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Introduction: Why Verification Matters
Doing business in China without verifying your counterpart exposes you to serious risks. These include fraud, non-performance, disputes over contract enforcement, loss of funds, reputational damage, and legal entanglements. Even if a company presents itself as legitimate, hidden issues like insolvency, undisclosed litigation, licensing gaps, or regulatory violations can derail partnerships.
Small businesses, startups, and international investors entering China for manufacturing, sourcing, distribution, investment, or strategic partnerships are often resource-constrained and cannot afford major legal or financial setbacks. A rigorous, structured due diligence process helps ensure that the Chinese partner is reliable, legally qualified, financially sound, and operationally aligned with business goals.
Key Areas of Legal Due Diligence in China
A comprehensive due diligence process should cover the following dimensions:
1. Corporate Due Existence and Legitimacy
Before moving forward with any agreement or transaction, it is essential to confirm that the Chinese company you’re dealing with is legally established, validly registered, and authorized to conduct business in its claimed capacity. This foundational check ensures that you are not transacting with a fraudulent, unlicensed, or defunct entity—which could invalidate your contract or expose you to legal and financial risks.
Business License (营业执照)
In China, the business license is the official government-issued document that confirms a company's legal registration. Every legitimate Chinese business must obtain one from the local branch of the State Administration for Market Regulation (SAMR). The license includes key information such as:
- Company name (in Chinese)
- Unified Social Credit Code (USCC) — a unique 18-digit ID number
- Legal representative
- Registered capital
- Business scope
- Type of legal entity
- Date of establishment and expiration (if any)
- Registered address
Why it matters: This license proves the company is allowed to operate. Any inconsistencies—such as a mismatch between the name on the license and what the company uses in communication—should be treated as a warning sign. Also, companies operating outside their approved business scope (经营范围) may face legal sanctions, and contracts in such areas could be unenforceable.
How to check: Always ask for a scanned or certified copy of the business license and compare it with official records from NECIPS (see below). Be especially cautious with expired or revoked licenses, or those with recent amendments that are not disclosed to you.
NECIPS Search (国家企业信用信息公示系统)
The National Enterprise Credit Information Publicity System (www.gsxt.gov.cn) is China’s central online platform for corporate registration and compliance records. It is publicly accessible (in Mandarin), and you can search by company name or USCC.
A NECIPS search can reveal:
- Legal existence and current operating status (active, revoked, liquidated, etc.)
- Full company profile including address, business scope, and capital
- Filing history, including annual reports and tax compliance
- Key personnel, including legal representative, directors, and supervisors
- Historical changes (e.g. name, address, shareholder structure)
- Records of administrative penalties or blacklisting
Why it matters: NECIPS is the official source of truth. If a company is not found or listed as “revoked” (吊销) or “cancelled” (注销), it is no longer legally valid. Discrepancies between the company’s provided information and NECIPS records can indicate misrepresentation or out-of-date documentation.
Pro tip: Check for frequent changes in legal representative or registered capital, which could suggest instability or internal disputes.
Articles of Association (公司章程)
The Articles of Association is the internal governance document filed with the company’s initial registration. It lays out the rules and procedures for:
- How major decisions are made (e.g. investment, financing, M&A)
- Rights and obligations of shareholders
- Powers and responsibilities of directors and executives
- Voting mechanisms and approval thresholds
- Capital contribution timelines and structures
Why it matters: This document reveals how the company is governed and who has decision-making power. This is especially important in deals involving equity participation, joint ventures, or long-term partnerships where governance rights and approval authority come into play. It also helps clarify whether the person you are negotiating with has the power to bind the company legally.
How to obtain: The Articles are not always publicly available, but they can be requested during due diligence or accessed via legal counsel with the company’s consent. For higher-stake transactions, insist on reviewing a copy and verify its alignment with your deal structure.
2. Good Standing and Operational Status
Verifying that a Chinese company is not only legally registered but also in good operational standing is a crucial step in assessing whether it can fulfill its contractual obligations. Even if a company exists on paper, it may be inactive, suspended by authorities, or falling behind on compliance requirements—all of which could lead to default or legal complications down the road.
Operational Continuity (经营状态)
A company’s operational status is a key indicator of whether it is actively conducting business. On the NECIPS platform, this is typically listed as one of the following:
- 正常 (Active / Normal operations)
- 吊销 (Revoked)
- 注销 (Cancelled / Deregistered)
- 停业 (Suspended)
Why it matters: Only companies listed as “normal” are in good standing to engage in business transactions. If the company’s status is “revoked” or “cancelled,” it no longer has legal capacity to enter into new contracts, and any agreement you sign may be invalid or unenforceable. A “suspended” status could indicate financial distress, pending restructuring, or regulatory enforcement.
How to check: You can find this information on the company’s NECIPS profile. If the status is anything other than “normal,” seek clarification from the company and legal advice before proceeding. Pay attention to how long the company has maintained this status and whether there have been any recent changes.
