New trend in compulsory liquidation procedures

By Xu Bangwei and Lin Xiaolu, Jingtian & Gongcheng

With the transformation and upgrading of industry in China, and progress in supply-side reforms, Chinese legislation concerning the scope of entities with liquidation obligations, and the liability bearable by parties with liquidation obligations, is showing a gradual trend towards broadening and severity, the hope being that this will drive the large number of “zombie companies” in operational difficulty out of the market. Additionally, there are numerous foreign-invested enterprises that have been unable to successfully achieve a transformation, and that are also hoping they can quickly complete liquidation and de-registration procedures and remit the remaining capital back to the investing country. However, in practice, there are many “zombie companies” whose official seals, licences and certificates, financial accounts and/or main personnel are missing for various reasons, and under such circumstances voluntary or compulsory liquidation faces numerous obstacles.

Liquidation obligations
Xu Bangwei
Jingtian & Gongcheng

In two compulsory liquidation cases in which the authors were recently involved, the People’s Courts of Haidian and Changping districts in Beijing each rendered civil rulings determining the liquidation committee shall apply for de-registration of the company, while the compulsory liquidation procedure had to be terminated. These rulings enabled our clients to cancel the enterprises invested in China and remit large amounts of remaining capital to the investing countries according to law. The rulings in both cases clarify that when substantive obstacles make the completion of a compulsory liquidation procedure impossible, de-registration should nonetheless be carried out, which is of groundbreaking significance in the judicial practice of courts in the Beijing region, and even courts around the country.

Common difficulties encountered in the compulsory liquidation of companies. Based on the current legal regime in China, liquidation procedures are divided into voluntary liquidation and compulsory liquidation procedures. The term “voluntary liquidation” means a liquidation procedure initiated by a company itself after grounds for dissolution arise, whereas the term “compulsory liquidation” means a liquidation procedure initiated by a people’s court after institution of a legal action by a creditor or shareholder.

Liquidation obligations
Lin Xiaolu
Jingtian & Gongcheng

When the whereabouts of the company’s official seal, licences and certificates, financial accounts and/or main personnel are unknown, a voluntary liquidation procedure is difficult to initiate because the company cannot carry out the procedures for recordal of the liquidation committee, or carry out company financial and tax audits, making the initiation of a compulsory liquidation procedure the only potential option. However, article 28 of the Minutes of the Work Conference on the Trial of Compulsory Company Liquidation Cases specifies that under such a circumstance the compulsory liquidation procedure should be terminated on the grounds that the liquidation is unable to proceed.

Based on publicly available cases, the vast majority of courts around the country fail to express any opinion in their rulings terminating a compulsory liquidation procedure on whether the company is subsequently to be de-registered. Under such a circumstance, the company liquidation committee designated by the court remains unable to submit company liquidation materials that comply with the requirements of the Administrative Regulations for Enterprise Registration, also making it impossible for the administration for industry and commerce to carry out the de-registration of the company in accordance with the regulations.

New precedents of the Beijing courts. In the above-mentioned two compulsory liquidation cases, we reviewed a large volume of documentation, carried out repeated and voluminous communication with the courts and the liquidation committees, and set the following views before the courts.

First, de-registration of a company is the main objective of a liquidation procedure and the outcome that naturally follows after the conclusion of a liquidation procedure. Company liquidation is a special procedure that is to be carried out after the dissolution of a company, and its objective is to ultimately extinguish the corporate personality. In other words, even if the compulsory liquidation procedure is terminated, its outcome still signifies the conclusion of the compulsory liquidation procedure and, as such, the company’s registration should be cancelled and the company terminated.

Second, the current regulations, judicial practice and academic opinions show that there are corresponding institutional arrangements for the debt processing of the company after the liquidation procedure is terminated due to the inability to liquidate. Therefore, the de-registration of the company after the termination of the compulsory liquidation process will not harm the interests of the creditors.

Third, if a company cannot be de-registered when liquidation is unable to proceed, a large number of “zombie enterprises” will emerge, something that runs counter to the current policy of intensifying supply-side structural reforms and disposing of zombie enterprises. Once an enterprise goes into liquidation, although it still has legal personality, it may not engage in new business activities. If, under such a circumstance, a company is unable to de-register due to termination of the compulsory liquidation procedure for whatever reason, it will enter into a state of suspension, squatting on a large quantity of public resources, and its shareholders may also be unable to de-register due to their holding of equity in a zombie enterprise, thereby creating a situation where one zombie enterprise gives birth to multiple zombie companies, jeopardizing the national economy.

Finally, both the Haidian and Changping courts accepted the above-mentioned reasons provided by our firm, determining in the main text of their rulings to terminate the compulsory liquidation of the target company and have the liquidation committees apply for de-registration of the target companies in accordance with the law.

The change in courts’ attitude awaits further observation. Because creditors’ rights and debtors’ responsibilities differ in various cases, the court and liquidation committee may have reasonable concerns to support a judicial cancellation of registration of the company. After the two cases mentioned in this column, other courts have also followed by issuing similar rulings, showing that, in judicial practice, a positive change in the attitude to the de-registration of a company after the termination of a compulsory liquidation procedure has occurred.

But whether such attitude can give rise to uniform judicial practice awaits further observation. When a similar situation is encountered at this stage, it is still necessary for the legal counsel of the company to formulate a reasonable agency plan based on the specific circumstances of the company being liquidated, and to actively communicate with the court and the liquidation committee.

Xu Bangwei is a partner and Lin Xiaolu is an associate at Jingtian & Gongcheng

liquidation obligations

Jingtian & Gongcheng
34/F, Tower 3, China Central Place
77 Jianguo Road, Beijing 100025, China
Tel: +86 10 5809 1266
Fax: +86 10 5809 1100