seen numerous instances of companies being closed by investors in bad faith.

These bad faith liquidations often involve the leaders of indebted companies suddenly disappearing and the remaining shareholders are left unprotected. Furthermore, there are often reports of individuals shutting down companie in this way, then registering new companies which they also use to accumulate debts which are ultimately left unresolved. Even when such companies are successfully sued, the plaintiffs are usually unable to have the verdict enforced, as there are no assets left in the company to seize.

To help address this situation, on May 19, 2009, the Supreme Court promulgated the document, "Provisions on Some Issues about the Application of the Company Law of P.R.C (II)," which clarifies the liquidation obligations of liquidators and the liabilities in case of non-performance of these obligations.

With the establishment of these Provisions, China now can be said to have a complete legal system regarding company liquidation. To clarify how this system works, here are the answers to five important questions regarding company liquidation in China. (For the sake of convenience, the liquidation during bankruptcy is not discussed in this article).

When Can a Company Be Liquidated?

In short, the dissolution of a company will lead to the start of liquidation. According to Company Law, there may be the following reasons for dissolution:

A. The business operation term as agreed in the company's Articles of Association becomes expired or other condition for dissolution as agreed in the Articles of Association for dissolution occurs;
B. Resolution of dissolution is made by the meeting of shareholders;
C. The business license is revoked by the authorities, or the company is ordered to be closed by the authorities;
D. In the following instances, companies may be dissolved by shareholders holding 10% or more of the voting rights filing for dissolution with the court, and the court approving this dissolution:

•The company has failed to hold a meeting of the shareholders for two years, which leads to serious difficulty in the company's operation and management.

• The shareholders are unable to make any valid resolutions over a period of two years due to their failure meet the minimum voting percentage for a valid resolution as required by the law or by the company's Articles of Association.

• The directors are in conflict for an extended time and such conflict cannot be settled through the meeting of shareholders, and this leads to serious difficulties in the company's operation and management.

• There are other difficulties in operation and management of the company and such situation will bring great loss to the shareholders' interest if the company continues to be in operation.

Once the company is dissolved, then the liquidation shall start.

What are the Types of Liquidation?

Generally speaking, liquidations may be either voluntary or compulsory.

Voluntary Liquidation

Liquidations are considered voluntary when they are conducted by the company itself. In such instances, within 15 days after the company is dissolved, the company shall set up its own liquidation committee for the work of liquidation.

Compulsory Liquidation

If one of the following cases exists, the company's creditors or shareholder can apply to the court for designating a liquidation committee to conduct the liquidation:

A. No liquidation committee is set up for the work of liquidation within 15 days after the company is dissolved;
B. Although the liquidation committee is set up, the liquidation is deliberately delayed;
C. The liquidation is conducted in an illegal way, which may bring damage to the interest of creditors or shareholders.

After being examined by the court, the court may accept and conduct the liquidation under its supervision. The court may designate the liquidation committee which may carry out the work of liquidation.

Who Participates in a Liquidation Committee?

For voluntary liquidations, the members of a liquidation committee can be shareholders or legal or accounting professionals hired by the company. If the company is a public company, then the committee members shall include directors or other people designated by a meeting of the shareholders.

In compulsory liquidations, the members of the liquidation committee shall be designated by the court. If the shareholders, directors, supervisors, senior management personnel can participate, then the court may give priority consideration to including these individuals. However, if these individuals do not wish to participate, or if their participation provides no advantage to the liquidation, the court may designate other law or accounting professionals to take part in the committee.

What is the Responsibility of the Liquidation Committee?

The liquidation committee shall be responsible for:

a) iquidating the company property and issuing a balance sheet and asset list;
b) informing the company's creditors of the dissolution;
c) dealing with any pending transactions or business of the company;
d) settling all outstanding tax obligations;
e) resolving with company's accounts payable and receivable;
f) disposing of any remaining company assets (after paying off company debt);
g) addressing any litigation on behalf of the company.

Within 10 days after the liquidation committee is formed, the committee shall inform the company's creditors and must make a public announcement in the newspaper within 60 days. The creditors shall report their claims to the committee within 30 days upon receipt of the notification or within 45 after the newspaper announcement.

The committee shall be responsible for liquidation of the company property and make the liquidation plan and present it to a meeting of the shareholders (if it is a voluntary liquidation) or to the court (if it is a compulsory liquidation) for confirmation.

Distribution of the Company's Assets

As the company's assets are made liquid, the proceeds from this process must be distributed with the following priorities:

1. to pay liquidation expenses;
2. to pay employee's salary, social insurance fee and severance fee;
3. to pay outstanding tax obligations;
4. to pay company debt;
5. to distribute among shareholders if there is any property left.

Once these obligations have been carried out, then the company shall apply for deregistration with the government.

In the event that the company's assets are not sufficent to resolve its liabilities, then, unless it can reach a voluntary settlement with its creditors, then it must file for bankruptcy.

What is the Liability of Shareholders or Directors in Case of Non-performance of Liquidation Responsibilities?

In order to ensure that company leaders, particularly shareholders and directors, fulfill their liquidation obligations as required by law, and to protect the interest of company employees and creditors, the following liabilities may arise in case of non-performance of liquidation:

A. If the shareholders in a limited liability company or the directors and controlling shareholders in a stock company, fail to set up a liquidation committee to conduct the work of liquidation within 15 days after the company is dissolved, and the company's assets are thus depreciated, decreased, damaged or destroyed, creditors can demand that the shareholders compensate for such losses;

B. If the shareholders in a limited liability company, or the directors and controlling shareholders in a public company, delay or fail to fulfill their liquidation obligations. Or if the company's primary assets, accounting books or important documents are lost and the liquidation cannot be conducted. The creditors can demand that the shareholders, directors and/or controlling shareholders accept joint liability for the company's liabilities.

Therefore, the shareholders in the limited liability company and the directors and controlling shareholders are liable to conduct the liquidation in a timely and orderly manner. Otherwise, creditors may sue them directly for compensation or joint liability for these liabilities.

About the Author:

Erex Chen is a business lawyer at V & T Law Firm Shanghai office. His areas of speciality include foreign investment, corporate matters, employment, international trade, intellectual property and family law. Erex Chen is experienced in providing legal service for international corporations. The companies Erex Chen served include Best Buy, ADI, ACMEDA, Sigmatel, Sulzer, Aurora Taiwan, etc . Erex Chen graduated from the East China University of Politics and Law and obtained Master of Law degree. Erex Chen can be reached by erexcxl@yahoo.com.cn