Amended China M&A Rules Alter the Landscape of Offshore-Onshore Restructurings in China

On August 8, 2006, the Ministry of Commerce ("MOFCOM"), joined by other government authorities, amended and released the M&A rules of domestic enterprises in China. To read our legal update, please follow the link below to the Morrison & Foerster website.
http://www.mofo.com/news/updates/bulletins/bulletin02181.html

China Ministry of Information Industry Notice Signals Greater Scrutiny of Internet and Telecom Service Firms

The PRC Ministry of Information Industry ("MII") promulgated new rules on July 13, 2006, which impose significant new requirements on foreign-invested Internet and telecom service businesses and signal a policy shift toward greater scrutiny of companies operating in this area. To read our legal update, please follow the link below to the Morrison & Foerster website.
http://www.mofo.com/news/updates/files/update02231.html

Hong Kong and Mainland China to Introduce Reciprocal Enforcement of Court Judgments in Commercial Cases

Hong Kong and Mainland Chinese ("PRC") authorities have announced that legislation is likely to be introduced in both jurisdictions by the end of 2006 to allow the mutual recognition and enforcement of court judgments in commercial matters.

At present, no arrangement exists for judgments obtained in one jurisdiction to be formally recognized and enforced in the other. PRC court judgments that meet certain basic criteria may currently be enforced in Hong Kong by separate court action as a debt, in common with court judgments of many other countries (including the United States) with which Hong Kong has not established a reciprocal enforcement arrangement. Hong Kong court judgments are not presently enforceable in the PRC.

In contrast, arbitration awards obtained in Hong Kong and the PRC are recognized and enforceable in each other’s jurisdictions under the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards ("1958 Convention").

Details of the scheme

Details of the proposed arrangement are yet to be formally agreed. It is understood however that the main elements of the scheme will be as follows:

Money judgments. The proposed mutual enforcement regime will apply only to judgments for monetary sums, and will not include orders for remedies such as specific performance or injunction. This is consistent with the existing regimes in Hong Kong for enforcement of foreign court judgments under common law principles and under the Foreign Judgments (Reciprocal Enforcement) Ordinance ("FJREO").

Commercial matters. The scheme will apply only to commercial contractual disputes. Disputes that do not arise out of a commercial agreement, and disputes arising between private individuals, consumer, employment or marriage contracts will all be excluded.

Prior agreement to Hong Kong or Chinese jurisdiction. The parties must expressly have agreed in writing to designate a Hong Kong or Mainland court to have sole jurisdiction for resolving any dispute. This is to avoid the risk of parallel proceedings being instituted in both jurisdictions in the same dispute. It is not presently clear whether the parties will have to make the relevant jurisdiction agreement in the original contract or whether they may agree to Hong Kong or PRC jurisdiction once a dispute has arisen. What is clear however is that the arrangement will not have retrospective effect – it will not apply to Hong Kong or PRC jurisdiction clauses in agreements that are already in existence at the time legislation giving effect to the new scheme is introduced.

Final judgments. The arrangement is intended to apply only to a final court judgment. Difficulties have arisen on occasion recently when attempts have been made to enforce PRC judgments in Hong Kong under common law as a debt, because in some circumstances PRC judgments may be subject to a ‘protest’ procedure leading to a retrial of the case by the original court. Hong Kong courts have held that judgments subject to such a procedure are not final judgments.

Under the proposed reciprocal enforcement scheme, the protest procedure will not be available for judgments sought to be enforced in Hong Kong and the party seeking enforcement must produce a ‘certificate of final judgment’ from the relevant Mainland court.

Courts to which the scheme applies. The arrangement is intended to apply to judgments of the District Court and High Court in Hong Kong, and to the Supreme People’s Court, Intermediate and Higher People’s Courts, and a number of designated Basic People’s Courts (the latter typically in regions that have significant foreign investor and trading connections) in the PRC.

Grounds for refusing enforcement. The scheme will include safeguards against inappropriate enforcement of judgments, similar to those that already exist in Hong Kong under the FJREO and in relation to the enforcement of foreign arbitral awards under the 1958 Convention, in circumstances (among others) where:

(a) the relevant judgment has already been fully executed;
(b) the party against whom enforcement is sought was not given sufficient time to defend the original case;
(c) the judgment has been obtained by fraud;
(d) a court in the jurisdiction where enforcement is sought has already given judgment for the same claim;
(e) enforcement would be contrary to Hong Kong public policy (if sought to be enforced in Hong Kong) or the social and public interests of the PRC (if enforcement is intended in the PRC).

