This guide provides basic information on the legal framework for foreign investment and operations in China, in three parts:
Rather than establishing a new wholly-owned or joint venture (JV) company in the People's Republic of China (PRC), foreign investors may wish to acquire the equity or assets of an existing company. As in other jurisdictions, acquiring the equity of a company will normally mean acquiring it with all of its liabilities, whereas in an assets acquisition there is generally a choice whether or not to acquire any of the target company's liabilities.
Acquisitions and joint ventures: note that any acquisition of less than 100% of the equity of a domestic limited liability company (LLC) will result in the target being converted into a JV which will be subject to the more conservative legal regime governing JVs.
Particular care is required in structuring JVs with individual shareholders continuing post-acquisition. The JV regulations assume that a JV will have only a few corporate entities as investors. For instance, each party normally has the right to terminate the JV under certain circumstances, and to appoint board members. This will not be appropriate in situations where there are multiple individual shareholders. Special care is required to balance the investors' rights and interests in these circumstances.
Basic acquisition methods: subject to the broad rules applicable to all foreign investments, foreign investors may acquire an existing domestic business operation through either asset or equity acquisition.
Equity acquisitions can be accomplished either by purchasing existing equity or subscribing to a capital increase. Asset acquisitions can be accomplished by injecting the assets into an onshore, which will then operate them. In the latter case, the assets can either be purchased by the new company itself after establishment, or may be purchased by the investor of the newco and then contributed to the new registered capital of the newco.
Overall, asset acquisitions are less common than equity acquisitions. This is in part because it is so often difficult to transfer key assets free of encumbrances, and impossible to transfer key licences in heavily regulated industries. Also, from the perspective of the sellers, asset transfers may leave cash assets trapped in a predecessor company, rather than in the pockets of the controlling shareholders.
Approvals: approval from the Ministry of Commerce (MOFCOM) and State Administration of Industry and Commerce (SAIC or local AIC) registration for all equity transfers involving foreign investors. Approval from the PRC National Development and Reform Commission may also be required where, in an asset acquisition, the foreign company needs to set up a new business to operate the assets to be acquired.
Additional or higher-level approvals may be required where the target is a state-owned enterprise or a listed company.
Central MOFCOM approval is required where (1) the target company has traditional brands or a well known trademark or is doing business in an industry key to national security and national economic security, or (2) shares are used as consideration. Use of shares is only permitted if the consideration shares are already listed on a stock market, or are those of an overseas special purpose vehicle to be used as a listing vehicle for the PRC target company's business.
M&A anti-monopoly review: under the PCR Anti-Monopoly Law (AML), the parties are required to report and notify any acquisition or merger to the Anti-Monopoly Office of MOFCOM for merger review if the transaction meets certain thresholds relating to global and PRC revenue and presence.
A transaction that does not meet the thresholds may still be subject to review should the Anti-Monopoly Office consider that the transaction is likely to result in the, 'Elimination or restriction of competition.'
National security review: in 2011, China implemented a new national security prior review requirement for foreign acquisitions of domestic companies' equity or assets by foreign entities.
The requirement applies to any transaction targeting domestic military industrial enterprises and tertiary enterprises, enterprises located near major and sensitive military facilities, other entities related to national defence or security, or in other sectors related to national security such as major agricultural products, major energy and resources, infrastructure, transportation services, key technologies and key equipment manufacture. Proposed transactions may be ordered to be modified or prohibited, as a result of the review.
The rules do not expressly apply to JVs, although an analogous informal review may take place in those cases.
State-owned enterprises and state-owned assets: foreign investors can acquire the equity or assets of State-owned Enterprises (SOEs) or their subsidiaries. However, the process is designed to ensure that state assets are not undervalued and to minimise the impact on employees. Therefore, the process is quite cumbersome and burdensome. It is administered primarily by the State-owned Assets Supervision and Administration Commission (SASAC) at central and lower levels.
In any transaction involving SOEs or state assets, it is critical to confirm that the seller has complied with the mandatory procedures for state asset transfers. These include use of a local state asset clearinghouse, internal approval and approval by the relevant SASAC, auditing, evaluation, publication of and invitation to bid, and undertaking a bidding process if two or more interested parties respond.
