Is a business allowed to go dormant?

Whether a company is allowed to remain inactive under PRC law was not clearly regulated by PRC law before March 2022. On March 1, 2022, the PRC Administrative Regulations on Registration of Market Entities entered into force. They state that a market entity is allowed to be inactive, but must meet the respective legal requirements. Please find below an overview of the legal requirements for a company to be inactive under PRC law, along with the relevant legal implications.

Whether a company is allowed to remain inactive under PRC law, i.e. maintain its legal existence, but without carrying out any business operations, was not clearly regulated by the law of the PRC before March 2022. Article 211 of the Company law in the PRC (latest amended version effective as of October 26, 2018) states that the Companies Registration Authority may revoke a company’s business license, if such company has not commenced business for more than 6 months after its establishment or has not exercised any operational activity for more than 6 consecutive months. Section 211 of Company law in the PRC indicates that a company can suspend its activities for a maximum of 6 months without incurring administrative sanctions. However, it does not explicitly allow a business to be inactive. It also does not stipulate any detail on the dormancy of companies.

On March 1, 2022, the PRC Administrative Regulations on Registration of Market Entities promulgated by the State Council of the PRC (“Regulations“) and his Implementation rules promulgated by the PRC State Administration for Market Regulation (“Rules“) entered into force. They provide a clear answer to the above question: a market entity is allowed to be inactive, but must meet the corresponding legal requirements.

In this article, we list the legal requirements for a business to be inactive under PRC law, along with the relevant legal implications.

1. Definition of “market entities”

Pursuant to Article 2 of the Regulation, “market entities” are natural persons, legal persons and organizations of non-legal persons which carry out profit-making commercial activities in the PRC, such as

  • companies, non-societal business legal persons and their branches;
  • sole proprietorship, partnerships and their branches;
  • specialized farmers’ cooperative and their subsidiaries;
  • sole proprietorships;
  • branches of foreign companies; and
  • other market entities stipulated in laws or administrative regulations.

Thus, a company is a market entity for which the provisions on dormancy provided for by the Regulations and Rules apply.

2. Legal requirements for mothballing

According to Article 30 of the Rules and Chapter 6 of the Rules, a company must meet the following legal requirements to enter dormancy (Chinese: 歇业):

  • If a company is experiencing business difficulties caused by a natural disaster, accident or other disaster, public health incident, social security incident, etc. (“Causes of Dormancy“), it may decide to suspend its activity, provided that it negotiates beforehand with its employees the treatment of their employment relationships in accordance with the law and ensures the filing of files with the registration authority which is the market competent supervisory administration at the domicile of the company (“MSA“).
  • The maximum allowed dormancy period is 3 years.

If the company has failed to address the case with the MSA before it goes dormant, the MSA orders the company to handle the case and, for further non-compliance, imposes a fine of up to go up to 50,000 RMB. If the Company continues such non-compliance for more than 6 months without resuming operations or delisting the Company, MSA may, at its discretion, revoke the Company’s license to operate pursuant to Section 211 of the Company law in the PRC. In this case, the company is dissolved and liquidated in accordance with article 180 of the Company law in the PRC.

3. Registered address during dormancy

A duly registered dormant company may waive its registered address and instead use a different address for the delivery of legal documents (Chinese: 法律文件送达地址), provided that such address is specified and completed in the form. request for MSA for dormancy. A filed address for delivery of legal documents will not change the jurisdiction of the originating MSA having jurisdiction over the inactive company. It is only if the company wishes to resume its commercial activity at a place other than its registered office that it must ask the competent MSA to change its registered office.

Based on our anonymous telephone inquiries with a number of MSAs in Shanghai, we understand that the original registered address of a dormant company will remain unchanged and still visible in the company registry, even if the company has requested another address for delivery of legal documents. documents while dormant. However, in this case, it will be possible for another company to “occupy” the registered office of the dormant company if it can conclude a respective lease agreement with the owner.

Thus, a dormant company can terminate its lease contract for its head office to save rent, provided that another address for the delivery of legal documents is filed with the MSA. The risk in this case will be that the company can no longer resume its business activities at its registered address and will have to move to another location.

