The failure of a registered company in China to meet information disclosure requirements may result in inclusion on a “list of companies with abnormal operations.” The public nature of this list incentivizes companies to comply with disclosure requirements, while longer-term noncompliance results in inclusion on a blacklist that carries more severe penalties. Inclusion on the abnormal operations list is not necessarily a serious issue of concern, and ought to be evaluated within the broader scope of a company’s profile.

 

List of Companies with Abnormal Operations

In 2014, new regulations outlining information disclosure requirements for Chinese companies created a list of companies with abnormal operations (企业经营异常名录). The list includes companies that have failed to comply with information disclosure requirements.
There are four circumstances under which a company would be added to the list:

  1. Failure to publicize annual reports within the prescribed time frame;
  2. Failure to publicize other required information within the prescribed time frame;
  3. Publicized information conceals facts or involves falsification;
  4. Failure to contact the company at its publicized registered address.

PSA conducts due diligence investigations into a large number of companies in China each month; all of these investigations include checks for inclusion on the abnormal operations list. In our experience, the first circumstance listed above (failure to publicize annual reports) is the most common reason for a company to be included on the list. In most cases, the company rectifies this issue and is removed from the list in due course. Only in a handful of cases have we found that a company has failed to rectify the issue for more than three years, causing it to be added to the blacklist described below.

Consequences of Inclusion on the List

The list of companies with abnormal operations is available online, and a Chinese-language database search will reveal whether a company is included on the list. Therefore, potential reputational damage associated with inclusion on the list is itself intended to incentivize companies to adhere to information disclosure regulations.

If a company updates its information within three years of being included on an abnormal operations list, it may apply to be removed. If a company remains on the list for more than three years, it will be added to a blacklist, which may be accessed online. When other regulatory bodies learn of a company’s inclusion on the blacklist, they have the discretion to impose wide-ranging penalties. Potential consequences may include the company’s legal representative being barred from serving as legal representative of another entity for a fixed period of time, and the company being prohibited from participating in bids for government projects. Operations of companies that primarily serve as government contractors would be significantly impacted by inclusion on the blacklist.

Reasons for Inclusion on the List

The four circumstances under which a company may be included in the abnormal operations list are introduced above. However, not all circumstances carry the same level of risk. For example, failure to make timely information disclosures is not always indicative of serious operational issues within a company, especially in the case of small or newly-registered companies that may not be familiar with disclosure requirements. On the other hand, disclosures that involve falsification are potentially more serious. Therefore, careful attention should be paid to which category a company’s inclusion in the list falls under.

Is Abnormal Operations a Business Risk?

When considering entering into a business relationship with a company registered in China, you may find that it is (or has been) included on the abnormal operations list. This finding alone should not end consideration of a business relationship; instead, it should be evaluated alongside other findings. It is often the case that direct communication with a company’s key principals results in a more robust understanding of the nature of a company. When asking companies’ principals about their inclusion on the abnormal operations list, PSA has found that some instances are more easily explained – small companies founded by one or two individuals that are simply focused on other aspects of business – while other instances may indicate a higher level of risk, such as falsification of publicized information.

Market Regulation in China

In March 2018, the formation of the State Administration of Market Regulations (“SAMR”; 国家市场监督管理总局) was announced. The SAMR, which reports to the State Council, took over responsibility for oversight of enterprise registration and information disclosure – including the abnormal operations list – which was previously handled by the State Administration of Industry and Commerce. As a national-level department, the SAMR has branches in administrative regions across the country.

To learn more about mitigating third-party risks in China with due diligence reporting and advisory services, contact Daniel Skeens in PSA’s Shanghai office at daniel.skeens@psagroup.com. To speak with our North American representative office contact Waleed Magazachi at waleed.magazachi@psagroup.com or +1 (416) 303-6298.