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China WFOE. Do It Right Or Your Money Never Leaves.

By Dan Harris and Steve Dickinson

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China Economics Blog used the term, Hotel California effect (borrowing from a scholarly article), to describe the problems foreigners so often have in getting their money out of China. I love that term (both because it so well describes things and because it combines law and music) and I have since used that term many times with clients who insist something in China "must be legal" because so and so did it or because the local government is encouraging them to do it. If my using lyrical symbolism fails, I flat out tell them that, "of course, China will take your money, but the problem will be when you try to take it out." I then tell them of the person who came to us after having sold his condo that he had purchased illegally and having been told by all of the banks that he would not be able to deposit his cash proceeds. I have a speech I give to American lawyers that focuses on the mistakes they tend to make in advising their clients regarding China. One of the foremost is the failure to account for business expenditures in such a way so that they can qualify as expenditures that apply towards the minimum required capital for forming a wholly foreign owned entity (WFOE). I recently received two very similar emails from companies that had failed to abide by China's laws on this. Both were very angry at the Chinese government. I had the not so fun job of telling them the Chinese government was merely following the law; it was their China "consultant" who had failed to comply. Here is an amalgamation of my email correspondence with these two companies, with my having changed things to disguise all identities. First email from American company:

We are an American company that has gone through hell this year trying to set up a ________ business in Sichuan Province. The Chinese lawyer who did this for us is not even returning our calls. We registered as a WOFE with 4.0 million RMB (about $500,000) in start up capital. The money has finally arrived in China and is about to be converted from US dollars to RMB. Needless to say we have spent at awful lot on remodeling and set up including 2.0 million RMB for five years rent up front. The Bank of China has now informed us that they cannot reimburse us any of that because that would mean sending the money back out to a foreigner?s account and that the money is meant to be kept in China. We have tried to explain that the 2.0 million has been spent and went to a local who is renting to us and all we are seeking is to be reimbursed from our own business for the money we put up front. That bank is acting as though it is in charge of our account, not us. How would you proceed in this situation?

Here was my response: Based on the facts you have provided, it appears the bank is merely following very clear Chinese law. We have never been in this situation because we have our clients sign what we call a contingent lease (these are very common in China and generally accepted by landlords) whereby the money gets paid only AFTER the WOFE is formed. I have heard of what you describe happening a few other times and I use it in a lecture I give called The Eight Things Every Lawyer Must Know About China. The way I see it, you have the following choices: 1. Pay a lawyer to see if there is anything you can do here. If there is, it will have been money well spent. 2. Chalk it up to experience. 3. Get a good lawyer in China so this sort of thing does not keep happening because I can assure you that if you do not, it will. The good news though is that you have not really lost any money, you have just lost access to it for a while. But, my big fear here is that you have done it so wrong that you will never be able to take your money out. We had someone who purchased a Shanghai condo illegally and when he sold it for cash, no bank would even take his money. He ended up stuffing ~$450,000 into the mattress at his condo and using it for daily expenditures. But you might consider just letting it go and then just using this money to build up your business. But again, I would be worried about putting more money into the business until you make sure you can get it out at some later date. I am sorry you are in this predicament. Whomever helped you set up your WFOE certainly did you no service here as they completely ignored a fundamental rule regarding funding. Maybe you should contact them and push them to help you get out of this mess they have put you in. For how to form a WFOE in China, check out "Chinese Company Formation -- Forming a Wholly Foreign Owned Entity (WFOE) in China" and "Chinese Company Formation, Part II -- WFOE Minimum Capital Requirements."

Full post as published by China Law Blog on March 22, 2009 (boomark / email).