- Legal sense of a WFOE
Are you consider register a WFOE in China? Why so many people do business in China in the name of a company rather than in the name of themselves? It is not just because a company seems more formal but also company always means limited liability. As per Article 3 of Company Law of the People’s Republic of China (2018 Amendment) , A company is an enterprise legal person, which has independent legal person property and enjoys the right to legal person property. It shall bear the liabilities for its debts with all its property. For a limited liability company, a shareholder shall be liable for the company to the extent of the capital contributions it has paid. For a joint stock limited company, a shareholder shall be liable for the company to the extent of the shares it has subscribed to. To this end, a shareholder of a company is legally liable for debt of the company within the scope of the shares it has subscribed in such company, rather than all his or her personal or family assets. The shareholders do not need to worry that if the company goes bankruptcy, his or her personal assets or family assets may gone. The limited liability of a company establishes a barrier for the shareholder preventing unlimited liability for the company’s debt.
While every coin has two sides. Under particular circumstances, the shareholder may undertake unlimited or joint liability from the company’s debt. One-person limited liability company is one of such case. According to Article 63 of Company Law of the People’s Republic of China (2018 Amendment), if the shareholder of a one-person limited liability company is unable to prove that the property of the one-person limited liability company is independent from his own property, he shall bear joint liabilities for the debts of the company.
WFOE is abbreviation for Wholly Foreign Owned Enterprise, which means WFOE is one-person limited liability company. As per the above, the shareholder may be jointly liable for the debts of the WFOE, i.e. WFOE is not limited liability to the shareholder.
2. Types of WFOE
a. If company A is a company registered outside mainland China, and owns 100% of company B, then company B is a WFOE.
b. If Individual A is a non-Chinese citizen, and owns 100 of a company, then such company is a WFOE.
Usually, option a is much easier to prove that the property of the WFOE is independent from the shareholder’s own property, rejecting the joint liabilities for the debts of the WFOE.
If there is no independent financial statement to prove that the shareholder’s personal property is independent of the one-person company(WFEO)’s property, it can be deemed as property confusion and the shareholder shall be jointly liable for the company’s debts. In this regard, option b is much harder to reject the joint liabilities for the debts of the WFOE.
Please refer to: Li Mugen v. Shanghai Jiedong Industrial Co., Ltd sales contract disputes,（2016）沪01民终5055号, Shanghai First Intermediate People’s Court, China Judgements Online, 29th August 2016.
As per the analysis of above, WFOE may not be good form of business for doing business in China. Furthermore, As the new foreign investment law comes into effect, strictly speaking, WFOE, JV(both CJV and EJV) are regulated the same as domestic LLCs, partnership, etc. As for overseas investors, the choice for incorporation of LLC with two or more shareholders, or FILP with one GP and several LPs, will be better options compare with WFOE, if considering the control of unlimited liability issue as well as the tax planning. Please pay attention to our detailed legal analysis in further articles.