Pro tip: A company that was recently reinstated or re-registered under a new name might be attempting to distance itself from prior liabilities. Historical records on NECIPS will help uncover such changes.
Annual Filings and Tax Compliance (年度报告与纳税记录)
Chinese companies are required to submit annual reports (年度报告) to the Administration for Market Regulation (AMR) and disclose key financial and operational details. These reports are available on NECIPS and include:
- Confirmation of registered capital
- Number of employees
- Business revenue (if voluntarily disclosed)
- Information about key shareholders and any changes
- Taxpayer compliance status
Why it matters: Consistent and timely filings indicate a company’s commitment to compliance and transparency. A company that fails to submit annual reports may be flagged as “abnormal” (经营异常), making it harder to participate in tenders, financing, or cross-border transactions.
How to check: On NECIPS, look under the section for “Annual Reports” (年度报告) and ensure reports were filed for each calendar year. Incomplete or missing reports are red flags, especially if the company has been operating for several years.
Pro tip: You can also check whether the company has been placed on the “Abnormal Business Operations List” (经营异常名录), which indicates failure to meet mandatory filing or information disclosure requirements. Such companies are often denied access to financing and government procurement.
3. Industry-Specific Licenses and Permits
In China, many sectors are considered regulated industries, meaning that companies operating in these areas must obtain special permits or approvals in addition to their standard business license. These industry-specific licenses are not merely procedural—they are legal prerequisites for the company to operate lawfully within a particular sector. Failure to hold the appropriate license can result in fines, forced suspension, or even criminal penalties, and may render your contract invalid or unenforceable.
Regulated Sectors Requiring Additional Licenses
Common examples of regulated industries include:
- Education (especially foreign language schools or training centers)
- Pharmaceuticals and medical devices
- Food and beverage manufacturing or distribution
- Cross-border e-commerce
- Logistics, warehousing, and freight forwarding
- Fintech, payments, and insurance
- Telecommunications and value-added internet services
Why it matters: A company may appear to operate normally, but without a valid industry license, it is technically operating illegally. For example, a logistics company without a transportation permit cannot legally handle freight, and a software platform offering paid services in China may require an ICP (Internet Content Provider) license.
What this means for you: If you rely on the company to fulfill a regulated function—such as distributing your medical product, storing your goods, or processing data—you could be exposed to downstream regulatory enforcement or non-performance risk if their license is revoked or never issued.
How to Validate Industry Licenses
- Ask for the license directly: Reputable companies should be willing to provide a scanned or hard copy of their sector-specific license, especially during due diligence.
- Check for license numbers online: Most legitimate companies will list license numbers on their websites, marketing materials, or contracts. For instance, a website in China must display its ICP license at the bottom of the homepage (e.g. 京ICP备12345678号).
- Search regulator databases: Depending on the industry, you can cross-check the license with the relevant regulatory authority’s website. Examples include:
- SAMR (State Administration for Market Regulation) – food, pharma, advertising
- MIIT (Ministry of Industry and Information Technology) – telecom, software, ICP licenses
- NMPA (National Medical Products Administration) – medical devices and pharmaceuticals
- Ministry of Education – training and private schools
- Ministry of Transport – logistics and warehousing
Pro tip: Be wary of licenses that are narrowly scoped, recently issued, or close to expiration. Also, check if the license is in the exact company name (not a parent or affiliate), as licenses are not transferable.
Consequences of Missing or Invalid Licenses
- Contract risks: Under Chinese law, a contract involving illegal operations (e.g., a company acting beyond its licensed scope) may be held void, meaning it cannot be enforced in court.
- Regulatory enforcement: If you are working closely with a company that violates local licensing laws, your business may be scrutinized by Chinese regulators—even if you’re based abroad.
- Reputational and compliance exposure: Especially for publicly funded startups, investors, or businesses under AML/KYC scrutiny, working with an unlicensed operator can raise red flags during audits or reviews.
Special Note: VIE Structures and Licensing Risks
Many companies operating in restricted sectors in China—such as telecommunications, online education, video streaming, fintech, and other TMT-related areas—are not allowed to be directly owned or controlled by foreign entities. To circumvent these restrictions, some Chinese businesses (especially those listed on U.S. exchanges like NASDAQ or NYSE) adopt a Variable Interest Entity (VIE) structure.
Under this model:
- A Chinese domestic company holds the necessary licenses and regulatory approvals.
- A foreign-listed holding company enters into contractual arrangements to control and receive profits from the licensed domestic company, without owning it outright.
Why it matters: While widely used, the VIE structure does not provide legal ownership of the core operating assets or licenses. This creates a layer of legal and regulatory risk—particularly if the PRC government changes its stance on enforcement or deems certain contracts invalid.
Implications for foreign investors:
- Even if you are investing in a Chinese company via a foreign listing (e.g., ADRs on NASDAQ), if that company relies on a VIE structure, it may not directly hold the required licenses to operate in its core business.
- As part of your due diligence, it is prudent—if feasible—to request clarity on which entity actually holds the relevant license in China, and whether the control relationship is purely contractual or based on equity ownership.
