Cutting your losses when restructuring China operations

March 17, 2009 | BY

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Foreign companies are contemplating how to restructure their loss-making or low-profit China operations. There are several good options available, and several unwise choices, too. By Ghislain de Mareuil and Julie Tong, DLA Piper, Shanghai.

Although restructurings often involve mergers and acquisitions (for example, selling out the struggling business or combining it with another company), this article will not address those specific and wide-ranging options but will concentrate on other issues related to restructuring and closing down, from a strategic level.


When a China-incorporated foreign-invested company is loss-making or insufficiently profitable, several options are available to it, including downsizing or closing down. There are also specifics to consider when the company to be restructured is part of a larger group.

What not to do
One option when a business is poorly performing should be clearly ruled out: fleeing. The media has reported cases of investors and managers simply running away, leaving their businesses and – they hoped – all liabilities including unpaid debts and wages, behind them. Doing this is not only illegal, but short-sighted as it implies never doing business in China again. Furthermore, new regulations were passed in December 2008, targeting this very situation. Under these regulations, (namely the Working Guidelines on Cross-border Pursuit of Liability and Initiation of Legal Action by Relevant Interested Parties in Connection with Abnormal Withdrawal from China of Foreign Investors), China commits to follow both international and domestic rules to address such cases and seeks assistance from foreign countries.1

Another choice that can not be recommended is the so-called wait and hope option: doing nothing while the company's performance is deteriorating. This indeed exposes the company to the risk of bankruptcy. As defined by the PRC Enterprise Bankruptcy Law (中华人民共和国企业破产法), a company is insolvent if (i) it is not able to repay debts due; and (ii) its overall assets are not enough to pay off all the debts, or it obviously lacks the ability to clear off its debts. If those insolvency criteria are met, court-controlled or court-supervised bankruptcy proceedings are triggered at the initiative of the company's management or creditors.

Generally speaking, bankruptcy proceedings result in:


(i) a blow to the reputation of the company or group as a result of the bankruptcy proceeding announcement – such a blow sometimes proves fatal in itself (even if the company could otherwise have been turned around) as creditors and clients tend to vanish when they hear of such proceedings;

(ii) the loss of management control of the company's operation to the benefit of court-appointed administrators and the court itself; and

(iii) personal consequences for the company's management – under the PRC Company Law (中华人民共和国公司法), directors or chief executives of a bankrupt company can not be appointed in a senior management position in any other company within three years after completion of the bankruptcy proceedings; furthermore, in very rare and particular cases, the individual liability of company management might be engaged.


For those – the majority, obviously – who are willing to anticipate and avoid this, the following options (which are non-exclusive and on the contrary could be combined) may be considered: downsizing, closing down and, for multinationals having several affiliated entities in China, group restructuring.

As a health warning, there is no perfect option suitable for every company. The sectors, financial status, objectives and the overall China strategies of the company must be considered when choosing among the options.


Downsizing
Downsizing can be achieved through various means, the most common of which are:


1. Redundancy

Reducing the workforce is key to any downsizing. Terminating employees is a more and more sensitive matter in China as dismissed employees increasingly challenge their termination or severance package before the labour arbitration committees and courts2.


• Severance calculation

Severance packages normally amount to one month of salary for each year of service for the company. In the event that the monthly salary exceeds three-times the local average salary3, certain caps will apply. Specifically, the severance package is capped at three-times the local average salary and 12 months. The table below shows an example of how to calculate the severance indemnity:

Employees

Monthly salary

Years of service

Severance entitlement

Employee A

Rmb100,000

14

9,000 x 12 = 108,000*

Employee B

Rmb8,000

14

8,000 x 14 = 112,000

Employee C

Rmb2,000

14

2,000 x 14 = 28,000

* It is assumed here that the local average monthly salary is Rmb9,000.

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