Every few months we get an email from someone seeking our help to prevent the Chinese government (broadly defined) from shutting down their business. Something is definitely afoot in China right now as we received three such emails just this week. The following is a composite of these three emails:
We set up a WFOE and started a small XYZ business inside a residential compound in ______. The local authorities came knocking the other day, pointing out that it is impossible to license our venue for any sort of business — “our company legal address is necessarily elsewhere.” Apparently there is only a title deed for the entire complex, which was built some 5 years ago. We have the property management company fully on our side, but they seem unable to do anything, or don’t know what to do. They have said that they intend to close us down. Just so you know, we are registered as a consulting company, not an XYZ business.
We would really like to have this resolved asap, as we will otherwise need to lay off our staff. Is there anything you can do?
We write back suggesting they retain local Chinese counsel. But what we really want to say is the following:
Dude, you have a big, probably insurmountable problem. And it is entirely of your own making. You no doubt used a cheap entity formation company to form your WFOE and, unfortunately, they went along with what you knew was illegal. Your business is illegal in four ways and there is no way a bunch of American lawyers can solve a problem like that.
Not that I need to tell you this, but just to be clear, your business is illegal for the following four reasons (and this is just what I am able to glean from your five sentence email:
- You registered your business as a consulting company but you are operating as an XYZ business. I’m guessing you did this because you wanted to keep your required minimum registered capital low.
- Your registered address is “necessarily elsewhere” because to register as a consulting business, you needed an office and your XYZ business is not an office.
- Your XYZ business location can never qualify as a legitimate WFOE because to do so you need your own separate space and where it is located (as you point out by saying there is only one title for the entire complex) constitutes just one business location.
- Your lease is illegal and that is why your landlord cannot help you. It sounds like your landlord is not authorized to lease out a part of the property for a business. The area in which the building is located is almost certainly not zoned for business.
I really don’t know what else to tell you other than that you had better get to a good local Chinese attorney and fast.
In “How To Form a China WFOE. Scope Really Really Matters,” we talked of how the scope you describe in your initial WFOE application matters even after your WFOE is approved:
BUT — and this is why I am writing this post now — if you under or overreach on the description of your business scope, you might find yourselves in big trouble. We are getting an increasing number of calls from American companies in trouble with the Chinese government for doing things in their business that were not mentioned in the business scope section of their initial WFOE.
In some cases, the companies have admitted to us that they were never “really comfortable” with the business scope mentioned in their applications, but that the company they had used to form their WFOE had “pushed” them into it as it would “make things much easier.” In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the company probably would never have been approved at all had it been upfront and honest in its application. In nearly all instances, the companies had managed to secure local approval but were now in trouble with Beijing, which constantly is auditing these applications. In one instance, the local government went back and changed its mind, probably after conducting an audit of its own.
I cannot go into any more detail on these matters, but I can give this advice: applying for a WFOE in China involves a heck of a lot more than just filling out a form and getting approval. It does matter for what you get approved and you (or whomever you are using for your WFOE application) need to know China’s foreign investment catalog inside and out before applying. You then must tailor your application to meet both the requirements of the foreign investment catalog AND the reality of what you will be doing in China. A failure to comply on both fronts will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.
If you take away nothing from this post, please at least understand that your getting local government approval for your WFOE does not mean you are out of the woods. There is little to no benefit in getting approval for a non-conforming WFOE.
In Leasing Requirements For A China WFOE To Be, Part II, we talked about the importance of having a valid lease for your WFOE and we even went so far as to say that without such a lease, you shouldnt’ even bother having a WFOE at all:
If you are not going to get the right space for a WFOE, you are probably better off not getting a WFOE at all. Registering a WFOE and then not complying with ALL of the requirements for having a legally operating WFOE is a classic example of trying to operate quasi-legally in China. For why this is a bad idea, check out “Quasi-Legal In China. Not The Place You Want To Be” and “Forming A Company in China. Do It Right Or Do It ALL Wrong, But Don’t Do A Rep Office.“
The Bottom Line: We have said it before and we will no doubt say it again. Form your WFOE correctly or don’t bother forming one at all. China’s economy is on the decline and that means it will be looking to get rid of foreign companies operating illegally. If your WFOE is not living up to its registration requirements/promises, you are at risk.
What are you seeing out there?