Acquisition of companies listed on PRC domestic stock markets: only companies limited by shares established in China (not LLCs, and not foreign companies) can be listed on the Shanghai and Shenzhen Stock Exchanges. Foreign investors may purchase the shares of domestic listed companies in three principal ways:
Acquire B shares: foreign investors may trade 'B shares' denominated in US$ listed on the Shanghai Stock Exchange or in HK$ listed on the Shenzhen Stock Exchange.
Acquire A shares through a Qualified Foreign Institutional Investor: the shares of most companies listed in China are 'A shares', i.e. Chinese currency (RMB) ordinary shares. Foreign investors may trade A shares through a Qualified Foreign Institutional Investor (QFII), large foreign asset managers who are specifically approved for this purpose, and highly regulated by the State Administration of Foreign Exchange (SAFE).
Acquire A shares as a strategic investor: a foreign investor may qualify as a strategic investor if it has net assets of more than US$100 million or manages overseas assets of more than US$500 million. Upon approval by MOFCOM, a strategic investor can, either directly or through a wholly-owned subsidiary, invest in A shares with a lock-up period of 3 years by acquiring existing A shares by written agreement from an existing shareholder, or subscribing to newly issued A shares directly from a listed company.
Complex China Securities Regulatory Commission and MOFCOM approval requirements apply to major acquisitions and changes of control. Particular care may be required to avoid the need to make a general tender offer when acquiring more than 30% of the shares of a listed company.
In addition to the foregoing, it is also possible for an onshore foreign invested enterprises (FIEs) to undertake limited purchases of A shares for its own account provided that this does not constitute a significant component of its income and therefore cause it to exceed its approved scope of business.
Existing FIEs – Onward Onshore Acquisitions: existing LLCs or Foreign invested company limited by shares may engage in acquisitions of domestic companies operating in areas of business open to foreign investment, subject to conditions established at law and in the companies' articles of association.
For such onward investments, only registration with the AIC is required to record the change in shareholding of the target. MOFCOM approval in advance is required only if the target company is operating in a restricted sector. Any subsidiaries of the target company should not be engaged in activities prohibited to foreign investment.
Again, a domestic subsidiary of an existing FIE generally does not enjoy FIE treatment for foreign exchange and other purposes, except in the Central-Western region or for holding company investments.
It should be noted that there are certain restrictions on the permitted sources of funds for onward investments. For existing companies, the reinvestment of RMB retained profits requires SAFE prior approval. For newly established and funded enterprises, it is prohibited outright to use foreign exchange registered capital to acquire equity interests in a domestic company.
Acquiring real property
The PRC legal regime does not recognize private ownership of land. All land is owned by the state or by collectives. Collectively owned land is generally for agricultural purposes and can only be used for construction after undergoing a complex conversion process.
Because of animosity to private property ownership during Mao's time, China's land registration and transfer infrastructure are still fairly imperfectly and irregularly developed. As a result, the process of obtaining land and buildings is often fraught with cost and risk. The situation is usually better on the developed east cost, in urban areas and in segregated economic development or trade zones.
FIEs can own buildings and structures on land by purchasing or being granted a 'land use right', which is a right to use land for a specific purpose and period of time. Land use rights do not include the right to use natural resources, minerals or treasure under the land. In general, buildings on land must be owned by the same party that holds the land use right.
There are three types of land use right in China.
Granted land use right: This is the most common type of land use right, and is initially obtained directly from local authorities by paying a fixed fee. The maximum use period varies depending on the use of the land:
- 40 years for commercial, tourism and entertainment use;
- 50 years for industrial, education, science, technology, culture, health or sports use (in several cities such as Shanghai, the term for new grants of industrial land use rights was shortened from 50 to 20 years from 1 April 2014);
- 70 years for residential use.
Granted land use rights can generally be freely transferred, let or mortgaged without having to obtain formal approval from the authorities. However, all such changes should be registered with the land management authorities.
An application to extend a granted land use right must be made no later than one year before its expiry.
Allocated land use right: This is a land use right allocated by the state free of payment for an indefinite period, normally for restricted uses such as governmental use, military use, infrastructure projects and public facilities.
The law does not expressly prohibit foreign companies or individuals from obtaining allocated land use rights. However, because of the restrictions on use and transfer, these rights are not normally held by foreign companies or individuals (utility or infrastructure projects being the most common exceptions).
Generally, allocated land use rights should first be converted to granted rights in order to be transferred. The process is cumbersome and difficult.
Leasing of buildings and land use rights: It is quite common for FIEs to lease premises (i.e., offices and facilities together with the relevant land use rights) rather than buying the right for a one-off payment. The maximum term of leases is 20 years, and they may be renewed upon expiry.
