Archives: forming a company in China

One of the most frustrating things about doing business in China is the paper work.

The seemingly endless paper work….

I was cc’ed on an email the other day from one of our China lawyers to one of our clients.  The client had signed the documents required for a WFOE using the wrong ink.  The ink the client used looked like the required ink, but it wasn’t.  We told the client that the local Administration for Industry and Commerce (the “AIC” is where the WFOE filings go) would likely reject the application due to the wrong ink, but the client chose to go ahead anyway so as to potentially avoid having to go through the signing process again.  This email (with all identifiers, including city) hidden, is to let our client know that the AIC did in fact refuse their application and setting out all that our client now needs to do to ensure acceptance the next time around.

To form a WFOE in China, you typically need around 25 documents, 33 originals, 594 signatures (18 times the 33 originals) and 297 seals (9 times the 33 originals).  Fun stuff, let me tell you.   I was quoted the other day in a New York Newsday article on China, in which a China consultant talked about how forming a China WFOE takes 6-12 months.  The Wall Street Journal’s China Real Time Report, in a piece entitled, American Firms Find China Hard Work, noted the following from the recently released AmCham survey:

Investment approvals are particularly vexatious, with complaints ranging from apparently arbitrary decisions to excessive paperwork. The proportion of U.S. firms who think foreign and local companies compete on a level playing field with regard to approvals has fallen to 14% from 29% in 2011, according to the chamber’s survey.

The below email should give you a bit of flavor as to why forming a company in China can be so “vexatious.”
In line with our expectations, the _______ AIC  rejected your WFOE application documents for having been signed with the wrong type of pen. Accordingly, please have the attached documents re-executed.

The instructions for signing follow:

1.    AOA-Chinese: We need 5 Originals, all signed by ____________ and bearing the seal of ___________.

2.    AOA-English: For reference only. No need to sign or return to me.

3.    Application form-Chinese: We need 2 Originals, both signed by both _________ and _________ and bearing the seal of ___________.

4.    Application form-English: For reference only. No need to sign or return to me.

5.    Application Letter for Economic promotion bureau-Chinese: We need 2 Originals, both signed by __________ and bearing the seal of ___________.

6.    Application letter for Economic promotion bureau-English: For reference only. No need to sign or return to me.

7.    Application letter for stamp carving-Chinese: We need 1 Original, signed by ____________.

8.    Application letter for stamp carving-English: For reference only. No need to sign or return to me.

9.    Appointment letter (executive director and supervisor)-Chinese: We need 3 Originals, all signed by __________ and bearing the seal of ____________.

10. Appointment letter (executive director and supervisor)-English: For reference only. No need to sign or return to me.

11. Appointment letter (General manager)-Chinese: We need 3 Originals, signed by all of the board members (i.e., _________, _______________, and ______________).

12. Appointment letter (General manager)-English: For reference only. No need to sign or return to me.

13. Foreign exchange registration application form-Chinese: We need 1 Original, signed by ____________.

14. Foreign exchange registration application form-English: For reference only. No need to sign or return to me.

15. FSR-Chinese: We need 3 Originals, all signed by _____________ and bearing the seal of __________.

16. FSR-English: For reference only. No need to sign or return to me.

17. Letter of authorization by legal person-Chinese: We need 2 Originals, both signed by ___________.

18. Letter of authorization by legal person-English: For reference only. No need to sign or return to me.

19. Letter of authorization for delivery of legal documents-Chinese: We need 3 Originals, all signed by ___________ and __________ and bearing the seal of ____________.

20. Letter of authorization for delivery of legal documents-English: For reference only. No need to sign or return to me.

21. Letter of undertaking to work safety-Chinese: We need 2 Originals, both signed by ___________ and bearing the seal of __________.

22. Letter of undertaking to work safety-English: For reference only. No need to sign or return to me.

23. The list of board members-Chinese: We need 3 Originals, all signed by _________ and bearing the seal of ___________.

24. The list of board members-English: For reference only. No need to sign or return to me.

25. Power of attorney: We need 3 Originals, all signed by _________ and bearing the seal of __________

 

IMPORTANT NOTES REGARDING SIGNATURES: 

(1) The execution documents listed above have yellow “stickies” in the document indicating where to sign, and whose signature is required. When you print out these documents, make sure you do not print out these notes as well.

(2) Make sure to use A4 paper to print the documents and that your printer is set to A4. Note the number of pages and formatting of the documents to ensure that the formatting is consistent. If you have problems printing the documents, we can mail them to you. If you do not use A4 paper and the proper formatting, the documents will be rejected.