- Also consider reviewing the contractual framework of the VIE arrangement (e.g., equity pledge agreements, loan agreements, power of attorney) for enforceability under PRC law.
Pro tip: While VIE structures are still common, they are now subject to increasing regulatory disclosure requirements and legal uncertainties—especially in sectors deemed “sensitive” by the Chinese government.
4. Litigation History and Legal Risks
Reviewing a company’s litigation history is one of the most direct ways to assess its past conduct, legal compliance, and overall credibility. While legal disputes can happen to any business, patterns, frequency, and the nature of those disputes often tell a deeper story about a company’s risk profile—and whether it’s a trustworthy counterparty for your business.
Frequent Lawsuits and Repeated Litigation
One or two isolated legal disputes may be normal for an active business. But a high volume or regular involvement in lawsuits, especially within a short period, should raise red flags.
Why it matters: Frequent litigation could indicate that the company:
- Has poor contractual discipline (e.g., often fails to meet obligations or deliverables)
- Is financially unstable and regularly sued by creditors or suppliers
- Engages in risky or aggressive business practices
- Has weak internal controls or governance
What to check: Depending on the nature of your transaction, your due diligence should establish a reasonable threshold for investigation. This threshold may vary depending on the size of the deal, nature of the business, and your risk tolerance. For example, a $20,000 supplier contract may not warrant digging into minor claims, but a multi-million dollar acquisition certainly would.
Access to Litigation Records in China
In practice, litigation and arbitration records in China are not always publicly accessible, particularly for foreign parties. Many court cases are not published online, and arbitration awards are generally confidential.
Why it matters: Relying solely on online databases may give you an incomplete picture. Important disputes—especially those settled privately or under arbitration—could be missed.
Recommendation: If there is any reason to believe the target has been involved in disputes, or if the transaction involves substantial risk, it is advisable to engage a qualified local lawyer. A lawyer in China can request additional case information, interpret local court disclosures, and assess the real impact of past or pending litigation on your deal.
Nature and Type of Legal Disputes
The specific categories of litigation the company is involved in can offer insight into operational or ethical weaknesses.
Examples of high-risk litigation types include:
- Labor disputes: Frequent disputes over wages, wrongful termination, or benefits may point to labor law non-compliance or poor HR management—critical if you plan to engage with the company operationally.
- Product liability: Lawsuits involving defective or unsafe products can be especially risky for e-commerce, manufacturing, or supply chain partnerships.
- Fraud or misrepresentation: These cases suggest serious credibility concerns and a high likelihood of reputational or financial damage.
- Intellectual property disputes: If the company is often involved in IP conflicts, it may have a history of infringement, unauthorized use, or weak internal IP policies.
Dishonest Judgment Debtor List (失信被执行人名单)
This is a publicly available list maintained by China’s Supreme People’s Court that identifies individuals or companies who have been ordered by a court to fulfill an obligation (such as a payment or action) and have refused to comply despite having the ability to do so.
Why it matters: Being on this list signals that the company—or its legal representative—is not just involved in a dispute, but is actively defying legal obligations. This is a serious issue for any potential business partner, as it reflects not only financial risk but a disregard for legal enforcement and integrity.
Consequences for companies on the list include:
- Restrictions on high-value expenditures (e.g., travel, flights, luxury consumption)
- Limitations on participating in government procurement, public tenders, or receiving government support
- Reputational damage and lowered credit standing
- Increased difficulty in accessing financing or foreign trade approvals
How to check: Visit the China Enforcement Information Online website to search by company or legal representative’s name (in Mandarin). A local lawyer can assist with targeted searches and accurate interpretation.
Don’t Forget Key Individuals: Legal Rep, Shareholders, and Directors
In some cases, especially in high-stakes transactions, it is also important to conduct background checks on the company’s key shareholders, legal representative, and senior executives or directors.
Why it matters: In China, the legal representative holds broad authority and is personally liable for many company acts. If this person—or any key stakeholder—is involved in litigation or listed as a dishonest judgment debtor, it could seriously affect the company’s credibility, ability to execute contracts, or access financing.
What to check:
- Search the Dishonest Judgment Debtor List for individuals tied to the company.
- Ask your local counsel to review litigation involving those individuals.
- Assess whether the person’s track record aligns with good business practices.
5. Regulatory Compliance and Government Penalties
Legal due diligence should go beyond litigation history to include a review of administrative enforcement actions and penalties imposed by government regulators. While lawsuits are often pursued by private parties, regulatory actions are initiated by the authorities themselves and can indicate systemic compliance failures, weak governance, or industry-specific legal breaches that might affect your business relationship.
Administrative Penalties and Public Enforcement Records
In China, a wide range of government agencies—such as the State Administration for Market Regulation (SAMR), Ministry of Ecology and Environment, Customs, Tax Bureau, and sector-specific authorities—have the power to impose administrative punishments on companies.
