Few people are naturally inclined to contemplate the prospect of divorce when getting married. Nevertheless, in the context of a joint venture with a Chinese partner, it is crucial to address liquidation issues at the outset, both in negotiation and in documentation. Without adequate protection, a foreign investor which wishes to terminate or even reorganise its investment is at the mercy of its joint venture partner and the Chinese authorities.
The Foreign Investment Enterprise Liquidation Procedures, promulgated in June 1996, should supersede previously issued local rules and provide a unified set of provisions that will apply to FIEs nationwide.
Timing
Liquidation according to the procedures may be said to begin as of the date when an enterprise's operations cease, or when its examination and approval authority approves its dissolution, or as decided by the People's Court or arbitrators as the expiry date of the enterprise's contract. The liquidation period will normally last for 180 days, but may be extended by up to 90 days if permission is granted by the approval authority.
A liquidation may follow two routes. One route, 'ordinary' liquidation, is initiated when the Board of Directors (or equivalent body) forms a liquidation committee to handle a liquidation. The committee must be formed within 15 days of the start of liquidation. It should consist of at least three people, led by a committee chairman, and will be charged with the following responsibilities:
* liquidating the FIE's assets, compiling a statement of assets and liabilities and developing a liquidation plan
* notifying creditors
* handling and winding up the enterprise's unfinished business
* providing a basis for assets appraisal and evaluation
* paying off taxes which the enterprise owes to the government
* clearing up claims and paying off debts
* disposing of the enterprise's residual assets after all liabilities have been settled, and
* participating in civil litigation on behalf of the enterprise.
After the liquidation committee is formed, the enterprise must furnish its members with accounting and financial statements, an inventory, lists of creditors and debtors and other relevant materials. The approval authority may send personnel to oversee the work of the committee.
Creditors and settlement
All known creditors must be contacted in writing and notified of the liquidation proceedings. They have 30 days to respond and file claims accompanied by evidentiary materials. If they fail to do so, the procedures appear to indicate that their priority status in the liquidation will be forfeited.
For the benefit of unknown creditors, the committee is required to publish two public notices announcing the liquidation, at least one of which must be in a national newspaper. The first notice must be placed no later than 10 days after the beginning of the liquidation period. Unknown creditors must respond within 90 days of the first notice in order to ensure that their claims are satisfied. If not, they may request to have their claims satisfied if the enterprise's residual assets have not yet been distributed; but once this has happened, they are deemed to have relinquished their claims.
Outstanding obligations must be settled in the following order of priority:
* expenses of managing, selling off and distributing the assets being liquidated
* costs of running public announcements, litigation and arbitration
* other liquidation expenses
* employees' wages and worker insurance premiums
* taxes payable to the government, and 'other' liabilities.
'Other' liabilities include the outstanding balance of any creditors' claims secured on property, where the value of the claim exceeds the revenue generated by the sale of the property.
Any assets remaining after the enterprise has paid off liquidation expenses and cleared all liabilities should be distributed to the enterprise partners in the proportion in which they made their investments, unless otherwise stipulated by law, administrative rules and regulations or in the enterprise's articles of association.
Special liquidation
Problems can arise if the partners to a joint venture disagree as to whether it should be liquidated. In the past, this could preclude liquidation altogether, since unanimous approval from the Board of Directors was necessary to start liquidation proceedings. So, where the Chinese partner balked at liquidation, the foreign investor faced a choice between negotiating an often unsatisfactory buyout or simply abandoning its investment altogether.
The procedures offer a route from this and other obstacles, namely 'special' liquidation ? the option of obtaining an arbitration or litigation decision in favour of liquidation, either of which would mandate the cooperation of the recalcitrant partner in the liquidation process. Unfortunately, to adopt this route requires the consent of the approval authority which, not being obliged to grant consent, is likely to side with the Chinese partner in any dispute.
Because the procedures do not concentrate on the rights of the parties or the enterprise to assets and obligations in respect of liabilities, they do not remove the need for careful drafting in constitutional documents. Foreign investors still need to structure their enterprise so that they can extract full value for the assets they contribute and are protected from liabilities. They must also provide separately for any alternative exits to liquidation, such as forced buyout or bring-along. Nevertheless, the procedures do mark an improvement in China's enterprise regulation regime.
Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For further details, contact Matthew Cosans through its offices in Hong Kong, tel: (852) 2846 3400 or Beijing tel: (86) 10 6465 4795.