Simultaneous enforcement. Proceedings may be taken to enforce a judgment in the jurisdiction where the judgment was obtained at the same time as proceedings are commenced in the reciprocal jurisdiction for recognition and enforcement. Although not clear at present, presumably the enforcing party must cease enforcement action in both jurisdictions once the judgment is fully executed in either jurisdiction.

Implications of the proposed scheme

As mentioned, the new agreement will not have retrospective effect. An update will be provided as soon as it is known when it will take effect. For businesses presently contemplating deals with PRC entities from late 2006 onwards, it will be important to consider whether any additional benefit will be gained (or burden sustained) from the scheme.

The fact that the PRC is a party to the 1958 Convention, as well as concerns over the quality and impartiality of PRC judges and its judicial system, has commonly led in contracts negotiated between PRC and foreign businesses to the inclusion of overseas arbitration clauses, usually in a jurisdiction or overseen by an arbitral body (such as the International Chamber of Commerce) unconnected with either party.

Arbitration may not however be the most efficient or cost-effective method of resolving a particular commercial dispute. Arbitration can prove more expensive than court proceedings (court costs in many jurisdictions including Hong Kong are nominal and judges free, whereas arbitrators and supervising arbitral bodies charge for their time spent dealing with the proceedings and for administrative costs such as rooms used for hearings).

It may be difficult to obtain urgent relief or effective protection from an arbitration tribunal in relation to a dispute given that it may take some days or weeks to appoint the tribunal members under the relevant appointment procedure. Even then it may not be possible for the tribunal to grant the type of interim relief sought and a court, may have to be requested to intervene if one has jurisdiction.

An obvious advantage of the proposed arrangement for foreign businesses is that they can, by including a Hong Kong choice of jurisdiction provision, take advantage of what is generally perceived as Hong Kong’s sophisticated and impartial court system to obtain money judgments against defaulting PRC contracting parties, which can then be directly enforced (subject to the procedural issues described above) against assets located in the PRC. In such circumstances the parties could choose Hong Kong law (which closely follows English law and continues to rely heavily on case precedents of the English courts and those of other Commonwealth jurisdictions) to govern their contract, or choose a suitable foreign governing law (in which case the Hong Kong courts would give full effect to the parties’ choice, relying on expert evidence in the event of a dispute over how the relevant foreign law should be applied).

A notable exclusion from the scheme, when compared with the reciprocal enforcement provisions under the 1958 Convention, is that non-monetary remedies (such as for a final injunction) cannot be made the subject of enforcement proceedings in the other jurisdiction. Parties with commercial disputes not related to a contract between them (such as infringement of intellectual property rights or tortious interference with business relationships) will not be able to take advantage of the scheme either.

Care will also have to be taken when drafting choice of law and jurisdiction provisions in commercial agreements to ensure that the wording complies (or does not comply, as the case may be) with the scheme’s requirements enabling reciprocal enforcement. Agreements that provide for the non-exclusive jurisdiction of the Hong Kong or PRC courts to resolve disputes (allowing for the possibility that another forum could be used in appropriate cases) would not comply with the provisions of the new arrangement.

In releasing the current details of the scheme, the Hong Kong authorities have announced that it should:

"… dovetail with the greater Pearl River Delta economic development plan, strengthen the relationship between the Mainland and Hong Kong, and reinforce Hong Kong’s status as a leading financial and legal services centre."

Only time and practical implementation of the scheme will tell if it is also of benefit to overseas investors and others in commercial relationships with PRC entities.

New China Listed Company Acquisition Measures

On July 31, 2006, the China Securities Regulatory Commission ("CSRC") amended and released the Administrative Measures for Acquisition of Listed Companies (the "Revised Administrative Measures"). The Revised Administrative Measures, which take effect September 1, 2006, supersede the current Administrative Measures for Acquisition of Listed Companies ("Current Administrative Measures"), which have been in effect since 2002.

The Revised Administrative Measures include several significant changes to the current rules on acquiring PRC listed companies under the Current Administrative Measures and such changes will have significant ramifications for companies interested in acquiring PRC listed companies.

