This Circular sets out a description of some of the problems encountered by the PRC Government's attempts at regulating the influx of foreign capital into the PRC in recent years, which include the misplaced emphasis upon the quantity rather than the quality of overseas investments; the granting of special concessions and preferential treatment which run contrary to PRC laws and administrative regulations; and finally the undervaluation of State assets which are contributed to the registered capital or equity of foreign investment enterprises ("FIEs"). In addition, the Circular identities the problem of PRC and foreign businessmen failing to honour their registered capital contribution commitments and empowers the local examination and approval authorities to play a stronger role in monitoring and if necessary suspending or terminating the business activities of the enterprises which they set up.
Monitoring of Parties' Registered Capital Contributions
The first three paragraphs of the Circular deal with the duties of the local examination, approval and registration authorities in carrying out their work. Firstly, they are obliged to ensure that FIEs strictly observe PRC laws, regulations and policies. Secondly, when assets which are partly owned by the State are being purchased or form part of the registered capital of a FIE, an official valuation report as well as a confirmation of that valuation must be submitted to them "together with such other materials as PRC regulations may stipulate". (The Circular does not go into any detail as to what these might be.) In addition, when a state owned asset is being sold to a foreign investor, an approval document must be registered with them and the transaction has to be handled in accordance with "applicable regulations" (again the Circular does not go into any detail about these regulations.)
The third paragraph of the Circular authorises the examination and approval authorities to demand official valuations of the "in-kind" contributions which they are making to the registered capital if they are dissatisfied with the valuation which is being attributed to them. (It is unclear if these valuations can be carried out by non-PRC valuers.)
The Circular also tightens up the position regarding the timescale within which staggered payments to the venture's registered capital must be completed. Previously the position was governed by the 1987 Provisions regarding "Investments Made By Various Parties in Sino-foreign Equity Joint Ventures" which merely stipulated that where the joint venture contract required contributions to be made in one lump sum, the parties had to do so within six months from the date of issue of the business licence. However where according to the joint venture contract the capital contributions were to be made in installments, the first installment (which had to be not less than 15% of the overall investment) was required to be made within three months from the date of issue of the business licence to the FIE. Although the Circular states that these Provisions are to remain in force, the time limits for the final capital contribution payment are now clearly spelt out, and the position is set out in the table below:-
Registered capital of - within 1 year of issuance US$500,000 or less of business licence Registered capital between - within 1.5 years of issuance US$500,000 and US$1 million of business licence Registered capital between - within 2 years of issuance US$1 million and US$3 million of business licence Registered capital between - within 3 years of issuance US$3 million and US$10 million of business licence Registered capital above - to be determined by the US$10 million authorities
Examination and approval authorities are not permitted to grant approvals to new FIEs unless their capital contribution timetables are clearly specified, whilst certificates of approval for FIEs which are found not to have been fully capitalised within the time periods referred to above will lapse automatically. In addition the registration authority can impose such penalties on the FIE as it wishes including cancellation of the business licence itself. If however one of the investors has already made its full capital contribution by that date, and the other investor has failed to remedy the situation despite receiving formal notification of its obligation to do so, that party will have the right to either cancel the joint venture contract or to seek a new joint venture partner.
Suspension and/or Cancellation of Business Activities
Paragraph four of the Circular enables approval authorities to retract approvals which they have already given to FIEs prior to the expiry of their business periods regardless of whether the investors themselves have breached any PRC laws or regulations. The types of FIEs which are at risk are those which are using the whole of a local province's assets in a particular industry. The Circular provides that fresh approvals for the setting up of such types of FIEs must not be given until further notice, whilst as far as those which are already in operation are concerned, the original examination authority and any other responsible government department are required to commence "rectification of the position".
Paragraph five compels investors to renegotiate their joint venture contracts in the following circumstances: if they are considered by the examination authorities to be too one-sided; if the PRC party has agreed to act as the guarantor for the foreign party's capital contributions or if the PRC party has agreed to provide the foreign party with a guaranteed rate of return on its investment in the form of loans or bonds. The relevant government authorities are prohibited from approving or registering FIEs in respect of which foreign investors refuse to renegotiate the joint venture contract.
Paragraph eleven of the Circular permits the investors themselves, in circumstances which justify them doing so, to reduce the scale of operation of their FIEs or even to reduce their investment or registered capital provided that the examination and approval authority is satisfied that the normal operation of the FIE will not be affected and that creditors' rights are adequately safeguarded. This is a notable development because up until now FIEs have been prohibited from reducing their registered capital during the FIE's period of operation (Article 22 of the "Regulations for the Implementation of the Law of the PRC on Joint Ventures Using Chinese and Foreign Investments").
Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.