Presentation on theme: "Chinese Regulation of Foreign Business"— Presentation transcript:
1 Chinese Regulation of Foreign Business James V. FeinermanJames M. Morita Professor of Asian Legal StudiesGeorgetown University Law Center
2 Foreign Investment in China China Investment Abroad Customs IntroductionForeign TradeForeign Investment in ChinaChina Investment AbroadCustomsCommodity InspectionTaxationCivil & Criminal LawsTechnical Standards of Different CountriesInternational Practices & Treaties
3 China: Basic Facts 2004 GDP: $1.65 Trillion (7th in the World) 2004 PPP-Adjusted GDP: $7.26 Trillion (2nd in the World)Average GDP Growth from : ~ 9.0%Projected 5-Year GDP Growth Average: 7.8% (2X > U.S.)2004 Foreign Direct Investment: $61 Billion
4 Selected 2004 FDI Recipients (Source: UNCTAD) Destination Amount % changeWORLDWIDE $648 Billion Up 2%AFRICA $18 Billion No ChangeLATIN AMERICA $68 Billion Up 45%ASIA $148 Billion Up 47%EUROPEAN UNION $216 Billion Down 36%USA $96 Billion Up 68%INDIA $5 Billion Up 25%HONG KONG $34 Billion Up 143%CHINA $61 Billion Up 13%
5 Look Before You LeapMarket Access -- Restrictions and Investment VehiclesIntellectual Property ProtectionLegal System/Dispute Resolution/CorruptionForeign Exchange/TaxationGuanxi = “Connections”Dealing with State-Owned EnterprisesFinancial Transparency/Hidden LiabilitiesEmployees and Employment Law MattersLand/Real EstateCorporate Governance and Corporate CultureLocal vs. National Issues (local protectionism)
6 Brief History of Foreign Investment Tight government control and “special treatment” of foreign investors moving towards loosening of control in light of World Trade Organization (WTO) agreements1970’s: first foreign investment lawsForeign Invested Enterprises (FIEs) in distinct legal categoryMore government control, but some special privileges• Late 90’s and 00’s: New M&A and FIE laws-- Provisional Measures on Domestic Investment by Foreign Invested Enterprises (2000)-- Rules on Merger and Division of Foreign Invested Enterprises (1999, amended in 2001)-- Investment Regulations/Investment Catalogue (2002)
7 Current Investment Framework (1) Important Sectors of China’s Economy Initially (Some Remain) Closed to Foreign InvestmentPre-WTO Liberalization Increases Availability of Wholly Foreign Owned Enterprises vs. Joint VenturesGovernment Approval at Local, Provincial or National Level Required for All InvestmentsLevel of Government Approval Depends on Amount, Location and Nature of Proposed Investment
8 Current Investment Framework (2) Special Economic Zones (SEZ’s) Provide Additional Flexibility/Advantages, e.g., Pudong WaigaoqiaoForeign Investment and Economic Development Concentrated on East CoastTax Advantages for Certain Foreign Invested Enterprises, but Regulations are ComplexRMB Still Not Fully Convertible (swap markets)
9 Market Access Foreign investment catalogue – 4 Categories EncouragedRestrictedProhibitedUnlisted = PermittedBusiness scope narrowly definedWTO concessionsImprove trade & foreign investment environmentOpen new service sectors to foreign investmentModify intellectual property rights and technology transfer rulesReduce tariffs and non-tariff barriers
10 New Foreign M&A Regulations Percentage restrictionsMandatory asset appraisals set floor on purchase priceProtection of existing creditors/guaranty of paymentRequirement for public noticeLabor issues“Employment Settlement Plan” approved by authoritiesCertain acquisitions must be approved by labor organizationPurchase PriceForm of consideration flexiblePayment within prescribed period after approvals
11 Growth Factors for M&A Investments Fast-growing number of qualified “target companies”Foreign investors’ increasing interest in existing Chinese businesses instead of greenfield investmentsState-owned companies being privatizedChinese companies seeking international financing/tech expertiseGlobal capital markets looking for “China concept”Potential increase in China asset values if RMB is revalued upward
13 Investment Vehicles (2) Representative Office• Quick to set up – registration vs. approval• Permitted activities include liaison, promotion, research, technical support• Not “really” permitted to engage in business, but 10% tax on deemed business incomeJoint Ventures• Equity Joint Venture (EJV) used to be more common• Cooperative Joint Venture (CJV) can be more flexible in structure, repatriation of investment, sharing of profits, etc.