Key changes in the Revised Administrative Measures include:

Broader Definition of Acquirer. Under the Current Administrative Measures, the term "Acquirer" refers to an investor acquiring the shares of a listed company. An acquirer is required to disclose certain information to the CSRC. The Revised Administrative Measures redefine the term to include "persons in concerted action" which include the investing parties who intend to gain control over the listed company by agreement or other arrangement. As a result, the persons in concerted action will be subject to the same obligation to disclose relevant information as imposed on the acquirer under the Current Administrative Measures.
"Indirect Acquisition" Recognized. The Revised Administrative Measures also recognize "indirect acquisition" whereby an acquirer gains actual control over a listed company by controlling the main shareholder(s) of that listed company, even though the acquirer does not directly acquire shares of the listed company. The Revised Administrative Measures further provide that the acquirers under an indirect acquisition are subject to the same disclosure obligations as imposed on an acquirer under direct acquisitions.
More Flexibility in Acquisitions by Tender Offer. The Current Administrative Measures require acquirers, with certain exceptions, to make a tender offer for all of a target company’s outstanding shares. In practice this chills investor willingness to make an acquisition due to the concern that the target company would be delisted if more than 75 percent of its shares are owned by a single shareholder. Although the Revised Administrative Measures also require acquirers who have obtained 30 percent of a listed company’s shares to make a tender offer for all of the target company’s outstanding shares, they allow an acquirer to determine what portion (but no less than 5 percent) of the target company’s shares that they intend to acquire.
The Revised Administrative Measures therefore give acquirers greater flexibility in determining what portion of a target’s shares they will acquire, and will allow an acquirer to gain control of a listed company without the obligation to purchase all of the outstanding shares. This will significantly reduce the costs of acquiring controlling interests in listed companies. This change is seen as reflecting the government’s attitude to encourage more acquisitions in the securities market.
Method of Determining Minimum Share Price Changed for Tender Offers. Under the Revised Administrative Measures, an acquirer would have to pay no less than the highest price the acquirer has paid in acquiring the target shares over the 6 months prior to the release of the public notice on acquisition. The Current Administrative Measures provide that the minimum share price in acquisition by tender offer shall be not less than the higher of (i) the highest price the acquirer has paid in acquiring the target shares over the 6 months prior to the release of the public notice on acquisition, and (ii) 90% of the arithmetic mean of the daily weighted average prices of the target shares for 30 trading days prior to the release of the public notice on acquisition.
Terms of Payment Tightened. The Revised Administrative Measures stipulate that an acquirer must pay the entire price of the shares before it can take possession of acquired shares. This is significantly stricter than the Current Administrative Measures which do not contain such requirement and under which the purchase price has usually been paid by installments as agreed by the parties.
Instruments of Payment Broadened. The Revised Administrative Measures, for the first time, allow the acquirers to pay the price in cash or shares or a combination of cash and shares. In contrast, under the Current Administrative Measures acquirers are only allowed to pay the price in cash without exceptions. The Revised Administrative Measures provide greater flexibility to an acquirer in terms of using its own shares as consideration for the target shares.

It is anticipated that the Revised Administrative Measures will encourage acquisitions in the PRC securities market by providing acquirers with more flexibility in determining the portion of outstanding shares to be acquired through acquisitions by offer, as well as more flexibility in determining the instrument of payment for the shares to be purchased. On the other hand, acquirers will have increased disclosure obligations under indirect acquisitions. Furthermore, as persons in concerted action are now included in the definition of acquirers, they are now subject to the same obligation to disclose relevant information.

China to Tighten Control Over Pollution Caused by Electronic Information Products

The Measures for the Control of Pollution from Electronic Information Products ("China RoHS") were promulgated by the MII and six other Ministries and Bureaus at the central government level on February 28, 2006. China RoHS are intended to protect the environment by controlling pollution caused by certain toxic and hazardous substances in electronic information products ("EIP"). The new measures will come into effect on March 1, 2007.

Classification. China RoHS apply to all EIP that are identified in the MII’s Notes by Category of Electronic Information Products. This list is posted on the MII website for reference by manufacturers. This list covers a wide range of electrical and electronic equipment. Product categories covered include batteries, computer equipment, home electronics products, telecommunication products, radio and television products, specialized electronics products, and electronic components and parts. China RoHS covers all EIP manufactured in, sold in, or imported into China. They do not cover EIP that are manufactured in China for export.

Covered Substances. China RoHS identifies six toxic and hazardous substances: Lead (Pb), Mercury (Hg), Cadmium (Cd), Hexavalent Chromium (Cr6+), Polybrominated Biphenyl (PBB) and Polybrominated Diphenyl Ether (PBDE). They also provides an open-ended category of "other toxic and hazardous substances or elements specified by the State." The lead regulator for China RoHS is the MII, which will be responsible for conducting an annual review of substances to be covered.

