Op-Ed Commentary: Chris Devonshire-Ellis
Dec. 12 – One of the prevailing issues concerning corporate establishment in China is still that of small consultants suggesting setting up a local Chinese company as a vehicle for a foreigner to get started in China. By a domestic Chinese company we refer not to a FICE, WFOE, or any of the foreign-invested vehicles, but to the practice of setting up a local company with Chinese directors and shareholders, with the foreigner effectively believing he is running the show. It is a false assumption.
There are several reasons why the establishment of a Chinese domestic company as a vehicle to enter the Chinese market may appear attractive. Firstly, the capitalization costs are low, and often licenses for specific scopes of business can be easier to obtain than for a foreign-invested entity. Consequently, for cash-strapped foreigners in China, the opportunity to perhaps get involved with such a company, even to the extent of funding it, may appear attractive at face value. However, the reality is very different.
Foreigners are not permitted to be either directors or shareholders of Chinese domestic companies, so you are effectively signing away any rights to any value in the business completely. It may well be that Chinese “friends” or those linked romantically may suggest such an arrangement. There are also Chinese consultants “offering” services to act as your directors in such businesses. Yet China does not recognize the concept of nominee directors or shareholders, and such promises are not supported under Chinese law.
Unfortunately, over the years we have seen many disputes arise from foreigners working in and having “set up” what then turn out to be Chinese-owned businesses. These have ranged from highly successful bars and restaurants in Shanghai, to entire factories with a workforce of thousands in South China. Despite the foreign party providing the initial investment, hard work, and effort, they have ended up with nothing following the breakdown of the relationship. I have even had divorcing couples screaming at each other in our offices over such disputes. Yet the foreign party has no recourse, and remains at the mercy of the Chinese directors and shareholders. Many have simply been dumped, and seen their efforts come to naught. The message is clear – don’t get involved with such entities if asked to fund them unless you are in a marriage with a Chinese partner that is 100 percent secure.