These punishments may include:
- Fines
- Business suspension orders
- Product recalls or destruction
- Revocation of permits or licenses
- Public censure or blacklisting
Why it matters: A company may appear to be operating normally, but repeated or serious regulatory penalties may indicate ongoing non-compliance with industry laws or ethical lapses. This is particularly important if the company is part of your supply chain or handling regulated goods or services on your behalf.
How to check: Administrative penalties are often published on:
- NECIPS (for general company-wide penalties)
- Industry-specific regulator websites (e.g., NMPA for pharmaceuticals, MIIT for telecom, MEE for environmental issues)
- Local AMR websites, which often list penalties imposed on companies in their jurisdiction
Because these databases are in Mandarin and not centralized, a local lawyer can be especially helpful in conducting this type of review efficiently and comprehensively.
Red Flags and High-Risk Violation Types
Certain types of regulatory breaches carry heightened risk—both legally and reputationally—especially for international businesses:
• Data privacy and cybersecurity violations:
With China’s increasingly strict data protection regime (including the Personal Information Protection Law, or PIPL), penalties in this area can lead to suspended apps, shut-down websites, and bans on handling user data.
• Environmental breaches:
Fines or shutdown orders for pollution or unsafe waste disposal are not only reputationally damaging, but may indicate poor internal risk controls—especially important for manufacturers or suppliers handling hazardous materials.
• Customs and export/import compliance:
Penalties for mislabeling, tariff evasion, or unlicensed import/export activities can result in shipment seizures or supply chain delays, which may affect your ability to fulfill orders or avoid customs audits in your own country.
• False advertising and consumer protection:
This is particularly relevant if the company is selling your products or acting as a distributor in China. Repeated violations of consumer protection laws may signal high refund rates, customer complaints, or unethical sales practices.
Pro tip: One-off penalties for minor administrative oversights may not be deal breakers—but repeated or unresolved penalties involving serious issues (e.g., product safety, environmental violations, fraud) are strong indicators to either renegotiate terms, increase contract protections, or walk away.
Importance of a Compliance Culture
Even a technically “compliant” company can pose a risk if it operates with a reactive or minimal compliance mindset. Reviewing administrative penalty history gives you insight into the company’s overall compliance culture—do they proactively prevent risks, or only respond when caught?
In higher-risk industries, or where the company is handling sensitive goods, data, or customer relationships on your behalf, this insight can be essential in deciding whether to proceed with the partnership or investment.
6. Employment Issues and Labor Disputes
Labor-related risks are often underestimated in cross-border transactions, but in China they can quickly escalate into legal, financial, and reputational liabilities—particularly in acquisitions, joint ventures (JVs), or operations involving staff secondment. For deals that involve integration with, or reliance on, the target’s workforce, employment due diligence is critical to understanding hidden obligations, compliance gaps, and the risk of post-deal disputes.
Labor Dispute Checks and Case History
Labor disputes can be reviewed by checking public databases such as China Judgments Online (裁判文书网) or through more thorough searches conducted by local counsel. These cases typically involve:
- Unpaid wages or bonuses
- Wrongful termination or forced resignation
- Failure to provide labor contracts
- Social insurance disputes
- Discrimination or harassment claims
Why it matters: A pattern of labor disputes may suggest:
- Chronic non-compliance with PRC labor laws
- Poor HR management or toxic workplace culture
- Financial stress (e.g., inability to pay staff on time)
- Increased likelihood of staff turnover, strikes, or post-closing claims
What to do: If the company has faced multiple labor lawsuits in recent years, ask for clarification during the due diligence process. In an acquisition or JV, these disputes may not only damage morale but also result in inherited liabilities.
HR Compliance Review: Payroll, Benefits, and Contracts
Chinese labor law is highly protective of employee rights. Even if no lawsuits are currently pending, a company may still be non-compliant in ways that can cause future problems. A compliance audit should include checks on:
• Employment contracts: Are written contracts signed with all full-time employees, as required by law? Contracts must be in Chinese and clearly define duties, compensation, probation terms, and termination clauses.
• Social insurance contributions: Employers must contribute to the “five insurances and one housing fund” (pension, medical, unemployment, work-related injury, maternity, and housing fund). Underpayment or non-payment is a common issue with SMEs.
• Payroll practices: Ensure wages are paid regularly and in compliance with local minimum wage laws. Also check for proper withholding and tax reporting.
• Use of dispatch workers or part-time staff: Excessive reliance on staffing agencies or improperly classified workers can be a red flag, as this often circumvents obligations around benefits and job security.
Why it matters: Labor violations can trigger government audits, administrative penalties, and sudden employee claims—especially when there’s a change in ownership or business restructuring. If employees feel their rights are compromised, they may sue or report the company to local labor authorities.
Additional Considerations in M&A or JV Scenarios
• Employee transfers: In an asset deal or restructuring, the acquiring party may need to renegotiate or re-sign labor contracts with transferred staff. This process requires advance planning and can trigger resistance or claims if not handled properly.