Labeling Requirements. China RoHS imposes labeling requirements so that covered products bear (a) the name and content of toxic or hazardous substances or elements, (b) the components containing toxic or hazardous substances and whether they can be recycled, (c) the product’s environmental protection use period ("EPUP"), and (d) the packaging must bear the name of the packaging material. Detailed labeling standards will be addressed in the as yet unreleased Marking for the Control of Pollution Caused by Electronic Information Products. An EIP’s label must be on the product itself, unless there are size or functional limitations, in which case the marking may be contained in the EIP’s manual or instructional brochure.

Environmental Protection Use Period. China RoHS defines the EPUP as the period during which the toxic or hazardous substances or elements contained in the EIP will not leak or migrate, causing serious pollution to the environment or serious damage to persons or property. The EPUP is not the same as a product’s safe useful life, and may be shorter or longer. The EPUP is determined by the manufacturer or importer itself.

Packaging. All packaging materials must be non-toxic, non-hazardous, easily degradable, and readily recyclable.

Catalogue for Priority Control of Pollution by Electronic Information Products. China RoHS provides that the seven governmental agencies that promulgated the measures will also issue a Catalogue for Priority Control of Pollution by Electronic Information Products (the "Catalogue"). The Catalogue will initially be empty, but an EIP will be added to it when it is confirmed that it can meet certain substitution or restriction standards, or if it is identified as having realized "mature technology and economic feasibility".

Two Stage Implementation of China RoHS Measures. The administration of EIP under China RoHS is divided into two stages.

  • Stage one refers to the period during which EIP manufacturers and sellers are only required to comply with labeling requirements regarding the name and amounts of toxic and hazardous substances, the EPUP, and whether products are recyclable after being discarded.
  • Stage two applies when a particular EIP is added to the Catalogue. At that time, an EIP identified in the Catalogue must comply with applicable substitution or restriction standards, and must obtain government-approved verification.

Online Copyright in China: Shifting Standards for Online Content

In May 2006 China’s State Council published the Regulation on the Protection of the Rights to Network Dissemination of Information (the "Regulations"), which supplement the Copyright Law. The Regulations, which came into effect July 1, 2006, substantively modify the rights of copyright holders under the PRC Copyright Law.

The protection of intellectual property in China is a highly contentious issue. Although the government over the past decade has promulgated a series of laws to protect patents, trademarks and copyright, the piracy of printed materials, trademarks, audio/visual works and virtually every other tangible expression of creative work has been unchecked. While the existing Copyright Law provides protection for copyright holders, various issues have arisen in the online context. Some were addressed in court cases; government agencies issued administrative procedures for handling some; and China's industry coalition released self-governing conventions for protecting online copyright. Since these did not have the force of national law, however, there remained ambiguities in addressing some of these issues. In recognition of the importance of online content, the State Council issued the Regulations to clarify and amend the rights of copyright holders in the online context. Key provisions under the Regulations include:

Prohibition on Circumventing Technical Measures. The Regulations permit the adoption of "technical measures" to prevent the unauthorized access or transmission of their works over information networks. While they prohibit the circumvention of such technical measures, as well as the manufacture, importation or distribution to the public of devices intended to circumvent the technical measures, they also provide explicit provisions permitting circumvention for
(1) scientific or educational purposes, (2) to make works available on a non-profit basis to blind people, (3) for governmental purposes fulfilling official duties, and
(4) to test security performance of computers or relevant systems and networks on the information network.

Prohibition on Circumventing DRM. The Regulations prohibit the removal or alteration of digital rights management ("DRM") information from any works, performances, or audio-visual products made available to the public over information networks, and prohibit anyone from transmitting works from which they know or should have known that DRM information was removed or altered. Unfortunately, there is a broad exception permitting circumvention of DRM if "the deletion or alteration is unavoidable due to technical reasons". Since the Regulations do not provide any guidance as to what "technical reasons" may involve, at least for the moment it appears that enforcement of the DRM-circumvention provision would be difficult.

Additional Exceptions to Copyright Online. In addition to the standard copyright exceptions such as fair use, reporting current events, classroom teaching and research, government use, and public speeches, the Regulations also include the unique Chinese exceptions of permitting translation of a Mandarin Chinese work into a minority national language within China and preparation of Braille works. However, the Regulations expand the number of exceptions online that significantly dilute rights in a work:

