Chasing foreign investors who abandon Chinese ventures

The Working Guidelines appear to be drafted and intended more as a political statement than legislation. Their intention seems to be to indicate to creditors, workers and others affected when a foreign investor disappears that the government is committed to act to protect their interests, as well as conveying to relevant local government departments the commitment of the central government regarding the issue and pushing them to act together to protect affected Chinese parties.

It is unlikely that additional legislation will be issued to implement the Working Guidelines; it is more likely that further internal documents will be issued within the four relevant departments – Chinese legislation already provides a substantial toolkit to government departments. Private parties, such as creditors and employees, have fewer opportunities for legal recourse but still have options available, including additional ammunition provided by the Provisions on Several Issues Concerning the Application of the «PRC Company Law» (2) (关于适用《中华人民共和国公司法》若干问题的规定 (二)) (Company Law Provisions), which were issued in May 2008 by the Supreme People's Court. The legal issues are more complex than the Working Guidelines indicate, but advisers to shareholders of troubled foreign-invested enterprises (FIEs), senior managers, board members and legal representatives should be aware of the extent of the liability that may threaten their clients.

Who is affected

The Working Guidelines refer to the right of affected Chinese parties to seek civil or criminal liability against foreign investors that have left China abnormally. They do not define “abnormal departure” although they appear to refer to the withdrawal of personnel and departure without undertaking proper closure procedures. These include liquidation, notification of creditors and cancellation of relevant licences. The Working Guidelines do not define “foreign investors”, but it appears that the term should include parties to joint ventures, shareholders in wholly foreign-owned enterprises, and possibly foreign parties to processing arrangements. Although “relevant parties” is not defined, it seems intended to include creditors, employees, and other affected parties.

What the Guidelines cover

Civil liability

The Working Guidelines remind affected Chinese parties that, under the Company Law Provisions, they may pursue the shareholders of an FIE as well as the FIE itself for losses suffered under various circumstances related to the failure to undertake proper closure procedures. The Company Law Provisions assert that foreign individual or corporate shareholders assume relevant civil liability or even joint and several liability for the obligations of their investee company. The Provisions are based on general language in the Company Law (中华人民共和国公司法), but create liability for the unwary investor by permitting creditors to pierce the corporate veil under certain conditions.¹

The Company Law Provisions permit creditors seeking compensation for losses suffered to seek proceedings against the shareholders of a limited liability company under a joint and several liability theory, if they can show that the shareholders have neglected the performance of their obligations, resulting in the destruction of crucial company assets, account books, and other important documents, rendering liquidation impossible. If senior managers of an FIE were to leave China with its financial records, it is likely that a Chinese court would rely on this provision to impose joint and several liability on the foreign investor. The Provisions provide an alternate basis under which creditors can seek damages against foreign shareholders: if they assert that they have suffered harm because shareholders have failed to commence liquidation of the FIE, resulting in the devaluation, loss, destruction or extinguishing of company assets.

The Working Guidelines also raise the possibility of enforcement of a Chinese civil judgment abroad, if the foreign investor does not have other assets in China. This assumes that a Chinese party will seek enforcement against a foreign investor in China in the first instance. Therefore foreign investors with multiple investments in China should be aware that if they abandon one company, creditors of one investment may seek enforcement against other assets in China. However, if the investor holds each investment through a separate holding company, this would block enforcement against other assets in China.

The Working Guidelines fail to make clear that imposition of liability becomes much more difficult when it has to be done after the investor has left the jurisdiction. They also do not explore the difficulties of the use of criminal or civil judicial assistance treaties (or arrangements with Hong Kong), or the use of the New York Convention.

Although the Working Guidelines refer to the possibility of enforcing a Chinese civil judgment abroad, agreements such as the Sino-South Korean Civil and Commercial Judicial Assistance Treaty generally do not allow such enforcement. Hong Kong's recently concluded reciprocal arrangement with the Mainland (through the Mainland Judgments (Reciprocal Enforcement) Ordinance) does permit the enforcement of mainland money judgments, but only if the mainland judgment meets certain criteria: it must have been made by certain designated courts, and pursuant to a “choice of court” agreement, defined as designating a mainland or Hong Kong court as the sole court for resolving issues that may arise with respect to a legal relationship; it does not include employment contracts. These criteria are likely to leave trade creditors and unpaid employees without recourse, because it is unlikely that the simple sales contracts used by mainland suppliers will include a choice of court agreement, and the reciprocal arrangement specifically excludes employment contracts. For creditors seeking enforcement against a British Virgin Island or Cayman Island holding company, there are no arrangements in place for the enforcement of Chinese civil judgments, and proceedings would need to be undertaken abroad.

The Working Guidelines also refer to providing assistance to Chinese parties that need to sue a foreign investor abroad, but do not detail the form in which this assistance will be provided, and whether it would include legal fees and other costs. It is unlikely that the Chinese government would be willing to fund legal proceedings abroad by numerous small creditors. The New York Convention (and the Hong Kong arrangement), not mentioned by the Working Guidelines, would provide an enforcement mechanism only in a limited set of circumstances, such as an arbitration clause incorporated in the contractual arrangements between the parties.

Criminal liability

The last section of the Working Guidelines refers to the minority of foreign investors who abandon their investments with large tax bills owing, and suggests that the criminal justice authorities can issue extradition orders or other criminal justice orders so that criminal suspects may be brought to justice. China and South Korea have an extradition treaty in place, but it is unknown whether it has been used to pursue tax evasion.

Other penalties not mentioned by the Working Guidelines

The Working Guidelines could have usefully warned foreign investors planning to abscond that other PRC legislation imposes penalties on certain members of certain senior management, such as the legal representative and chief financial officer, which is problematic for persons planning to continue to do business in China. Regulations relating to legal representatives, for example, bar a legal representative found personally liable for failure to de-register a company from taking the position of legal representative for a period of three years from the date that the company is de-registered.² Similar provisions exist for senior financial officers implicated in tax evasion. Finally, under certain circumstances, senior managers can be prevented from leaving China.

Forewarned is forearmed

The practical question is whether trade creditors, banks, and employees can make use of the methods described in the Working Guidelines in a timely fashion, because for many of them, “justice delayed will be justice denied” – enforcement abroad will be practically impossible. It is likely that by the time the business of the company has deteriorated to the conditions set forth in the Company Law Provisions, as a practical matter there will be few company or shareholder assets available against which enforcement actions can be taken. The Working Guidelines are a warning to Chinese parties to enforce their rights in a timely fashion; foreign investors should also know that that there are many more situations in which the Chinese courts may be able to penetrate the corporate veil between them and their onshore investments.

Endnotes

1. Article 20 … Shareholders of a company who abuse their shareholders' rights and cause the company or other shareholders to suffer damages shall bear compensation liability in accordance with the law.

Shareholders of a company who abuse the independent legal person status of the company and limited liability of shareholders to evade debts and cause damage to the interests of the creditors of the company shall bear joint liability for the company's debts.

2. Administrative Regulations on the Registration of the Legal Representative of Enterprises, Art 4(6), SAIC, June 23 1999; Company Law, Art. 147 (4); and Regulations on Registration of the PRC Legal Person, Art.30.