(3) All signatures must be made with a fine point rollerball pen using water-based ink, such as a Uniball, or a fountain pen. Do not use a thick ballpoint pen or a pen with oil-based ink. Sign in BLACK INK ONLY. All signatures must match the signature in the respective person’s passport.

(4) On those documents where the company seal (of __________) is requested, the seal should be affixed over the signature.

Once all of the above documents have been signed, please scan and email a copy to me, and send the physical documents directly to our China company formation agent.

Got all that everyone?

More from the Doing Business in China Seminar I co-moderated last week.

My law firm does a considerable business in forming China WFOEs.  Unlike forming a company in the United States, which costs very little in out of pocket costs (always less than USD$1000) and takes almost no time at all (a few days at most), forming a company in China can be a long and expensive process. We typically start the procedure by sending out an email with the following LONG list of questions and document requests

  • Legal Name and Structure. Full legal name, legal structure (corporation, LLC, partnership), state of formation, and registered legal address of the shareholder of the WFOE. I assume that your U.S. entity will be the shareholder. If this is not correct, please explain.
  • Company Registration Document. Most recent registration document (usually called an annual report) from the state of formation showing the name, address and officers and directors of the shareholder. Our office can obtain this document after we receive your response to item 1 above.
  • Proof of Shareholder Existence. For this we will need certified copies of a) a certificate of good standing and b) the most recent annual report for the shareholder. These documents must be authenticated by the secretary of state of the state of formation and also must be authenticated by the applicable Chinese consulate or embassy. This is a complex process. Our office will handle obtaining these documents and processing with the relevant Chinese consulate/embassy.
  • Name of WFOE in Chinese and English. We can assist in selecting the name if you wish. Chinese company names are complex. For now, what we need is the basic name that you want. We will then work with the local authorities to determine what should be the full legal name. Note that China is really only concerned with the Chinese version of the name. There is no real control on the English name that you use.
  • Lease of Space for the WFOE. The lease must be valid for at least one year beyond the eventual approval date for the WFOE. Since approval may take some time, it is best to have the initial term of the lease be at least one-and-a-half to two years. The lease must be in proper format and must be registered with the local real estate authority. We will also need proof that the landlord owns the property in question and has the authority to enter into the lease. This is usually proved by provision of a land rights certificate and proof of existence of the landlord (National ID for an individual, business license for a company). We will work with you during the leasing phase to ensure the lease is properly executed and that the landlord has proper authority. Prior to your entering into the lease, we will determine whether the proposed use is permitted for the premises and whether the proposed address is acceptable for a WFOE. Leases are often the biggest obstacle for WFOEs, so this is a matter to address right away. Note also that the specific details of the documentation requirements for a WFOE depend on the district where the WFOE will be formed. We therefore need to know the proposed address for the WFOE or at least the proposed district before we can make a final determination of the exact procedures that will be required for WFOE formation. Note also that we cannot even begin the registration process in China until we know the address of the proposed registered office for the WFOE, as well as the proposed use. This highlights the importance of the lease in the registration process.
  • Scope of Business.We must specify the scope of business of the WFOE. Please provide a statement of what services the WFOE will perform on a daily basis. We need reasonable detail for this, but no more than one page. The scope of business should address the following questions, among others.
    • How many employees will be working there? Are they full-time or part-time? Will they be working in the leased space or off-site.
    • Will the number of employees vary over time?
    • What is the nationality of these employees?
    • What will each of these employees be doing in this rented space – will they be programming? consulting? buying? selling? manufacturing? providing customer support? managing other employees? something else?
    • Who are the customers of the business? That is, who will be paying for the goods or services provided by the WFOE?
    • What is the projected cash flow of the business? Where will income go (i.e., to the WFOE, to the parent, to an affiliated entity)? How will expenses be paid (i.e., directly by the WFOE, by the parent, by an affiliated entity, etc.)? Where will the WFOE get its money to operate?

The scope of business will also be used in the company name as noted in Question 4. above.