  • The Public Facility Exception. Public facilities such as libraries, archival facilities, memorial halls, museums, and art galleries, now enjoy a broad right to copy, transmit, and make available to their patrons within their premises digital copies of works. Although a copyright holder can prohibit this use on a case-by-case basis, this imposes a burden on copyright holders to actively prohibit these uses.
  • The Compulsory Education Exception. To support China’s nine-year compulsory education requirement, an entity does not need to obtain permission to incorporate portions of works, short works, musical works or limited visual works into courseware made available over information networks. The entity must pay a fee, but in accordance with National Copyright Administration of China established rates ("NCA Copyright Fees") rather than negotiated licensing fees.
  • The Poverty Exception. For the "purpose of alleviating poverty", this exception applies to any work published by a Chinese entity that is related to farming, disease prevention, disaster precaution and relief, or works satisfying basic cultural demands. Under this exception, an entity can make these works’ available to people in rural areas over information networks at no charge. Network service providers are required to provide public notice of the works being made available, their authors, and proposed remuneration standards before making them available over the networks. If the copyright holder does not notify the network service provider within 30 days, then the works can be distributed over the network and the service provider is required to pay the copyright holder per the NCA Copyright Fees. If the holder subsequently objects to the distribution, the network service provider is required to immediately remove the works from the network.
  • In each of these above exceptions, the Regulations do require the entity distributing the work to comply with certain requirements, including displaying the name of the work and author, paying remuneration pursuant to the Regulations, and implementing technical measures to prevent people other than those explicitly permitted in the above exceptions from accessing the work.

Takedown Notices. A copyright holder can send a written notice to an ISP to remove any content that the copyright holder considers to be infringing copyright. The ISP is required to immediately remove the identified content, and to forward the notice to the party responsible for posting the claimed infringing content. If that party replies with a written statement explaining why the content is non-infringing, the ISP is required to replace the content and forward the written statement to the rights owner.

New Rules on Foreign Airline Representative Offices Promulgated

The Administrative Measures on the Examination and Approval of Representative Offices of Foreign Civil Aviation Enterprises ("Airline Measures") were promulgated by the General Administration of Civil Aviation ("CAAC") on April 3, 2006, and went into effect on May 3, 2006. These supersede the Notice on Implementing the Interim Provisions on the Administration of Permanent Representative Offices of Foreign Enterprises.

The Airline Measures consist of several significant changes in the procedural requirements for foreign airline representative offices ("AROs") renewing or amending the registration status of their Registration Certificates. Key changes in the Airline Measures include:

Term of the CAAC Approval Certificate Extended. The term of the CAAC Approval Certificate, which previously had been 1 year, has been extended so that it tracks the three year term of the foreign airline’s Operation Permit.

Changes of Address Must be Registered. AROs are now required to apply for a new CAAC Approval Certificate if they move to a new address. At this time AROs are required to send notification of a change of address to the CAAC, but the CCAC is not yet issuing new certificates while it handles the administrative issues related to preparing new CAAC Approval Certificates with appropriate for the registered address.

Execution Instructions Clarified. If a foreign airline changes its chief representative or representatives, or alters the name or address of the ARO, the application documents must be signed by the foreign airline’s legal representative. The ARO’s chief representative is allowed to sign the application documents for a change of office address within the same city.

Clarifying New Registration and Approval Regulations – SAIC’s Circular 81

The Circular for the Application of Laws and Regulations concerning the Approval and Registration of Foreign Invested Companies, Circular Gongshangwaiqizi [2006] No. 81, ("Circular 81") was jointly issued by the State Administration for Industry and Commerce ("SAIC"), Ministry of Commerce, General Administration of Customs, and State Administration of Foreign Exchange on May 10, 2006. SAIC also issued a press release and a notice to clarify several issues regarding the implementation of Circular 81 on May 10, 2006, and June 1, 2006, respectively.

Circular 81 was issued to clarify inconsistencies between the new Administrative Rules for Company Registration ("Registration Rules") and the recently revised Company Law. These inconsistencies affected the approval and registration of foreign invested enterprises ("FIEs"), and created uncertainty on the part of many foreign investors. A number of significant changes are summarized as follows:

FIE Establishment

  • Applications to establish FIEs now require additional documents, including:
(i) original attestation documents from foreign notarization authorities and the relevant Chinese Embassy attesting to the identities of the foreign investors, and
(ii) a Power of Attorney on Delivery of Legal Documents entered into between the foreign investors and their authorized local agent.
  • Wholly Foreign-Owned Enterprises ("WFOEs") and Contractual Joint Ventures are required to register with the local bureau of the SAIC within 30 days of issuance of their Certificate of Approval, while Equity Joint Ventures are required to register within 90 days. Failure to register within the stipulated time frame will require the foreign investor to obtain written confirmation from the approval authorities that the approval is still valid, or else to re-apply for approval.
  • The registered capital of an FIE must consist of at least 30% cash, while contributions in-kind and contributions of intangible property may represent no more than 70% of the registered capital.
  • If a foreign investor has obtained a loan, those funds will be considered "self-owned" funds of that investor and can be used as capital contributions to an FIE.
  • The first installment of an FIE’s registered capital must be at least 15% of the total registered capital and must be injected within three months of issuance of the FIE’s business license. The remainder of the registered capital must be injected within two years of issuance of the business license.
  • If a WFOE is established by a single foreign natural person, the registered capital shall be no less than RMB 100,000 and must be contributed in full within six months of issuance of the business license. Such a WFOE would not be permitted to establish a subsidiary in China.

