Registered Capital in China and Extending Credit

March 16, 2011 Posted by China Briefing Reading Time: 2 minutes

China due diligence when extending credit terms

Op-Ed Commentary: Chris Devonshire-Ellis

Mar. 16 – As is relatively well known, the limited liability status of a company registered in China is the same amount as its registered capital. This amount, which can vary considerably depending upon industry, is identified on the issued business license, as we showed in a recent article China Due Diligence You Can Conduct Yourself.

The problem with this mechanism is twofold, and especially as concerns local Chinese companies:

The business license, with the registered capital amount denoted, is issued prior to the registered capital amount actually being injected. The reason for this is that the license is required to establish the bank account. Chinese law states that the registered capital should be injected, however on occasion it is not, providing the business with the façade of having been capitalized when in fact it hasn’t.
Chinese law also dictates that registered capital, when injected, can be used to pay down against operating costs. Accordingly, many companies do this, and although the registered capital amount still appears on the business license, the actual capitalization may no longer be in the company.

To get around these problems, an additional step must be undertaken by any supplier wishing to extend credit terms to a Chinese buyer. Once the registered capital has been injected, all companies in China are required to provide an additional document, the Capital Verification Certificate. All businesses must have this (although that doesn’t prevent some from not obtaining one). The Capital Verification Certificate then indicates that at least the money was injected, and is recognition of the financial extent of the limited liability.

Of course, this doesn’t mean that the business may not have subsequently used the registered capital in operating costs – it is common to do so. However, should you wish to further examine the extent of the company finances, it is possible (and good due diligence practice) to request from the buyer a new Capital Verification Certificate. All he has to do is ask his bank, it’s the equivalent of asking for a bank reference. For obvious reasons, should one not be forthcoming, the extension of credit to that particular company may then be questionable.

Registered capital amounts on business licenses therefore do not necessarily indicate the extent of actual capitalization. Additional checks, and crucially, the Capital Verification Certificate, should also be undertaken and obtained.

Chris Devonshire-Ellis is the principal of Dezan Shira & Associates, China’s largest independent foreign investment practice. The firm maintains 10 offices in China and was established in 1992. For advice concerning due diligence in China, corporate establishment and tax/accounting matters, please email the firm at info@dezshira.com, visit the practice at www.dezshira.com or download the firm’s brochure here.