China has formulated two new regulations to strengthen the supervision of FIEs

by Professor Wei Jiaju

(General counsel, China Legal Consultancy CentreAttorney -at-Law, Tianping Law Office) In the latter half of 1997, China has promulgated two regulations with the purpose to strengthen the supervision of FIEs. The one is "Certain Regulations on the Changing of Equity Interest Owned by Investors in Foreign Investment Enterprises". The other is "Supplementary Provisions to the Several Provisions Regarding the Capital Contributions by the Parties to Sino-foreign Equity Joint Ventures".

"Certain Regulations on the Changing of Equity Interest Owned by Investors in Foreign Investment Enterprises"

Background

In the "Law of Sino-foreign Equity Joint Ventures" dated as far back as July 1979, it has permitted the assignment of "registered capital" in providing that "the assignment of one party's share in the registered capital shall be effected only with the consent of the other party(ies) to the venture". Given the fact that there was no such concept as equity interests then, here the registered capital represents the equity interests.

Later on, the "Regulations for the Implementation of the Law of Sino-foreign Equity Joint Ventures" (hereinafter referred to as the "Implementation Regulations") stipulated further:

"If one party to the joint venture intends to assign all or part of his investment subscribed to a third party, consent shall be obtained from the other party to the joint venture, and approval from the examination and approval authority is required."(23)

In comparison, the "Implementation Regulations" adds a necessary condition that in case of assignment, approval is required. This represents a step forward. Assignment amounts, in a sense, to reorganization of an enterprise. That explains why it is necessary to obtain approval from the examination and approval authority. This has been followed by the later regulation.

There are, however, apparent defects in this "Implementation Regulations",

1. It requires only the approval by the examination and approval authority, while it provides no test for making decision. As a result of which the test and standard used in practice differ from region to region and from case to case, no uniform rules could be followed.

2. It stipulated only the approval by the examination and approval authority in case of assignment to the third party. It is unclear whether it is required to submit for approval in the event of assignment between the parties to the joint venture. Consequently, in practice, it often effected without submitting for approval. The joint venture became a wholly Chinese-owned enterprise as a consequence of assignment of foreign equity interests to the Chinese partner but continue to benefit from preferential treatments. All these will occur without the knowledge of the examination and approval authority.

3. It provides only the assignability of the registered capital. It remains unclear whether the equity interests in the form of registered capital could be pledged, whether the equity interests could be acquired by way of pledge.

4. Since the nineties, the Foreign Investment Guidelines has been adopted, which stipulated the industries where state-owned assets are required to represent a controlling shareholding or have a dominating position. Question is, in the absence of effective legislative restrictions, the lacuna of law could easily be employed by the investors to circumvent the legal provisions to achieve their end.

"Certain Regulations on the Changing of Equity Interest Owned by Investors in Foreign Investment Enterprises" (hereinafter referred to as the "Regulations") is formulated specifically to meet this need, to strengthen the supervision legal measures for changing of equity interests in FIEs.

Main Provisions

1. Reaffirm the principle that the change of equity interests must be subject to examination and approval , it stipulates:

"The change of the Equity Interest of an investor in the Enterprise shall comply with relevant Chinese laws and regulations, and be subject to approval by the approval authority and alteration of registration with the registration authority pursuant to these Regulations. No changes of Equity Interest shall be valid until they are approved by the approval authority." (3)

It should be noted that here the more broad term of "change of the Equity Interest" is used to replace the formal assignment of "registered capital" (Equity Interest), whereby it includes, but not limited to, assignment, as a result, even the change of proportion of equity interest not involving the assignment, it shall be subject to examination and approval.

It should be noted further that the emphasis here is on the change of equity interest. Where such a change occurs, it will be subject to approval, irrespective of whether the party is a Chinese or foreign investor, and irrespective of whether there is a change of equity interest between the partners of the FIEs or assignment to a third party. Therefore, it made clear where the ambiguity existed in the past.

2. The main forms of change of equity interest are cited to include:

a) The Equity Interest is assigned among investors of the Enterprise through agreement;

b) An investor assigns its Equity Interest to its affiliate or other assignee, as consented by the other investors;

c) The registered capital of the Enterprise is adjusted by investors, and subsequently the proportional Equity Interest of each investor is changed;

d) As consented by the other investors, an investor of the Enterprise pledges its Equity Interest to a creditor, and the pledgee or other beneficiary subsequently obtains the Equity Interest of such Investor in compliance with the laws and regulations;

e) The Equity Interest of an investor of the Enterprise is lawfully obtained by its successor, creditor or other beneficiary upon its bankruptcy, dissolution, revocation or demise;

f) An investor of the Enterprise is merged or divided, and its successor following such transaction lawfully inherits the Equity Interest of the original investor; and

g) An investor of the Enterprise is replaced or the Equity Interest is changed as approved by the original approval authority due to failure of such investor to honor its obligation to pay capital contribution under the contract and articles of association of the Enterprise.

Compared with the sole concept of "assignment of the registered capital", the coverage of "Change of Equity of equity interest" of today has been much more broadened. It is evident that legislation in China in the field of supervision of foreign investment in particular, as well as the legislation in general has made a big step forward indeed after practice of 20 years.