Increasing Registered Capital of an FIE

  • When an FIE’s application to increase its registered capital is approved, it can immediately apply to update its foreign exchange registration certificate and foreign exchange capital account without waiting for issuance of the new business license. Once at least 20% of the increased registered capital has been paid-in, the FIE can renew its business license.

Branches and Liaison Offices

  • When an FIE applies to establish a branch, it now does not need to obtain a "transmission letter" from the local AIC; rather, it will apply directly to the AIC where the branch will be located.
  • Upon the establishment or cancellation of a branch, an FIE shall file for the record such change with the AIC where the FIE’s head office is registered.
  • When an FIE establishes a liaison office, it does not need to register such liaison office with the AIC.
  • An existing liaison office must either be de-registered or converted to branches when its existing registration certificate expires. After deregistration of an existing liaison office, it is permitted to continue operating and will be monitored by the local AIC. According to the SAIC, a deregistered liaison office may open a special bank account solely to receive operating funds from its parent FIE, but is not permitted to use that bank account for business activities.
  • Liaison offices are only permitted to engage in liaison-related activities and cannot engage in direct business activities.

Other Recent Revelopments

Revised Measures Governing Establishment of Express Handling Units

Earlier this year the General Administration of Customs ("Customs") revised existing regulations on the administration of express handling units ("EHUs"). The revised Measures on Supervision of Import and Export Express Delivery ("EHU Measures") came into effect May 1, 2006. The EHU Measures establish the required qualifications for a company or branch company to obtain a Registration Certificate for Operators of International Express Delivery Business ("EHU Certificate"). Key developments include:

Elimination of Investor Operational Requirements. The revised EHU Measures eliminated operational requirements that had been imposed on an applicant’s investors. Under the original EHU Measures, an applicant’s investors were required to have been engaged in the international freight forwarding business for one year in the case of Chinese investors and three years for foreign investors.
Application Requirements Updated. Additionally, under the original EHU Measures, applicants were required to hold an international freight forwarding enterprise certificate issued by the MOFCOM. However, regulations related to such certificates have been abolished and MOFCOM has stopped issuing the certificates. This resulted in companies not being able to apply for EHU Certificates. The revised EHU Measures now provide that an applicant that is a foreign invested enterprise or its branch company only needs to provide a copy of its Certificate of Approval for establishment and its business license that includes EHU activities in the permitted scope of business. The applicant can then register with the local bureau of Customs to engage in EHU activities.

Opinions on Adjustment of the Composition of Residential Units and Stabilization of the Price of Residential Units

On May 24, 2006, the State Council of the PRC issued a notice to implement the Opinions of the Ministry of Construction and Other Ministries on Adjustment of the Composition of Residential Units and Stabilization of the Price of Residential Units ("MOC Opinions") (Guo Ban Fa [2006] No. 37). The MOC Opinions were jointly published by the Ministry of Construction ("MOC"), the National Development and Reform Commission ("NDRC"), the Ministry of Supervision, the Ministry of Finance, the Ministry of Land and Resources, the People’s Bank of China ("PBOC"), the State Administration of Taxation, the Statistics Bureau, and the Central Banking Regulatory Commission.

In the notice, the State Council instructed the ministries and provincial and local governments to implement the MOC Opinions as well as the central government’s real estate policies. The stated objective of the MOC Opinions is to curb real estate speculation, stabilize housing prices and cool down the growth of investment in the real estate market.

The MOC Opinions include six provisions:
(1) adjustment of the structure of housing supply;
(2) taxation, lending and land policies;
(3) control of demolition of old urban residential houses and relocation of residents;
(4) regulation of the real estate market;
(5) housing development for low-income families; and
(6) improvement of real estate statistics and information disclosure.

