1. Chinese Regulation of Foreign Business
James V. Feinerman
James M. Morita Professor of Asian Legal Studies
Georgetown University Law Center

2. Foreign Investment in China China Investment Abroad Customs
Introduction
Foreign Trade
Foreign Investment in China
China Investment Abroad
Customs
Commodity Inspection
Taxation
Civil & Criminal Laws
Technical Standards of Different Countries
International 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 % change
WORLDWIDE $648 Billion Up 2%
AFRICA $18 Billion No Change
LATIN 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 Leap
Market Access -- Restrictions and Investment Vehicles
Intellectual Property Protection
Legal System/Dispute Resolution/Corruption
Foreign Exchange/Taxation
Guanxi = “Connections”
Dealing with State-Owned Enterprises
Financial Transparency/Hidden Liabilities
Employees and Employment Law Matters
Land/Real Estate
Corporate Governance and Corporate Culture
Local 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) agreements
1970’s: first foreign investment laws
Foreign Invested Enterprises (FIEs) in distinct legal category
More 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 Investment
Pre-WTO Liberalization Increases Availability of Wholly Foreign Owned Enterprises vs. Joint Ventures
Government Approval at Local, Provincial or National Level Required for All Investments
Level 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 Waigaoqiao
Foreign Investment and Economic Development Concentrated on East Coast
Tax Advantages for Certain Foreign Invested Enterprises, but Regulations are Complex
RMB Still Not Fully Convertible (swap markets)

9. Market Access Foreign investment catalogue – 4 Categories
Encouraged
Restricted
Prohibited
Unlisted = Permitted
Business scope narrowly defined
WTO concessions
Improve trade & foreign investment environment
Open new service sectors to foreign investment
Modify intellectual property rights and technology transfer rules
Reduce tariffs and non-tariff barriers

10. New Foreign M&A Regulations
Percentage restrictions
Mandatory asset appraisals set floor on purchase price
Protection of existing creditors/guaranty of payment
Requirement for public notice
Labor issues
“Employment Settlement Plan” approved by authorities
Certain acquisitions must be approved by labor organization
Purchase Price
Form of consideration flexible
Payment 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 investments
State-owned companies being privatized
Chinese companies seeking international financing/tech expertise
Global capital markets looking for “China concept”
Potential increase in China asset values if RMB is revalued upward

12. Investment Vehicles (1)
Representative office
Equity joint venture (“EJV”)
Cooperative joint venture (“CJV”)
Wholly foreign-owned enterprise (“WFOE”)
Limited Liability Company
Joint Stock Company
Others (e.g., Holding Company, Branch Office, Limited Partnership, Processing/Contractual Arrangements)

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 income
Joint 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. WFOE
Joint Ventures
Pros
(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.JV
Wholly Foreign-Owned Enterprises
Pros
(1) No Chinese partner or JV Contract
(2) Simple to establish
(3) Better IP protection
(4) Better integration with parent company
Cons
(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 Company
Governed by Board of Directors subordinate to equity owners
Registered capital must be contributed in a lump sum
Profits must be shared in proportion to equity contributions
Perpetual existence
Two-thirds majority to approve major issues
Lack of implementing regulations hinders use by foreign investors

17. Investment Vehicles (6)
Joint Stock Company
Most closely resembles U.S. corporation
Ownership represented by issued share capital
Theoretically able to list on Chinese or foreign stock exchange and issue debt instruments
Limited 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 diligence
Experienced international businesspeople appear to ignore this basic tenet when investing in China
Professional due diligence in the PRC presents peculiar challenges
less reliable information than foreign investors are used to
obscure and volatile state of China's legal system
Chinese companies’ lack of familiarity (and patience) with corporate formalities and record keeping
great breadth of authority afforded to China's bureaucracy.