3. "The Regulations" expressly stipulate corresponding procedures of approval and requirement to effect each form of change of equity interest. For example, the following 4 documents must be submitted in each case:

a) the written application to change the Equity Interest of the investors;

b) the original contract and articles of association of the Enterprise, and the amendment agreement thereof;

c) photocopies of the approval certificate and the business license of the Enterprise;

d) the list of the board members of the Enterprise following the changes of the Equity Interest of the investors; (9)

Various additional documents are required depending on different forms of change of equity interest. For example, in case of acquisition of equity interest by way of pledge, "the Regulations" states:

"As provided in the Security Law, to the extent that the ownership [title] of the pledged Equity Interest is transferred to the pledgee or other beneficiary, the Enterprise shall, in addition to the documents identified in item (1), (2), (3) and (5) of Article 9, submit to the approval authority effective proof evidencing that such pledgee and other beneficiary has obtained the Equity Interest of the original investor. The approval authority shall examine the case based upon the documents described in both the preceding sentence and Article 12 and pursuant to the relevant laws and regulations." (13)

"The Regulations" provides further the time period for going through the procedures:

"The approval authority shall decide whether the case is approved or not within thirty days of receipt of all the documents.

Within thirty days of approval by the approval authority of the change of Equity Interest owned by investors in the Enterprise, the Enterprise shall complete formalities with the approval authority for alteration of the foreign investment enterprise approval certificate. "(17)

"The Enterprise shall, within thirty days of alteration or cancellation of the foreign investment enterprise approval certificate, alter its registration with the registration authority pursuant to the Regulations of the People's Republic of China on the Administration of Legal Person Registration and the Company Registration of the People's Republic of China. Failure to effect alteration of registration with the registration authority pursuant to these Regulations shall be subject to penalty by the registration authority pursuant to relevant regulations." (18)

Consequently, it meets the requirements of standardization and high transparency.

4. "The Regulations" raises the principle to be followed in making the decision of approval and the tests, filling up the long existing lacuna of law.

The general principle is that change of equity interests

"shall be in line with the provisions of Chinese laws and regulations as to the qualifications of investors, as well as the industrial policies of China."(4)

The Law of Equity Joint Venture provides in the very beginning that the proportion of the investment contributed by the foreign partner shall in general not be less than 25%. This represents the floor of the proportion, failing which the nature of the enterprise will certainly be changed.

The Implementation Regulations, the matching regulations for implementation of the Law of Equity Joint Venture, denies the approval in establishing joint ventures in case they are detriment to China's sovereignty, nonconformity with the requirements of the development of China's national economy etc..

As a policy orientation, the Guiding List if Industries for Foreign Investment listed certain industries or programmes like the management of post and telecommunication, the air traffic control, the financial derivatives business, the broadcasting and TV industry, the newspaper etc. as those not permitted to be engaged by wholly foreign-owned enterprises.

Based on the foregoing laws, regulations and policies, "the Regulations" summarizes the test as follows:

"Where an Enterprise engages in an industry where wholly foreign-owned enterprises are not permitted under the Guiding List of Industries for Foreign Investment, changes of Equity Interest in such Enterprises shall not result in sole ownership of its Equity Interest by foreign investor(s). To the extent that an Enterprise is to become a wholly foreign-owned enterprise as a result of Equity Interest changes, requirements for the establishment of wholly foreign-owned enterprises under the Detailed Rules for the Implementation of Wholly Foreign-Owned Enterprise Law of the People's Republic of China ("WFO Rules") shall be satisfied.

Should the Enterprise engage in any industry where state-owned assets are required to represent a controlling shareholding or have a dominating position in an enterprise, changes of Equity Interest [of such Enterprises] shall not result in circumstance where foreign investors or any entities other than state-owned enterprises of China become a controlling shareholder or hold a dominating position ."(4)

"The change of the Equity Interest of an investor in an Enterprise shall not result in the holding of less than 25% of the registered capital of the Enterprise by the foreign investor unless the foreign investor assigns all its Equity Interest to the Chinese investor."(5)

It further stipulates the respective procedures to go through in each case:

"The authority which first approved the establishment of an Enterprise shall be the competent authority to approve the changes of the Equity Interest of investors in such Enterprise. Where the Chinese investor in a sino-foreign equity or cooperative joint venture intends to change its Equity Interest and subsequently the Enterprise is proposed to become a wholly foreign-owned enterprise which engages in the industry where wholly foreign-owned enterprises are restricted under Article 5 of the WFO Rules, such changes of the Equity Interest of the Chinese investors shall be subject to approval by the Ministry of Foreign Trade and Economic Cooperation ("MOFTEC")." (7)

"Should the Chinese investor acquire all the Equity Interest of the Enterprise, it shall , within thirty days of approval by the approval authority of the change of Equity Interest owned by investors in the Enterprise, cancel the foreign investment enterprise approval certificate with the approval authority, which shall, within fifteen days of cancellation of the foreign investment enterprise approval certificate, give the original registration authority of the Enterprise a notice to such effect." (17)

"Should the Chinese investors acquire all the Equity Interest of the Enterprise as a result of changes of the Equity Interest owned by the investors in the Enterprise, the Enterprise shall, for the purpose of alteration of registration, submit to the registration authority relevant documents required for the registration of a new enterprise of similar class to itself. Upon verification by the registration authority, the Legal Entity Business License of the People's Republic of China shall be surrendered for cancellation. In its place, a Legal Entity Business License shall be issued." (19)

From the above, one can easily conclude that "the Regulations" is both a comprehensive and detailed, as well as an operational legislation. It proves to be a successful measure to strengthen the FIEs.

To be continued

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