The key points of the MOC Opinions include the following:

  • All local (municipal and county-level) governments are required to set construction targets for ordinary commodity premises, economically affordable premises, and low rent residential premises in their 11th five-year plans. The local governments must announce their construction plans before the end of September 2006.
  • Starting from June 1, 2006, commodity premises with internal construction areas smaller than 90 square meters must account for at least 70% of the total development and construction areas. However, the MOC Opinions did not make it clear whether the "total development and construction areas" refer to those for each real estate development project or the entire development and construction areas in a given city.
  • Business tax will be levied on the total transfer price of residential premises if they have been owned for less than 5 years.
  • Developers must come up with 35% of the project funding on their own before they are eligible for bank lending.
  • Purchasers must pay more than 30% of the total purchase price in their initial installment payments, unless the internal construction areas of the residential premises are smaller than 90 square meters.
  • Development of villa-type projects continues to be banned.
  • Developers’ land use rights may be forfeited without any compensation if the land remains undeveloped for two years after purchase or payment of land grant fees.
  • Sales of premises under construction without a pre-sale license are strictly prohibited. Developers may be fined or have their business licenses revoked if they engage in hoarding, price-jacking, and other prohibited practices.

On the heels of the MOC Opinions, the MOC and other ministries issued the following rules in July 2006, which limit foreign investment in the real estate market and impose restrictions on real estate planning and transaction:

  • Opinion on Regulating the Entry into and the Administration of Foreign Investment in the Real Estate Market (Jian Zhu Fang [2006] No. 171), which was promulgated jointly by the MOC, the Ministry of Commerce, the NDRC, the PBOC, the State Administration of Industry and Commerce ("SAIC"), and the State Administration of Foreign Exchange on July 12, 2006. For further discussion of this opinion, please refer to our client alert below:
    http://www.mofo.com/news/updates/files/update02233.html
  • Opinions on the Implementation of Unit Composition Ratio Requirement for Newly-built Residential Properties (Jian Zhu Fang [2006] No. 165), issued by MOC on July 6, 2006; and
  • Circular on Further Regulation of Real Estate Transactions) (Jiang Zhu Fang [2006] No. 166), issued jointly by MOC, NDRC, and SAIC on July 6, 2006.

The MOC Opinions and the related rules discussed above will have a far-reaching impact on the development of the real estate industry in PRC. Additional measures are expected to be published to supplement and clarify these rules. For any specific real estate project, it will be necessary to consult with local authorities to seek guidance on their own practices and the implementation of these rules.

Ear to the Ground

Amendments to PRC Partnership Law Expected

Significant amendments have been proposed to China’s Partnership Law originally promulgated by the National People’s Congress on February 23, 1997, which would alter the tax treatment of partnerships, and also create two new forms of partnership: the limited partnership and the limited liability partnership. The proposed amendments to the Partnership Law were deliberated by the Standing Committee of China’s National People’s Congress for a second time in June. Under China’s legislative system, a bill will be enacted as law after undergoing three rounds of hearings before the national legislature. It is widely anticipated that the third and final reading of the bill will be completed soon and the revised Partnership Law will then come into effect.

The major proposed amendments to the Partnership Law include:

Limited Partnerships. The proposed amendments would permit creation of limited partnerships ("LPs"), which would have two kinds of partners: general partners and limited partners. The proposal would require a LP to have at least one general partner with unlimited liability for the partnership. The liability of limited partners would be limited solely to the amount of their capital contributions. An LP’s general partners would have managerial power, while limited partners would typically be financial investors and would be restricted from taking an active managerial role in the LP.
Limited Liability Partnerships. The proposed amendments would also permit creation of limited liability partnerships ("LLPs"). All partners in a LLP are considered general partners, but none of the partners would assume unlimited liability. The partners would be liable for the amount of their capital contribution, and then each would only be subject to personal liability for intentional or negligent harm caused by their individual actions. The proposed amendment would also require LLPs to allocate a portion of their revenue to setting up a risk fund to offset their operational debt. It is widely expected that the LLP form of partnership will put domestic professional firms on an even playing field with foreign competitors.
"Pass-through" Tax Treatment. The proposed amendment would introduce a significant change to the Partnership Law by exempting all partnerships from corporate income tax. Similarly to U.S. partnership tax treatment, China’s partnerships would have all profits and losses "pass-through" and be attributed to the individual partners, avoiding taxation at the business entity level. This is advantageous in a variety of business arrangements, particularly those of venture capital backed deals. While this treatment is considered a key feature of the proposed amendments, actual implementation would require further guidance from the State Tax Bureau on handling relevant tax filings.
"Legal Person" as Partner. The current law requires that all partners in a partnership be natural persons. The proposed amendments would permit any legal person, including corporate entities, to become a partner. Wholly state-owned enterprises and publicly listed companies would be restricted to participation in LPs as limited partners due to concerns regarding the stripping of state-owned assets and protection of minority shareholders.
Foreign Participation. The current Partnership Law is silent on the participation of foreign natural persons in domestic partnerships, and therefore there has been very limited interest on the part of foreign investors. The proposed amendments would explicitly permit foreign individuals and entities to enter into partnerships in China. However, these provisions were the most contentious due to concerns raised by Chinese lawmakers during the second reading that partnerships involving foreigners might strip China-registered intellectual property rights. It is unclear whether these provisions regarding foreign participation will remain in the proposal for the third reading.