• Severance obligations: If a reduction in workforce is anticipated, the acquiring company may be responsible for severance payments or damages, depending on how the deal is structured.
• Collective agreements or union involvement: While not as common in private enterprises, if the company has signed collective agreements, those obligations may carry over in a merger or acquisition.
Pro tip: SMEs in China often cut corners to reduce labor costs, especially in competitive industries. Even if employees don’t currently complain, that doesn’t mean the company is in full compliance. Silent risks can surface after a deal closes—particularly when employees see a foreign party stepping in.
Employee Stock Ownership Plans (ESOPs) and Equity Incentives
In recent years, it has become increasingly common for private companies in China—especially in the tech, e-commerce, biotech, and venture-backed startup sectors—to implement employee equity incentive plans. These often include phantom equity, share options, or promises of future equity to attract and retain key talent.
Why it matters:
- ESOPs create future ownership dilution that needs to be factored into valuation and cap table modeling.
- Poorly documented or informally promised equity incentives can create employment disputes, especially during M&A, listing preparations, or internal reorganizations.
- If the incentive pool is not properly accounted for in governance documents (e.g., board resolutions, Articles of Association), it may be legally unenforceable—or worse, trigger retroactive claims from employees.
Common risks include:
- Oral promises or side letters made to key staff without proper board or shareholder approval
- Unregistered option plans or incentive pools that contradict what’s filed with the AMR
- Lack of clarity on vesting schedules, termination clauses, or treatment in change-of-control scenarios
- ESOPs structured through offshore entities (e.g., Cayman or HK holding companies), making it harder to determine which entity actually issues the options
What to review during due diligence:
- Full list of current and proposed ESOP participants, with grant amounts and vesting terms
- Governing documents (e.g., ESOP plan rules, option agreements, shareholder or board resolutions)
- Any prior employee disputes related to unfulfilled equity incentives
- Whether tax and reporting obligations have been met under Chinese law
Pro tip: In cross-border M&A, clarify how employee equity will be treated post-closing—will it be assumed, cancelled, or converted into options in the acquirer? Mismanaging this can result in talent loss or legal disputes.
7. Asset Review and Onsite Due Diligence
When entering into transactions that involve equity ownership, joint ventures, or reliance on tangible or intangible assets, verifying what the company actually owns—and how those assets are used—is essential. In many Chinese companies, especially private SMEs, record-keeping can be informal, and public disclosures may not reflect actual business operations. A combination of document-based review and onsite inspections provides a fuller picture of operational reality and risk exposure.
Confirm Legal Ownership of Core Assets
Start by identifying and verifying all material assets that are critical to the business. This includes:
• Real estate: Ownership of office buildings, warehouses, or factories must be verified through the local real estate registration bureau. In many cases, SMEs operate out of leased or unregistered premises—ensure the lease is valid and transferrable, and that land use rights (if applicable) are properly held.
• Machinery and equipment: Review fixed asset lists and cross-check them with invoices, photos, and physical inspections. Be cautious of inflated asset values or overreported equipment utilization.
• Inventory and raw materials: For trading or manufacturing businesses, it’s important to verify stock levels, ownership (especially for consigned goods), and warehouse conditions.
• Accounts receivable and payables: For financial DD, validate the aging of receivables and the credibility of key customers. Also assess whether payables to suppliers pose short-term liquidity risks.
Why it matters: If a company claims ownership of an asset it doesn’t legally control—or if key equipment is heavily encumbered—you may face serious execution risks or legal disputes post-deal. For example, acquiring a manufacturer without verified equipment or land use rights can delay production, void permits, or create regulatory violations.
Onsite Inspections: Seeing Is Believing
In China, the value of a site visit cannot be overstated. What you find onsite may differ dramatically from what appears in documents or slide decks.
What to observe during a site visit:
- Office and factory occupancy: Are staff physically present? Is the operation active and aligned with the company’s business scope?
- Equipment usage: Are machines functioning and maintained? Or is the site underused or idle?
- Employee headcount and morale: Observe employee numbers, uniforms, workstation use, and workplace culture—all of which help verify real scale of operations.
- Logistics infrastructure: For logistics or warehousing businesses, verify delivery capacity, storage conditions, and movement of goods.
Why it matters: Onsite due diligence is particularly valuable when dealing with SMEs, where disclosure is often less formal and risks are more hidden. A polished PPT or website may not reveal empty facilities or borrowed equipment.
Pro tip: Conduct unannounced or semi-surprise visits if the business relationship allows. Scheduled visits often present a curated version of reality.
Intellectual Property (IP) Ownership
For tech-driven, product-based, or consumer brands, IP assets are a core part of enterprise value. Confirm the following:
• Trademarks: Search the China Trademark Office (CTMO) database for trademarks registered under the company’s name. Watch for brand names that are used but not legally owned by the entity you’re dealing with.
• Patents and utility models: Check with the China National Intellectual Property Administration (CNIPA) to verify ownership and status (granted, expired, or under review).
• Copyrighted software or content: Ensure software used in operations or provided to customers is either properly licensed or registered by the company.
