Foreign-invested enterprise (FIE) owners and managers who try to dodge their obligations in China may be prosecuted under international and local law in addition to facing civil litigation.

Under the PRC Company Law, an investor’s liability in a limited liability company (LLC) is limited to the extent of that investor’s holdings in the LLC. However, there are exceptions to this rule that LLCs should consider. Due to the global economic crisis, some companies’ management and investors have tried to abandon their responsibilities in China. Workers may show up to work to discover their managers and investors have vanished, leaving unpaid taxes, debts and employee salaries.

In response, the PRC Ministry of Commerce, Ministry of Foreign Affairs, Ministry of Justice and Ministry of Public Security issued November 2008 guidelines on how to pursue FIEs into other jurisdictions. Under the guidelines, when foreign investors try to escape their obligations, any party with legal standing can commence a legal action in a court or petition a district attorney’s office for a criminal investigation. After the case is accepted by court or an investigation opened by the district attorney, the PRC central government will work with the foreign jurisdiction’s government authorities to assist on the service, evidence collection and investigation in accordance with relevant international or bilateral treaties. If the complainants prevail at court, the PRC government will help the claimants enforce the judgment. Furthermore, the guidelines encourage PRC citizens with the legal standing to pursue responsible foreign persons and directly bring action abroad in the home country of the responsible persons. It means that a China-based creditor of an FIE is encouraged by the PRC government to commence actions in the foreign courts with jurisdictions over the investors of the FIE for damages.

The legal basis is that under the PRC Company Law and Supreme People’s Court Interpretation on Certain Issues of PRC Company Law, foreign investors including their management, investors and directors must choose to either dissolve or file bankruptcy for liquidation in accordance with the PRC law when they decide to wind-up the FIE. Closing down a company without completing the insolvency process violates PRC law, and the responsible parties may face sanctions.

The guidelines are intended to remind China-based creditors, local authorities owed funds and employees looking for their salaries that they can pursue management even after they have closed up shop. The guidelines are also a warning to FIE management and investors that they may face litigation and criminal investigations in China and elsewhere if they fail to go through the legal process of winding down a company.

However, through our recent experience, we have discovered PRC courts are unwilling to accept bankruptcy cases. The Shanghai court system has accepted only a few voluntary bankruptcy cases and refused to take many other petitions. Thus, we believe, the PRC government wants to maintain social stability and avoid mass layoffs that insolvency proceedings may lead to. In some cases, the relevant government agencies requested foreign investors to invest more only for the purpose of dissolving the company.

Thus, key management personnel and investors are confronted by two difficult choices if the FIE is insolvent. If they try to follow insolvency procedures, the process is difficult and their petition may not even be accepted. On the other hand, if they choose to close the facility without engaging the insolvency process, they may face civil and criminal liabilities in China or abroad. We strongly recommend FIEs considering these choices consult with a legal professional before taking any action.