  • Feasability Study.  We must provide a feasibility study that states the basic business plan of the WFOE. Our staff will draft that document. In order to do this, in addition to the information requested in Question 6 above, we need the following information:
    • Statement of start up expenses in reasonable detail.
    • One year and five year proforma income statement and balance sheet.
    • Statement of what services/product the WFOE will provide (to the extent not addressed in Question 6).
    • Statement of the expected cash flow of the WFOE: what entities will pay and what will they pay for (to the extent not addressed in Question 6)
    • Initial staffing plan for the WFOE with a three year and five year projection. Of particular importance is the nationality of the staff (to the extent not addressed in Question 6).
    • Statement of the business opportunity this WFOE will exploit, the expected market for the service, how you propose to meet the needs of that market and the benefit to China from the project.
  • Registered Capital.  We must state the amount of the registered capital for the WFOE. This amount is the actual amount of capital that will be paid in by the shareholder as start-up capital for the WFOE. Registered capital is not a deposit: it is the actual operating capital used by the WFOE for payment of start up expenses such as rent, remodeling, equipment and salaries. There is no set number, since the amount required for each WFOE is different. As a rule of thumb, most Chinese regulatory authorities expect that registered capital will be equal to at least the first years expenses. Some districts have a minimum amount for registered capital. For example, districts in Shanghai generally require at least US $150,000 in registered capital. Note also that certain businesses will be required to have higher registered capital minimums. The rule is that all registered capital must be paid within two years after approval of formation of the WFOE. Fifteen percent of this amount, or the required minimum, whichever is greater, must be paid within 90 days after formation of the WFOE. The amount of registered capital must be considered carefully. Any amounts paid into the WFOE by the shareholder in excess of registered capital will be treated as income to the WFOE, and taxed as such. Accordingly, it is important not to set the registered capital number so low that you would encounter this problem. We will discuss this in more detail with you as we progress.
  • Management. WFOE can be managed through a) a board of directors or b) through a single managing director. For a board of directors, the number of directors is typically three. One director is selected as the representative director who has the right to enter into agreements on behalf of the WFOE. For the managing director, a single person is appointed as the managing director. This person is also the representative director. You will need to determine which management method you will use. For single shareholder WFOEs, the managing director approach is common. You will need to designate the following:
    • Directors.
    • If you will use a board, state how many directors. Provide the full name and address of each director.
    • If you will use a managing director, provide the full name and address of each director.
    • General manager.
    • The daily business of the WFOE will be managed by a general manager. This person can be a member of the board or an independent individual. The person can be a Chinese national or a foreign national. The person can be a resident of China or a non-resident. Typically, for a WFOE the general manager is a Chinese national who does not serve on the board and who is resident in China. However, there is no fixed pattern.
    • Supervisor.
    • The supervisor is responsible for supervising the conduct of the board in order to protect the rights of shareholders. In a one shareholder WFOE, the supervisor position is not necessary. However, Chinese law requires an appointment to this position. The person must be independent and cannot be a director or the general manager.
  • Documentation for each person.For each person above, provide the following:
    • Name and address.
    • ID: For non-Chinese citizens, we will need four color copies of their passport. For Chinese citizens, we will need four color copies of their national ID card.
    • Resume: one or two page, including birth information and address, signed, four originals.
    • Photos: four 2″ visa size photos.
  • Proof of financial status. Normally, this can be done through a letter from your bank stating the basics of your deposit relation with the bank. We will provide you with an approved form for this letter. In some cases, the Chinese authorities will require an audit of the investor company. We will determine as soon as possible whether such an audit will be required.

And the above is just for a typical WFOE.  There are going to be all sorts of variations, depending on the type of WFOE being formed and even on the city or district in which it is being formed.

Everyone always wants to know how long forming a China WFOE will take and we always tell our WFOE formation clients (before they retain us) that it typically takes from 3-6 months and that our primary goal is always to work as quickly as we can, but that whenever we are faced with a situation where we have to choose between doing something 100% right and doing it fast, we always choose accuracy and precision over speed. If your WFOE is rejected once, the odds of it ever being accepted go way down.

Sometimes potential (and even existing) WFOE formation clients tell us of “someone” out there claiming to be able to form a WFOE in “just a couple of months.”  To that, I always respond that every single reputable law firm (both Chinese and American and European) with whom I have spoken has told me that three months is their bottom line estimate for the time it takes to form a WFOE.  I am bringing all of this up now because at the Doing Business in China seminar, two lawyers from two different highly reputable law firms put on their PowerPoints how long it takes to form a China WFOE.  One put six months and the other put 4-6 months.  These are the figures from start to finish and include the 30-90 days it can take once all documentation has been submitted to the appropriate authorities.

If anyone is assuring you that they can do a WFOE formation in “record time,” run, don’t walk away.  Forming a WFOE in China takes time.  Months of it.