Why it matters: In cross-border licensing, SaaS, manufacturing, or consumer goods deals, lack of IP ownership can cause disputes, invalidate contracts, or create barriers to enforcement. In some cases, the key IP might be owned by an affiliate or individual shareholder, not the operating company—creating hidden dependencies and legal ambiguity.
Recommendation: Ask for a full IP asset list and proof of ownership or licensing. Have a lawyer verify ownership registrations and confirm there are no third-party claims or co-ownership issues.
Watch for Mortgaged or Encumbered Assets
In many Chinese companies—especially private enterprises—core assets may be pledged as collateral for loans or guarantees. These pledges may not be visible from a basic asset list or even a standard balance sheet.
Common examples of encumbered assets include:
- Real estate mortgaged to banks or guarantee institutions
- Machinery and production lines pledged under asset-backed loans
- Registered trademarks or patents pledged to secure financing
- Company shares pledged by shareholders as personal or corporate guarantees
Why it matters: If assets are encumbered and you are unaware of it:
- You may have no priority claim to those assets in case of liquidation or dispute.
- Equity investors could find that the company’s shares are already pledged to creditors—potentially restricting transferability or voting power.
- If pledged IP or machinery is seized due to default, it may disrupt your planned operations, licensing, or fulfillment.
How to check:
- Real estate and asset pledges can be found in local real estate bureaus or asset pledge registries.
- Trademark and IP pledges are recorded with CNIPA and can be searched by a lawyer.
- Equity pledges are recorded with the AMR (Administration for Market Regulation) and are accessible via NECIPS or by legal request.
Pro tip: Even if you’re not acquiring the assets directly, encumbrances can still expose you to indirect risk—especially if the company’s ability to perform is dependent on retaining control over those assets.
8. Management and Shareholding Structure
Understanding who ultimately controls, owns, and manages a Chinese company is essential for assessing governance risks, decision-making authority, and legal accountability. This is especially important for foreign investors entering joint ventures, strategic partnerships, or M&A transactions, where visibility into control dynamics can make or break deal execution and post-deal success.
Identify the Legal Representative and Directors
In China, the legal representative (法定代表人) is a unique role with broad authority under PRC law. This individual—not the board or shareholders—has the legal power to bind the company in contracts, regulatory filings, and litigation. They may or may not be a shareholder or senior executive.
Why it matters:
- The legal rep’s actions are presumed to be on behalf of the company, unless proven otherwise.
- If the legal rep has a history of litigation, non-compliance, or is listed on the Dishonest Judgment Debtor List, it creates significant trust and enforcement risk.
Also identify the directors, general manager, and supervisors. Directors influence strategic direction, while supervisors monitor legality and compliance—especially relevant in SOEs and large private companies.
Map Out the Shareholding Structure
Request and review a detailed shareholder chart, showing not only direct shareholders, but also indirect ownership through intermediate holding companies or nominee arrangements. Pay attention to:
- Equity distribution (majority vs. minority shareholders)
- Voting rights and governance mechanisms (e.g., supermajority clauses)
- Presence of offshore holding entities or trusts
- Unusual or frequent changes in shareholding
Why it matters: The true controlling party (实际控制人) may not be immediately visible—especially in companies that have undergone complex restructuring or financing rounds. Without transparency on who holds real power, you may face hidden risks, delayed approvals, or conflicting interests in JV or board decisions.
Red flags to watch for:
- Nominee shareholders (代持人) who may not act independently
- Multiple offshore layers that obscure beneficial ownership
- Sudden or unexplained recent transfers of shares
Check for Pledges Over Shares
In China, shareholders can pledge their equity interest as collateral for loans. These share pledges are registered with the AMR (Administration for Market Regulation) and can be searched through NECIPS.
Why it matters:
- If shares are pledged, the shareholder may lose voting rights or control in case of default.
- The company could be indirectly affected if lenders enforce the pledge or seek to influence company operations.
- For new investors or partners, share pledges may complicate equity transfers or introduce third-party risks.
Tip: During due diligence, request a confirmation of whether any equity is subject to a pledge, judicial freeze, or dispute. Engage a local lawyer to check AMR records and identify unregistered arrangements.
Review Capital Contributions and Registered Capital
In China, each company has a registered capital amount (注册资本), which is the total investment shareholders commit to contribute. It is a key indicator of a company’s financial baseline and shareholder responsibility.
Key considerations include:
- Has the registered capital been fully contributed?
- Are any contributions overdue under the Articles of Association?
- Were contributions made in cash or in-kind (e.g., IP or equipment)?
Why it matters: If the company or its shareholders fail to contribute the committed capital on time, it can result in liability to creditors, regulatory penalties, or reduced protection in disputes.
