The Chinese limited liability status grand misrepresentation technique
A commonly misunderstood area by foreign investors when assessing the creditworthiness of a Chinese business is the aspect of “Limited Liability Status.” Usually, in the West, this is issued in the form of a cash injection into the business, and can be checked via the public records office. Extending credit then, say of US$1 million, to a company with a limited liability of just US$25,000 may then start to flag up red with your accounts department. It’s a good way of protecting yourself against providing over-credit to customers more likely to default, and also a proven method of assessing risk when providing credit in the form of cash or sales.
All well and good.
However, in China, not only is there no public records office, those pesky China business licenses that state “the amount of registered capital” are prone to inaccuracies as well. As is always the case in China, the devil is in the details.
The registered capital amount as displayed on a Chinese business license also fulfills the same criteria as the limited liability status. So if a business has RMB1 million as its registered capital, the directors are also responsible for that amount of liability. If you want to send product worth US$1 million to a Chinese company, you’d better start assessing the amount of risk in the published registered capital amount shown on the license.
But it doesn’t stop there.
The trick is that when applying for a business license, the Chinese have to state the amount of registered capital required before the company is formed. The application is processed, the business license issued – and it states the required amount. But this doesn’t actually mean it has been paid up. And often, it hasn’t been.
Accordingly, a further check is needed to verify the registered capital amount was in fact paid. This document, a “Capital Verification Report,” has to be issued by a third party Chinese CPA firm cross checking bank statements showing the amount was injected. The false production of such a certificate means the CPA firm can also be liable for fraud.
If the Chinese side can produce this – then the business was capitalized and this can be taken that at the time, they did possess sufficient funding to fulfill their limited liability status. Accordingly the credit risk is reduced.
If they cannot – then the business was never capitalized and that impressive registered capital amount as shown on the business license is meaningless. The credit risk then increases.
It’s these simple checks that can separate a good sale to China from a delinquent sale to China, and they are easy to carry out. Anyone requiring further assistance on credit checks on Chinese companies can contact Dezan Shira & Associates, the firm that publishes China Briefing at firstname.lastname@example.org.