Believe it.

For more on forming a WFOE in China, check out the following:

What are you seeing out there on WFOE formations?

Last week I did a quick post on the leasing requirements for forming a WFOE. That post generated some excellent comments/questions, hence, this Part II.

A couple people asked about the legality of “virtual offices.” 

Virtual offices were once common in China though as far as I know, they have always been 100% improper for a WFOE. WFOEs must have a separate and unique address in a space that is zoned for the business that the WFOE will be do. If it is an office, then a small office will do, but it must have a separate and unique address and a sublease will not work. However, if the WFOE needs more, like a workshop or a warehouse, then that is what must be leased. In Beijing, Shanghai and Guangzhou, for instance, the authorities actually come out and inspect the space and if it is not in compliance with the requirements for a WFOE they will reject the application for the WFOE.

I have received calls from people who have had their WFOE rejected for this very reason and, as I have written previously, once you have your WFOE application rejected (no matter for what reason), it becomes much more difficult ever to get it accepted.

In the old days, companies oftentimes wanted a virtual office in a favorable tax district (e.g., Pudong) and then had their real office in some other district or city.  However, under China’s new tax code this tax reason is no more.

Note also that for the WFOE to be approved, the lease is supposed to be registered and if you are going to get the tax deduction for your lease payments, you need a registered lease and a receipt (a fa piao) from your landlord. I do not see how this can be done if you are using illegal and unregistered space. 

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.

Every couple of weeks my firm gets an email or a phone call from a small business that is seeking to justify forming a Rep Office in China instead of a Wholly Foreign Owned Enterprise (WFOE). These small businesses typically go into advocacy mode explaining why their business can and should be a Rep Office in China. They then go on to explain that they simply cannot afford to form a WFOE in China due to the minimum capital requirements, the legal fees, and the taxes. 

They then want me to condone their Rep Office plans but I never do.

In fact, the increasing number of these requests has caused me to get even blunter than usual, and my most recent response exemplifies this: 

What you are describing doing as part of an RO [Rep Office] is definitely not proper for an RO. Not even close. 

In terms of minimum capital required, because it is Dongguan, it is likely to be pretty high. Sorry. 

You pretty much have two choices. You can operate completely off the grid and risk getting shut down, or you form a WFOE. Probably the worst thing you could do would be to form an RO that operates illegally because they you are just drawing attention to yourself.  

I get the sense that the people contacting us on these things are hoping that they somehow have found THE loophole that nobody else has found and that if only they can get the blessings of an attorney for what they are doing, that their operating illegally will somehow not be illegal. I wish I had some magic oil I could sell (for a helluva lot of money) that I could sprinkle on illegal China businesses to make them legal, but I have no such thing.

Those who think they are going “sorta” legal by forming what is clearly an illegal Rep Office in China are very similar to those who think they are “sorta” protecting themselves legally by doing a “sorta” joint venture with their girlfriend. I wrote about those people in a post, entitled, “Operating Illegally In China. Half-Assing It Does Not Help.” In that post, I described the following email I had recently received from my co-blogger, Steve Dickinson:

We had one of these the other day and it precipitated an email from my co-blogger, Steve Dickinson, to me, which went as follows:

If these people are going to go illegal in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don’t work in China, because you and I have won enough China contract cases to know that they do.

It is because the Chinese judges are totally on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking that somehow they are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember John Smith’s [yes, it is an alias] company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His US LLC [and with it, the China WFOE] were just purchased by _______ [a pretty big name U.S. company]. The reason the purchase was successful is that the whole company was “clean” and therefore it could be purchased by a foreign public company.

I then concluded that post with the following:

As lawyers we are never going to tell our client to go full illegal, but in my role as a blogger, I have to think going full illegal would probably make better sense than paying a lawyer to draft a void contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.

The same holds true with respect to forming a Rep Office when a WFOE is required. Forming the Rep Office in that situation will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE. On top of that, as I am always saying, you should not form a Rep Office with plans to form a WFOE in a year or so “if everything works out.” You should not do this because you will end up paying THREE times as you will pay for forming the Rep Office, pay for shutting down the Rep Office (and this is not cheap), and then pay for forming the WFOE.

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written me to tell me that “so and so” company formation company is willing to form the Rep Office for them, as though this mere fact means that my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE.

For more on what is involved in forming a company in China, check out the following:

Doing business in China? Don’t do it half right because you are only increasing your risk. 

What do you think?