China question: What are the liabilities for a failed WFOE?

The domestic perspective

Directors and senior managers

Under the PRC Enterprise Bankruptcy Law (中华人民共和国企业破产法), if a WFOE is bankrupted because the directors, supervisors or senior managers violate loyalty or diligence duties, they assume civil liabilities and cannot work in that capacity at any other enterprises for three years from the date bankruptcy procedures are completed.

The PRC Company Law (中华人民共和国公司法) sets out detailed provisions over loyalty and diligence duties of directors and senior managers. According to the Law, directors, supervisors and senior managers shall observe laws, administrative regulations and the company's articles of association (AOA), and bear the loyalty and diligence duties. Directors, supervisors and senior managers cannot take advantage of their functions and powers to accept bribes or collect other illegal earnings, or illegally take possession of the enterprise's property. In addition, if a WFOE suffers losses because its director, supervisor or senior manager violates laws, they are legally obliged to compensate the enterprise.

The Company Law also lists activities of directors and senior managers that constitute violation of loyalty. Some of these activities include misappropriating funds, opening an account in the name of the director or senior manager or in the name of another person to deposit the funds of the enterprise, or loans using the enterprise's property as a guarantee. If a director or a senior manager conducts any of the activities in the Company Law, which leads to bankruptcy, they shall assume the liabilities, in addition to returning the earnings derived from such illegal activities.

Shareholders

In general, if a WFOE has limited liability, shareholders assume liability of the capital contributions subscribed by shareholders. If shares limit the WFOE, shareholders assume liability to the extent of the shares they hold.

There are restrictions on company shareholder's liability. According to the Company Law, shareholders of a WFOE are prohibited from abusing their independent legal status or limited liability to damage creditor's interests. If a shareholder abuses its independent legal status or limited liability to evade debts, which seriously damage creditor's interests, the shareholder assumes joint and several liabilities. For example, if shareholders shut down the WFOE in bad faith to evade debts due to the creditor, the policy of limited liability will not apply and shareholders shall assume joint and several liabilities to the creditor.

He Fan

Haiwen & Partners, Shanghai

The international perspective