China has increasingly emphasised environmental protection in recent years, and continues to legislate actively in this area. The importance that China now places on environmental issues is reflected in the upgrade (in March 2008) of the original State Environmental Protection Administration to full ministerial status – it is now the Ministry of Environmental Protection.
Although PRC law currently lays the burden of environmental remediation on the polluter, liability may in the future also be extended to non-culpable successor occupants. Environmental due diligence is therefore of critical importance in any greenfield project or acquisition of existing facilities.
Environmental impact assessment (EIA): an EIA is required before a construction project (and related investment) can be approved.
The EIA (either in the form of a full report, or simpler registration form) must be prepared by a qualified environmental engineering firm and approved by the competent environmental protection authority.
A re-assessment report is required where major changes are made to a project's nature, scale, location, production process or waste treatment measures, or where construction of the project has not commenced within five years after approval.
Environmental protection facilities: these are required for projects where pollutants are handled on site. They must be designed, engineered and operated simultaneously with the main body of the construction project.
Local environmental protection authorities will carry out examination of environmental protection facilities upon completion of construction. Projects can be put into formal operation only after issuance of an Inspection and Acceptance Letter confirming that the project has passed examination.
Waste discharge control: a system of waste discharge control permits is in effect for air, water and noise.
A project may not discharge waste without a discharge permit or exceed the permitted discharge volumes. To obtain a discharge permit, an enterprise must have passed examination by the environmental protection authority by demonstrating that suitable waste treatment facilities have been installed and that the waste to be discharged after treatment complies with both national and local standards.
Ongoing supervision: local environmental protection authorities exercise ongoing supervision on all operating projects through waste discharge sampling.
Protecting intellectual property rights (IPR)
Foreign businesses operating in China must take care to protect their valuable IPR, ranging from trade names and brands, to copyrights, patentable inventions, trade secrets and know-how. IPR strategy should be considered early in the investment planning process, and monitored, updated and implemented on a continuing basis.
Registrations: China has established registration regimes to recognise exclusive rights to use various forms of IPR. These include trademarks, trade names, Patents, designs and integrated circuit layouts, new varieties of plant, copyright and software and domain names.
Treaties: China is a signatory to a range of key international treaties on IPR, including the Paris Convention (patents and trademarks), Patent Cooperation Treaty (patents), Berne Convention (copyrights), WIPO Copyright Treaty (copyrights), and the Madrid Treaty and Protocol (trademarks).
Enforcement: several avenues are available for enforcing intellectual property rights against violators, with administrative (rather than judicial) action being most common. Administrative actions may include investigation, seizure, confiscation, administrative injunctions, fines and even closing down infringing businesses.
Litigation for IPR owners and criminal prosecution are other possibilities.
Employment contracts: the Employment Contract Law came into force in 2008 and significantly strengthened the rights of employees in China. Key elements include:
- a written contract, which generally must be signed within one month after starting a new job;
- termination by an employer is not freely permissible – it must be by notice, can only be based on one of a number of limited statutory grounds and is subject to compliance with mandatory procedures;
- an open term contract must be offered to an employee after the completion of two fixed-term contracts and to an employee who has been working for the employer for a consecutive period of not less than 10 years.
- company rules on issues directly involving the personal interests of employees should be discussed with all employees and the labour union – this includes rules on working hours, breaks and vacation and health and safety.
Trade unions: employees in China have the right to set up a workplace labour union. If employees request to set up a union, the employer must offer assistance and allocate 2% of the monthly payroll to the union. Current PRC regulations allow unions a role in major decisions by FIEs including the right to review dismissals, participate in meetings and review company rules.
Expatriates and visas: foreign nationals can generally be hired freely by FIEs, and full-time employees and their families are generally entitled to long-term multiple entry work visas. However the authorities have significant discretion in this area. Different types of visa are available depending on the intended purpose and duration of the stay, and subject to satisfaction of relevant approval requirements. Detailed advice should be obtained from an experienced visa agent, especially if an employee intends to convert a tourist or business visa to a work visa after arrival.
Enterprise termination and bankruptcy
The PRC's first generally applicable company bankruptcy law came into effect in 2007. The slow pace of development in this area reflects the PRC's early reluctance to sanction the failure of state-owned enterprises. Ultimately, the government adopted provisions broadly quite similar to those in Western economies.