Liquidation following a foreign acquisition

By Kathryn Cui, Concord & Partners
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Foreign investment in the PRC increasingly takes the form of acquisitions, with equity acquisitions being the most common. In practice, if the corporate structure of a target is complex, the acquirer may elect not to purchase certain of its subsidiaries or joint ventures for market, product, strategic or other reasons.

Kathryn Cui, Concord & Partners
Kathryn Cui
Concord & Partners

In a large equity acquisition, the equity transfer agreement is likely to contain a non-compete provision that specifies that for a certain number years after completion of the transaction, the target may not engage in the production of similar products or operate in a similar industry nationwide.

The non-compete obligation may equally apply to subsidiaries or joint ventures held by the target (in which it holds more than 25% of the equity) which are disclosed during the due diligence stage but which are excluded from the acquisition. Meeting these non-compete obligations may require a number of different actions, including the liquidation and closing down of subsidiary companies.

Legal basis

At present, the dissolution and liquidation of any company in the PRC, whether a wholly Chinese-owned company or foreign investment enterprise (FIE), must be carried out in accordance with provisions of the PRC Company Law and the PRC Enterprise Insolvency Law. For an FIE, if foreign investment laws or regulations contain special provisions on matters about which the Company Law is silent, those special provisions will apply.

If a company is to be terminated because of a non-compete obligation given by shareholders during the course of an acquisition, the company’s dissolution is based on shareholder consent and the company may be liquidated pursuant to its articles of association or a resolution of a shareholders’ meeting or the board of directors.

If the company has sufficient property to discharge all of its debts, it will be terminated and deregistered after all of its debts have been discharged and any remaining property has been distributed. If the company’s assets are insufficient to discharge its debts, or it clearly lacks the capacity to repay, and if its creditors are unable to agree on a debt repayment plan, the company will enter bankruptcy liquidation. Under this procedure, once the company has equitably discharged its debts, its legal personality will be cancelled.

To terminate, an enterprise must undergo three steps: dissolution, liquidation and de-registration. The dissolution of a company does not immediately result in the loss of its corporate personality, but it is required to cease its activities, enter the liquidation procedure and end its existing legal relationships. The final step after completion of the liquidation procedure is de-registration of the company.

The liquidation procedure

With the exception of the requirement to register with and secure an official reply from the competent foreign economic relations and trade authority, the liquidation procedure for an FIE is essentially identical to that for a Chinese-owned enterprise.

When registering its liquidation, a Chinese-owned enterprise is required to submit the following documents to the administration for industry and commerce: a written application, the resolution of the shareholders’ meeting or board of directors, a photocopy of the company’s business licence, the liquidation plan of the liquidation committee, a copy of the capital verification report, the most recent valid audit report and the list of the members of the shareholders’ meeting and board of directors.

An FIE must first apply for dissolution, then submit the same documents to the competent foreign economic relations and trade authority, together with a written application for early termination and the original of its approval certificate. The authority will review the documentation and issue an official reply approving the dissolution of the FIE. The formal date of commencement of liquidation will be stipulated in the official reply.

Responsibility for liquidation lies with the company’s liquidation committee. During the liquidation period, this committee replaces the company’s highest authority and succeeds to all of its powers. Externally, it represents the company being liquidated in expressing its intentions, instituting and responding to legal actions. Internally, it attends to liquidation-related matters.

The liquidation committee must formulate the liquidation plan and, based on that plan, dispose of the company’s property and complete the liquidation procedure. Payments must be made strictly in the following sequence: liquidation expenses; the wages and labour insurance premiums of employees; state taxes; and other debts.

Once the liquidation report has been approved by the shareholders, the company will enter the final stage of the liquidation procedure, namely deregistration with the administration for industry and commerce; return of the original and duplicates of the business licence; securing of the deregistration approval document; return and destruction of the company’s official seal within a reasonable period of time; cancellation of registration certificates with other government authorities; distribution to the shareholders of the remaining assets in accordance with the liquidation report, including applying to the foreign exchange control authority to complete the payment of foreign exchange to any foreign shareholder(s); cancellation of the foreign exchange registration certificate; and closing of the company’s bank accounts.

The ultimate symbol of the completion of deregistration is the publication by the company of a newspaper announcement that its liquidation has been completed. The law does not currently set any time limit for the period between commencement of the liquidation of a company and completion of the liquidation.

Once a company has been deregistered, its shareholders must arrange for the safekeeping of its accounting files and, in accordance with the Accounting Files Administrative Measures, keep the company’s accounting files for future reference.

Legal liability for liquidation

Under the Company Law, after dissolution the shareholders of a limited liability company and the directors and controlling shareholder of a joint stock limited company are the parties obliged to carry out liquidation after the dissolution of the company. Should they fail to do so, they will bear the attendant civil liability.

Kathryn Cui is the managing partner of Concord & Partners’ Shenzhen office

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