Approaches to recover debts from a dormant company in Mainland China

When international creditors experience default in payment from debtors, there are various options and means which can be used to pursue recovery, such as the issuance of demand letters, conducting on-site visits, commencing litigation/arbitration proceedings, or applying for winding up proceedings against the debtors. However, due to the current economic downturn in many countries, quite a number of companies stay dormant for debt evasion purposes.

Such companies are often established for a few years already and are gone out of business after owing substantial amount of money. Even though their business licenses might not have been revoked by the government authorities, they have ceased running business. Collecting unpaid debts from these dormant companies can be challenging. This article explores possible measures for creditors looking to recover bad debts from dormant companies in Mainland China.

According to a recent survey, nearly 20% of the debtors were not in operation and cannot be located during legal proceedings. When creditors come across debtors from dormant companies, the dilemma would be: if no legal action is initiated, the claims may soon be time-barred, however, if legal action is commenced, it is very likely that they may not be able to recover any of the unpaid debts. Creditors may end up paying for a huge amount of legal costs without any recovery.

In general, dormant companies have little or no assets, but their shareholders might still have substantial assets. In fact, a company has no assets to pay off debts does not necessarily mean that creditors cannot pursue recovery. There are situations where creditors are able to recover debts from shareholders of the debtor’s companies.

One-person limited liability company

In practice, small companies may set up as one-person limited liability companies (“one-person company”), with only one individual shareholder. If the creditor has a claim against a one-person company for a substantial amount, the individual shareholder can be included as a co-defendant in starting legal action. According to Article 63 of the Chinese Company Law, if its individual shareholder cannot prove that the company’s property is independent of his/her own property, he/she should be held liable for the company’s debts.

Further, if the company’s shareholder is a married couple and the company is established during their marriage, the court may hold that the company is actually a one-person company in the absence of a property division agreement filed with the Administration for Market Regulation (“AMR”) when setting up the company.

Corporate liquidation

Dormant companies usually moves out from their registered address following business suspension. Creditors can then lodge a complaint to the AMR against these companies. It is highly likely that the AMR will order to rectify this situation. If the situation persists, the AMR is able to revoke their business licenses. Creditors can then apply to the relevant court for compulsory liquidation.

However, there might be a possibility that the liquidation proceedings cannot be completed due to the loss or absence of the company’s financial documents since dormant companies might have moved registered addresses to somewhere else. In order to address this issue, Article 18 (2) of Chinese Company Law provides that if a company’s shareholders fail to fulfill their obligations and responsibilities, resulting in the company being unable to be liquidated due to the loss or absence of the company's main property, financial documentation and/or other important documents, the company's creditors will be entitled bring a claim against the shareholders to bear joint and several liability for the company's debts.

Litigation against shareholders

Sometimes shareholder’s limited liability might be a tool for debtors evade debts on purpose. Shareholders of dormant companies might transfer the company’s property to affiliated companies, parent and subsidiary companies.

Creditors may file lawsuits against shareholders of debtors under such situation. Article 20(3) of the Chinese Company Law provides that shareholders of a company who misuse corporate personality to evade debts and harm interests of creditors, should bear joint and several liability for the company debts. This includes:

1. Mixing of companies’ business and their shareholder's business; mixing of companies’ employees and their shareholder's employees, especially the financial staff; and mixing of companies’ premises and their shareholder's premises;
2. Excessive and absolute control of companies by their shareholder, which results in their shareholders’ manipulating companies’ decision-making process and a complete loss of independence;
3. An apparent mismatch between the amount of capital actually invested by shareholders after companies’ establishment and the risks involved in running companies.

Another approach to force a dormant company to pay is to take legal action against its shareholders who have not fulfilled their obligations to pay the company’s registered capital. However, the Chinese Company Law has abolished the minimum amount requirement of registered capital for most companies and the registered capital can be paid in instalments. For example, RMB 10 million registered capital contributions can be paid throughout 10 years. If a dormant company has no funds to repay its debts and the payment of registered capital by its shareholders is not yet due, it is unlikely that creditors will be able to obtain recovery from its shareholders. Article 35 of the Chinese Bankruptcy Law sets out that, after a bankruptcy application has been accepted by a court, if shareholders of the debtor company have not fully accomplished their capital contribution obligation, the administrator can request these shareholders to settle the capital contribution even if their payment obligations are not due.

Debt recovery against dormant companies can be very challenging but with appropriate and well-considered recovery strategy, there are possibilities for creditors to obtain successful recovery. Clyde & Co Westlink JLV has significant debt recovery experience in collecting unpaid debts and account receivables for a wide range of local and multinational corporations across the world. If you would like to understand more about our debt recovery practice in Mainland China, please contact Victor Yang or Francesca Hu.