For a deeper dive into registered capital obligations, contribution timelines, and the changes under China’s new Company Law in 2024, we recommend reading our companion blog: China Registered Capital: What SMEs Must Know Under the 2024 Company Law
Review Previous Rounds of Equity Financing and Convertible Instruments
For companies that have raised funds from outside investors—whether through formal equity financing, convertible debt, or hybrid instruments—it's essential to review the full history and terms of these transactions. This includes SAFEs (Simple Agreements for Future Equity), convertible loan agreements, and equity subscription contracts.
Why it matters:
- These instruments often come with conversion rights, valuation caps, discount mechanisms, or triggers (such as financing thresholds or IPO events).
- If not properly disclosed or documented, they may lead to unexpected share dilution, control shifts, or conflicting investor rights that complicate your transaction or valuation.
- Some convertible instruments may have already matured and triggered equity issuance, but not yet been reflected in the official AMR records.
What to do:
- Request full documentation of past financing rounds and any convertible agreements, including board or shareholder resolutions approving them.
- Ask whether any conversion has occurred or is pending, and how it affects the current cap table.
- Cross-check whether the issued shares match what’s recorded in official filings.
Assess Investor Shareholder Rights
Professional investors (e.g., VCs, private equity, institutional funds) often negotiate special shareholder rights—even if they hold a minority stake. These rights may include:
- Board seats or observer rights
- Veto rights on key decisions (M&A, dividends, business scope changes)
- Liquidation preferences or anti-dilution protections
- Preemptive rights, tag-along or drag-along rights
- Information and inspection rights
Why it matters:
- These provisions may give minority investors disproportionate influence, which can restrict your operational flexibility or slow post-deal execution.
- In joint ventures or secondary acquisitions, such rights can impact governance, exit terms, or dividend distributions.
Pro tip: Carefully review the company’s Articles of Association and shareholders’ agreements to identify any embedded rights held by institutional or strategic investors. Pay attention to any terms that survive a change of control or that require consent from specific shareholders.
9. AML/KYC and Enhanced Due Diligence (EDD)
For businesses in regulated industries—especially financial institutions, funds, cross-border investors, or public companies—compliance with Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements is not optional. It is a legal obligation and a core risk management function. Basic company-level due diligence is no longer sufficient in today’s regulatory environment, especially when transacting with Chinese counterparties. Instead, Enhanced Due Diligence (EDD) should be performed to go deeper into ownership, control, affiliations, and reputational background.
UBO Identification and Verification
A cornerstone of AML/KYC compliance is identifying the Ultimate Beneficial Owner (UBO)—the person or entity that ultimately owns or controls the company, typically defined as anyone with 25% or more of the equity interest (though stricter internal thresholds may apply depending on jurisdiction).
Why it matters:
- Shell companies or multi-layered ownership structures can be used to obscure true ownership, creating risks related to money laundering, sanctions evasion, or fraud.
- Regulators and financial institutions require disclosure and verification of beneficial ownership for onboarding, investment approval, and ongoing monitoring.
How to conduct UBO checks:
- Review the company’s shareholder structure and trace ownership through intermediate holding companies or nominee shareholders.
- Request copies of ID documents, passports, business licenses, or other identifying documents of ultimate owners.
- Use compliance screening tools to assess nationality, domicile, and potential regulatory red flags.
Tip: If the UBO is based in a high-risk jurisdiction or has known associations with sanctioned individuals or entities, escalate the file for internal legal and compliance review.
Screening for Politically Exposed Persons (PEPs)
PEPs include current or former government officials, high-ranking military officers, state-owned enterprise executives, and their close family members or associates. Engaging with a PEP—even unknowingly—can increase exposure to bribery, influence-peddling, or enforcement scrutiny.
Why it matters:
- Transactions involving PEPs often require heightened review, approvals, and monitoring under FATF, OFAC, FinCEN, EU, and similar frameworks.
- Failure to flag a PEP during onboarding or due diligence can result in regulatory penalties or reputational damage.
How to screen for PEPs:
- Run director and UBO names through global compliance databases like World-Check, Dow Jones Risk & Compliance, Refinitiv, or LexisNexis AML tools.
- Conduct open-source and media research in both English and Chinese to identify affiliations that may not appear in English-language databases.
- Engage a local legal team to provide background reports or reputation reviews if there is reason to believe a party may be politically connected.
Reputation and Adverse Media Checks
Even if a party is not on a watchlist or sanctions list, negative news, criminal allegations, or public scandals can present serious risks to your business, especially in reputationally sensitive sectors like finance, fintech, ESG, or international trade.
What to look for:
- History of fraud allegations, tax evasion, IP theft, or consumer rights violations
- Public controversies involving environmental or labor law breaches
- Associations with companies or individuals sanctioned or investigated by foreign governments
How to conduct checks:
- Search local news platforms, including WeChat articles, Sina News, and Caixin, using the Chinese names of individuals and companies
- Use adverse media screening software or local compliance vendors for deeper scans
- Look for discrepancies between what the company discloses and what is publicly known
Tip: In China, reputation matters immensely. A company or individual publicly associated with scandal or misconduct may have difficulty obtaining licenses, bank loans, or government contracts—issues that can indirectly affect your partnership or investment.