20. Due Diligence: Key Points
Nature and Powers of the Partner
Financial Records
Employees
Contractual Obligations
Tax
Ownership 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 transfer
appendix listing all of the Chinese partner's assets and liabilities that are to be transferred to the new entity
land use rights, buildings and other fixed assets
"allocated" or "granted" state-owned land use rights
Allocated 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 years
granted 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 domain
inventory, receivables, intangibles and contractual rights

22. Valuation Issues – Cash and In-Kind
relative value of parties' contributions determines shares of profits
value 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 contract
non-cash contributions by foreign parties must also be valued by the State Import and Export Commodities Inspection Administration
actual contribution of both cash and non-cash inputs must be verified by a licensed PRC accounting firm
state-owned assets (such as assets owned by state enterprises) must be valued by a valuation firm licensed by the State Assets Management Bureau
localities have standards to value land use rights; foreign investors should investigate whether Chinese side’s valuation falls within the official range
investors 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 reduced
Conditions to the Effectiveness of JVs
Transfer of property
Contribution of assets
Necessary approvals
Feasibility Studies – Prior Approval Mandatory
Objectives; sources of investment; sources of foreign exchange and raw materials; site; technology requirements
Economic benefit analysis; financial projections
Labor requirements
Marketing plans; distribution; export percentages; forex balancing
Non-competition clauses
Geographic
Product line(s)
Marketing plans; distribution
Chinese 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 entity
Facilitates future transfers of the investment
Where there are multiple foreign investors in a JV, foreign parties may work out the details of their cooperation in a shareholders agreement
Chinese JV law does not provide for more complex corporate capital structures, such as preferred stock, redemption rights, or the like

25. Exit Strategies
Most 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 China
investment 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 Threat
IP violations are widespread in China
Infringing/counterfeiting (20%+ of consumer products)
Piracy (90%+ of movies, software, games, books)
Imitation of product designs
IP theft by employees/partners
In the US, Canada, Japan and the EU, China is the
No. 1 source of seizures of infringing goods
China government entities may acquiesce in infringing activities
Local governments (sole source of funds and salaries for local courts and judges) protect local taxpayers and employers
National government determined to advance China’s technology

27. Intellectual Property Enforcement (1)
China IP Legal Enforcement - Dual Track System
Administrative Enforcement
Special enforcement task forces in administrative agencies
Judicial Enforcement
Civil litigation: IP tribunals in intermediate people’s courts to hear cases
Criminal prosecution for IP crimes

28. Intellectual Property Enforcement (2)
Administrative Enforcement
More effective for Trademark infringement and counterfeiting complaints than patent or copyright infringement – over 73,000 proceedings in 2004
No real equivalent in U.S. or other Western countries
Fast in taking action and cost-effective
More domestic parties than foreign parties use this system
Administrative IP agencies participate in enforcement – “ public interest” required in copyright cases
Some agencies may conduct raids, confiscate infringing goods, destroy equipment for making infringing goods, and impose fines
Agencies may examine and copy infringer’ s accounting records
Agencies cannot award infringement damages – aggrieved party must file an infringement suit in courts to seek damages

29. Intellectual Property Enforcement (3)
Judicial Enforcement
Civil Enforcement – 2004
9,323 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 disputes
555 “others”
Criminal Enforcement -2004
653 individuals convicted for IP crimes
385 criminal cases

30. Intellectual Property Enforcement (4)
Foreign Party Practical Strategies
Early filing necessary to protect rights
Trademarks and Copyrights
Utility and Invention Patents
Design Patents
Ensure the quality of Chinese translations and patent prosecution in China
Undertake careful due diligence on potential partners
Aggressively monitor for infringements and take steps to enforce rights before infringement spreads
Require confidentiality/non-compete agreements with employees and partners (BUT limited enforceability)
Formulate proper investment and corporate structure in China
Enlist political/media support – you may have Chinese allies!

31. Intellectual Property -- Conclusions
China’s IP Laws “Closing in” on International Standards
IP Enforcement in China -- “Work In Progress”
Foreign Companies Should File and Protect IP in China
Patents
Trademarks and copyrights
Non-compete and confidentiality agreements
Foreign IP Owners Can Successfully Enforce IP in China
Don’t be afraid to sue in China
Don’t wait too long – two year statute of limitations
Choose counsel carefully