14 Investment Vehicles (3) Joint Ventures vs. WFOEJoint VenturesPros(1) Greater range of investment areas(2) Easier government approval(3) Operational facilities / infrastructure in place(4) Access to market, customers, etc.Cons(1) Misunderstandings possible(2) IP protection concerns(3) Complicates exit strategies
15 Investment Vehicles (4) Wholly Foreign Owned vs.JVWholly Foreign-Owned EnterprisesPros(1) No Chinese partner or JV Contract(2) Simple to establish(3) Better IP protection(4) Better integration with parent companyCons(1) Legal and regulatory restrictions(2) Lack of existing sales and distribution network(3) No production site and workforce(4) Lack of local “guanxi”
16 Investment Vehicles (5) Limited Liability CompanyGoverned by Board of Directors subordinate to equity ownersRegistered capital must be contributed in a lump sumProfits must be shared in proportion to equity contributionsPerpetual existenceTwo-thirds majority to approve major issuesLack of implementing regulations hinders use by foreign investors
17 Investment Vehicles (6) Joint Stock CompanyMost closely resembles U.S. corporationOwnership represented by issued share capitalTheoretically able to list on Chinese or foreign stock exchange and issue debt instrumentsLimited foreign participation due to complex requirements and approvals
18 Selecting the Chinese Partner While foreign companies are increasingly likely to establish wholly foreign-owned enterprises in the PRC, most still seek a Chinese co-venturer. Typical reasons to opt for a joint venture include:Chinese policy discourages or prohibits wholly foreign-owned enterprises in the sector in question.The Chinese partner holds a dominant market position, which the proposed joint venture will inherit.The Chinese partner has a distribution network, assets, relationships, or other advantages that will permit the joint venture access to markets, raw materials or quotas.
19 Due Diligence: Overview Investor's first line of protection -- thorough business and legal due diligenceExperienced international businesspeople appear to ignore this basic tenet when investing in ChinaProfessional due diligence in the PRC presents peculiar challengesless reliable information than foreign investors are used toobscure and volatile state of China's legal systemChinese companies’ lack of familiarity (and patience) with corporate formalities and record keepinggreat breadth of authority afforded to China's bureaucracy.
20 Due Diligence: Key Points Nature and Powers of the PartnerFinancial RecordsEmployeesContractual ObligationsTaxOwnership of Assets
21 Transition Issues for Transfers of Existing Facilities into Joint Ventures If existing plant or facility will become part of the joint venture:mechanics and details of this transferappendix listing all of the Chinese partner's assets and liabilities that are to be transferred to the new entityland use rights, buildings and other fixed assets"allocated" or "granted" state-owned land use rightsAllocated land is transferred to the user for free (annual land use tax)user has no right to transfer; state may recover the land at any time without paying compensation.When land is "granted," the user pays the state a land grant premium for the right to use it for a stated period of yearsgranted land use right is transferable (including by mortgage and lease), and may not be abrogated by the state (except for compensation in the exercise of its right of eminent domaininventory, receivables, intangibles and contractual rights
22 Valuation Issues – Cash and In-Kind relative value of parties' contributions determines shares of profitsvalue of non-cash contributions is usually a hotly-negotiated issue (Chinese contributions in-kind; foreign usually cash or combination)value of such contributions must be set forth in the capital contribution section of the joint venture contractnon-cash contributions by foreign parties must also be valued by the State Import and Export Commodities Inspection Administrationactual contribution of both cash and non-cash inputs must be verified by a licensed PRC accounting firmstate-owned assets (such as assets owned by state enterprises) must be valued by a valuation firm licensed by the State Assets Management Bureaulocalities have standards to value land use rights; foreign investors should investigate whether Chinese side’s valuation falls within the official rangeinvestors should bear in mind that the official guidelines assume granted land use rights rather than allocated land use rights.