4. Employees in a period of inactivity

Section 30 of the Regulations requires that before going dormant, the company negotiates with its employees the management of their labor relations in accordance with the law. This formulation is broad and the “management of their employment relationships” can literally be understood as, for example, the modification or termination of their employment contracts. Nevertheless, this article indicates that it is not obligatory that the company lays off all its employees to enter in dormancy. This understanding was verbally confirmed by the MSAs we consulted for reference.

In the event that a business wishes to go dormant, it will normally not need employees (and administrative and financial work can normally be outsourced to external service providers). In this case, the company must appropriately terminate the employment contracts with its employees, either by agreement or by unilateral notice of termination according to the applicable legal grounds for termination and pay legal severance payments to the employees.

5. Resumption of commercial activities

Pursuant to Article 42(1) of the Rules, if the company decides to resume or has in fact resumed its business activities after filing the mothbally, it must make a public announcement on the website of the National System of credit information (http://www.gsxt.gov.cn) within 30 days of its decision or the start of business operations. Further, pursuant to Section 42(2) of the Rules, if the period of inactivity as filed with the MSA has expired or the accumulated period of inactivity has reached 3 years, the company is deemed to have automatically resumed its commercial activities. If, however, the company decides not to resume its commercial activity, it will fulfill in due time the legal formalities of liquidation and deregistration of the company.

6. Reporting obligations during dormancy

Despite the absence of relevant explicit provisions in the Regulations and Rules, we understand that an inactive company must still duly make all reports, filings, declarations, etc. annually or regularly required by law, which mainly include (for example):

  • Annual reports in the National Enterprise Credit Information Publicity System (http://www.gsxt.gov.cn),
  • Tax declaration (even if the inactive company has no tax to pay).

Our understanding was verbally confirmed by the MSAs and tax offices we contacted for a reference request. If the inactive company fails to duly submit an annual report, the MSA must “blacklist the company” in the abnormal business transaction list and may impose a fine of up to RMB 10,000. If the inactive company does not meet the tax reporting requirements and does not submit the tax payment documents within the prescribed period, the tax authorities shall order the taxpayer to make rectifications within a prescribed period and may impose a fine not not exceeding 2,000 RMB to the taxpayer. In serious cases, the tax authorities may impose a fine ranging from RMB 2,000 to RMB 10,000 on the taxpayer.

7. Formalities and practice of the MSA

To request mothballing, a company must prepare and submit to the relevant MSA the following documents:

(1) a “Market Entity Inactivity Registration Application Form”, to be signed by the company’s legal representative and bearing the company’s seal, and

(2) a “Dormancy Registration Commitment Letter”, to be signed by all shareholders of the company.

From our reference inquiries with a number of MSAs in Shanghai, we understand that MSAs will generally approve the filing of a dormancy request as long as the company indicates a cause for dormancy (e.g. business difficulties due to the COVID-19 outbreak). The company only has to fill in the cause of inactivity applicable in the letter of commitment on the filing of an inactivity file without having to provide proof. Therefore, it is quite simple for a company or other market entities to request a hibernation with the relevant MSA. According to information provided by business service provider Qi Cha Cha (www.qcc.com), there are currently about 130 merchant entities registered in Shanghai with “dormant” (Chinese: 歇业) status, of which about 50 are companies.

8. Conclusion

The inactivity provisions in the Regulations and Rules provide investors and companies with a clear legal basis to temporarily suspend their business activities. In our view, these provisions are the response of the PRC legislator to the current epidemic situation which has caused business difficulties in many business entities. These entities, their investors and their managers may need time to observe the market, consider alternative business strategies and obtain funding opportunities when they do not want to incur business losses or additional operational costs and do not want no longer bear the administrative burden of winding up the company. Thus, dormancy is an option for them to have a transition period before deciding whether to resume or stop business completely. If inactivity is being considered, we suggest that investors and managers consider this option thoroughly taking into account the downsides of inactivity, such as loss of business, suppliers and customers, additional costs such as severance pay for employees, fees for external service providers, relocation costs after business recovery, etc. Investors and managers must weigh the economic pros and cons of inactivity to find the best solution for their business.

About Charles D. Goolsby

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