The proposed amendments to the Partnership Law are widely anticipated to encourage economic growth by offering additional flexible business structures with favorable tax characteristics. In particular, the proposal for establishing LPs is seen as directly encouraging the venture capital industry and investment of capital into high-tech enterprises, while LLPs would strengthen the development of professional and intermediary service industries such as accounting and law firms.

Latest Developments in the PRC’s Anti-Monopoly Law

After a decade of debate and preparation, it appears the PRC’s Anti-Monopoly Law ("AML") may finally be enacted. In June of 2006, the PRC State Council approved a draft of the AML and subsequently sent the draft to the Legislative Affairs Office of the National People’s Congress ("NPC"). The NPC Standing Committee recently completed the first reading of the draft law and, depending on the scheduling of the second and third readings later this year, the law may be promulgated in late 2006 or early 2007.

Based on the draft AML that was circulated by the PRC government to industry groups for comment, the draft AML has 57 articles under eight different chapters. The following may be of particular interest to companies involved in the PRC market:

Two Regulatory Organizations to Be Established

Pursuant to the draft AML, a supervisory body, the Anti-Monopoly Commission ("AMC"), will be established, and such commission will report directly to the State Council. AMC commissioners will be representatives from an unspecified group of relevant State Council regulatory bodies, such as the MOFCOM and the SAIC. The key mandate of the AMC is to "organize, lead and coordinate the anti-monopoly work."

A new enforcement agency, the AML Enforcement Authority ("AEA"), will also be established. The AEA will report to the State Council directly. The AEA’s mandate is the enforcement of AML, including investigation and regulation of monopolistic behavior.

The Three Pillars of the AML

The AML will regulate operators (natural persons, legal persons or other organizations) that engage in certain monopolistic conduct that may eliminate or restrict competition. Specifically, the AML will prohibit the following three types of monopolistic conduct:

(a) Agreements among operators ("monopoly agreements") that may eliminate or restrict competition.
These include vertical agreements among operators that (i) fix, maintain or change prices of products; (ii) limit the production volume or sales volume of products; (iii) segment the sales markets or the raw material purchasing markets; (iv) limit the purchase of new technology or new facilities or limit the development of new products, or new technology;
(v) jointly boycott transactions; or (iv) other monopoly agreements determined by the AEA.
(b) Abuse of dominant market position
In determining whether an operator abuses its dominant market position in a relevant market, the regulators can examine a non-exclusive list of factors, which include (i) selling products at unfair high prices or buying products at unfair low prices;
(ii) selling products at prices below cost, (iii) refusing to trade with trading partners; or (iv) imposing trading or trading conditions on trading partners. It should be noted that under the definition of "dominant market position," two or more operators can be held collectively as dominating a relevant market. Furthermore, the draft AML includes an automatic assumption of market dominance if one operator holds a market share of 50% or more of a relevant market, or two operators hold a market share of 66% or more of a relevant market, or three operators hold a market share of 75% or more of a relevant market.
(c) Concentration of business that may eliminate or restrict competition.
The definition of "concentration" includes (i) a merger with one or more operators, (ii) acquisition of substantial amount of voting shares or assets of one or more operators, and (iii) acquisition of control of or influence over one or more operators by agreements. Operators must notify the AEA when the combined global turnover of all operators to a merger transaction exceeds RMB 12 billion ($1.5 billion), and the turnover of one of the merger operators in China exceeds RMB 800 million ($100 million) before the merger can take place.
The draft AML establishes a two-step review process for all concentration reviews. The AEA will conduct a preliminary review within 30 days after receipt of the notification. For concentrations that need additional review after the preliminary review, the AEA will take another 90 days to finish its second-step review.

Penalties for monopolistic conduct

The draft AML sets penalties for monopolistic conduct at a minimum of one percent and a maximum of 10% of turnover.

Administrative Monopolies

Although the current draft AML contains several controversial provisions restricting "administrative monopolies," it is unclear how these provisions would be applied.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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