23 Other Issues Registered Capital Conditions to the Effectiveness of JVs Minimum of 1/3 total capital; cannot be reducedConditions to the Effectiveness of JVsTransfer of propertyContribution of assetsNecessary approvalsFeasibility Studies – Prior Approval MandatoryObjectives; sources of investment; sources of foreign exchange and raw materials; site; technology requirementsEconomic benefit analysis; financial projectionsLabor requirementsMarketing plans; distribution; export percentages; forex balancingNon-competition clausesGeographicProduct line(s)Marketing plans; distributionChinese Law Opinion Letters
24 Off-shore Holding Structures Most foreign investors prefer to conduct their Chinese investments through a series of offshore, single purpose, limited liability companies:Permits investors to limit China project liability to one offshore entityFacilitates future transfers of the investmentWhere there are multiple foreign investors in a JV, foreign parties may work out the details of their cooperation in a shareholders agreementChinese JV law does not provide for more complex corporate capital structures, such as preferred stock, redemption rights, or the like
25 Exit StrategiesMost investors in China are strategic investors –manufacturing firms wishing to establish long-term production facilities to service China and Asian regional markets.They typically are not greatly concerned about the mechanics or financial consequences of disposing of their investments,Growing group of financial investors in Chinainvestment funds,merchant banks,other financial institutions.These investors are keenly interested in strategies for tax-efficient exit from their investments within a set time horizon.
26 Intellectual Property IP Rights Violations Remain a Serious ThreatIP violations are widespread in ChinaInfringing/counterfeiting (20%+ of consumer products)Piracy (90%+ of movies, software, games, books)Imitation of product designsIP theft by employees/partnersIn the US, Canada, Japan and the EU, China is theNo. 1 source of seizures of infringing goodsChina government entities may acquiesce in infringing activitiesLocal governments (sole source of funds and salaries for local courts and judges) protect local taxpayers and employersNational government determined to advance China’s technology
27 Intellectual Property Enforcement (1) China IP Legal Enforcement - Dual Track SystemAdministrative EnforcementSpecial enforcement task forces in administrative agenciesJudicial EnforcementCivil litigation: IP tribunals in intermediate people’s courts to hear casesCriminal prosecution for IP crimes
28 Intellectual Property Enforcement (2) Administrative EnforcementMore effective for Trademark infringement and counterfeiting complaints than patent or copyright infringement – over 73,000 proceedings in 2004No real equivalent in U.S. or other Western countriesFast in taking action and cost-effectiveMore domestic parties than foreign parties use this systemAdministrative IP agencies participate in enforcement – “ public interest” required in copyright casesSome agencies may conduct raids, confiscate infringing goods, destroy equipment for making infringing goods, and impose finesAgencies may examine and copy infringer’ s accounting recordsAgencies cannot award infringement damages – aggrieved party must file an infringement suit in courts to seek damages
29 Intellectual Property Enforcement (3) Judicial EnforcementCivil Enforcement – 20049,323 IP cases filed (about 35% increase over 2003, comparable to U.S. - 9,558)4,264 copyright cases (more than U.S )2,549 patent cases (comparable to U.S )1325 TM cases (fewer than U.S. - 3,496)630 technology contract disputes555 “others”Criminal Enforcement -2004653 individuals convicted for IP crimes385 criminal cases
30 Intellectual Property Enforcement (4) Foreign Party Practical StrategiesEarly filing necessary to protect rightsTrademarks and CopyrightsUtility and Invention PatentsDesign PatentsEnsure the quality of Chinese translations and patent prosecution in ChinaUndertake careful due diligence on potential partnersAggressively monitor for infringements and take steps to enforce rights before infringement spreadsRequire confidentiality/non-compete agreements with employees and partners (BUT limited enforceability)Formulate proper investment and corporate structure in ChinaEnlist political/media support – you may have Chinese allies!
31 Intellectual Property -- Conclusions China’s IP Laws “Closing in” on International StandardsIP Enforcement in China -- “Work In Progress”Foreign Companies Should File and Protect IP in ChinaPatentsTrademarks and copyrightsNon-compete and confidentiality agreementsForeign IP Owners Can Successfully Enforce IP in ChinaDon’t be afraid to sue in ChinaDon’t wait too long – two year statute of limitationsChoose counsel carefully