10. Hidden Ownership and Related Party Risks
When dealing with private Chinese companies—especially those that are family-run or part of a loosely structured group—it's important to go beyond the surface-level ownership records. Two risks that commonly arise are related party transactions (关联交易) and nominee shareholding (代持). These arrangements can materially affect the valuation, governance, and integrity of the company, and are often not disclosed unless specifically investigated.
Related Party Transactions (RPTs) and Affiliated Entities (关联交易和关联公司)
It is common in China for a controlling shareholder to operate multiple affiliated companies within a “group,” even if they are not registered as a formal corporate group. These entities often engage in intercompany transactions, including:
- Shared office space or labor resources
- Internal loans or cross-guarantees
- Transfer pricing of goods or services
- Use of IP or customer accounts across entities
Why it matters:
• These transactions may not be at arm’s length and can be structured to shift revenue, costs, or profits across entities in a way that obscures true financial performance.
• Undisclosed RPTs may affect the target company’s net income, tax liability, risk profile, or valuation.
• If you are acquiring a stake in the company or entering a joint venture, these transactions may divert value to other entities you do not control.
How to investigate:
- Request a full list of companies owned or controlled by the same shareholder(s)—this may include legal entities held by family members, spouses, or other proxies.
- Look at major customer and supplier relationships to see if any are affiliated parties.
- Review audited financials (if available) for disclosures of RPTs and balances due to/from affiliates.
- Ask local legal or accounting professionals to conduct group mapping and identify hidden affiliations.
Pro tip: Be cautious when financial statements show unusually high receivables or payables with “other entities”—this often signals off-balance-sheet activity within a related group.
Nominee Shareholding Arrangements (代持)
In a nominee arrangement (代持), the person listed as a shareholder in the company records is not the actual owner of the shares. Instead, they are “holding shares on behalf” of another party—often due to regulatory, personal, or political reasons.
Why it happens:
- A shareholder may be under restrictions (e.g., civil servants or party officials)
- The actual owner may want to stay anonymous due to tax, capital control, or compliance concerns
- The real controlling party is a foreign national, which may create regulatory challenges in restricted industries
Why it matters:
• These arrangements are not legally recognized under PRC Company Law, and the true beneficial owner may have no enforceable shareholder rights.
• In corruption or fraud cases, nominee shareholders are sometimes used to obscure illicit ownership, and may later deny their obligations.
• For investors or partners, the presence of a nominee shareholder may mean you’re not really dealing with the decision-maker, which poses serious contractual and reputational risks.
How to identify:
- Cross-check shareholder names with known associates of the legal rep or controlling family.
- Ask direct questions during due diligence—nominee arrangements are sometimes disclosed if the relationship is stable.
- Monitor for signs such as: no clear business background for the shareholder, use of common or repeated addresses across multiple companies, or frequent ownership transfers among individuals.
When to escalate:
- If there are suspicions of nominee holdings, involve legal counsel to investigate further.
- In high-risk industries or deal sizes, request legal declarations or background checks to confirm beneficial ownership.
Why These Issues Matter to International SMEs, Startups, and Investors
Businesses entering China are often dealing with unfamiliar suppliers, manufacturers, local agents, or prospective JV partners. These relationships may involve significant financial exposure or long-term commitments, but many SMEs and startups don’t have internal legal teams or the resources to navigate the Chinese legal system.
Yet, they still need:
- Peace of mind before wiring payments or signing contracts
- Assurance that the counterparty exists, is properly licensed, and can deliver on obligations
- Clarity on who they’re really dealing with—and who actually controls the company
- Confidence that the partner complies with local laws and international expectations, especially where funding, compliance, or reputation are on the line
This guide is designed to help founders, business owners, investors, and legal advisors ask the right questions, structure due diligence efforts effectively, and recognize when to bring in trusted local legal support.
How Trustiics Can Help
Through Trustiics, you can access vetted, experienced local lawyers in China without leaving your office—from anywhere in the world. Your selected lawyer can support you with:
- Due diligence on Chinese companies, including corporate records, licensing, litigation, and shareholder analysis
- Verification of legal status, ownership, regulatory compliance, and red flags such as dishonesty listings
- Review of company documents, contracts, and regulatory filings to uncover hidden risks or affiliate structures
You can take a look at the standard fixed-price service 72-hour Due Diligence in China or get started by selecting a lawyer, sending a request that describes your needs, and receiving a free quote. Once approved, you make a secure online payment held in escrow until the service is completed.
Alternatively, contact us at support@trustiics.com and our support team will coordinate the legal services for your business activities in China.
Conclusion
Due diligence is not just a procedural step—it’s a strategic investment in minimizing risk and making informed decisions. When dealing with Chinese companies, international businesses must go beyond surface-level checks and verify legal status, ownership, compliance, and operational integrity.
By following the framework in this guide—and working with the right legal professionals—you can engage confidently with partners in China, safeguard your business, and move forward with clarity.
Trust, but verify. And let Trustiics help.