SPECIAL FEATURE: A Practical Guide for PRC Property Valuation Under the Listing Rules

However, as we shall see in the Clarification Announcement discussed below, no business valuation on the listing applicant's property interests in the JV may be included if the long-term land use right certificate has not been obtained in the name of the JV.

THE CLARIFICATION ANNOUNCEMENT

On March 25 1998, the Exchange further clarified its requirements on PRC land titles in the announcement of the Clarification on Requirements for Land Use Title of Properties Situated in the Mainland of the PRC (Clarification Announcement). The requirements under the Clarification Announcement have also been adopted by the GEM Listing Rules. As a general rule, listing applicants are expected to have long-term land use right certificates and/or building ownership certificates and/or the real estate ownership certificate (which is a combined land and property certificate) (Title Certificate) for all Mainland properties in respect of new listing applications. If there is no long-term Title Certificate, any property revaluation surplus arising from then should be excluded from both the financial statements and the net tangible asset statement in the listing document.

Where the listing applicant has interests in a JV company whose income stream is derived from a Mainland property but the long-term Title Certificate for such property is not obtained by the JV, no business valuation on the applicant's interests in such a JV may be included in the listing document. If the Title Certificate is still held under the name of the Chinese party to the JV or a third party, steps have to be taken to transfer it to the name of the JV in order to ascribe a value to the particular property.

The scope of the general rule covers three types of companies. If these companies cannot produce a long-term Title Certificate, listing approval will not be granted. The first type is an infrastructure project company whose Mainland property is used in an infrastructure project (whether completed or under development). The second type is a property company holding Mainland property (whether completed or under development). A property company is defined as a company whose assets consist solely or mainly of properties or interests in companies whose assets consist solely or mainly of properties and whose income is solely or mainly derived from those properties. The rule applies where a Mainland property represents a substantial portion of the listing applicant's property assets in terms of either asset value or profit contribution, or in the opinion of the Exchange, is crucial to the listing applicant's activities. The third type is a company whose Mainland property is crucial to a listing applicant's activities in the opinion of the Exchange, unless otherwise permitted by the Exchange.

EXCEPTIONS TO THE RULE

For infrastructure project companies, the Exchange expressly recognizes one exception to the general rule. Where infrastructure projects are operated under long-term concessionary arrangements awarded by the government that do not provide for long-term land use right certificates to be granted, the Exchange may accept, for the purpose of the listing application, other evidence of the right to use the Mainland property for the period during which the assets are expected to be operated. This depends on the merits of each individual case. A government awarded long-term concessionary arrangement may include a concession agreement executed by the infrastructure project company and the PRC government at municipal, provincial or central level. The required arrangement will have to provide the infrastructure project company with direct contractual rights against the relevant PRC government under the concession agreement.

Nevertheless, the Clarification Announcement seems to apply to new listing applications only and not, for instance, to takeovers or rights issues. However, it is up to the Exchange to further clarify the intended scope of the Clarification Announcement.

It is advisable to consult with the Listing Division of the Exchange and obtain confidential advice early in the stage regarding issues such as whether the Title Certificate must be produced and the valuation of a property is required and capable of being included in the listing document.

CODE ON TAKEOVERS AND MERGERS

In merger and acquisition transactions a valuation may also be required under the Code on Takeovers and Mergers. The valuation must be included in the offer document or other document circulated to the shareholders of the offeree company by its board, when valuations of assets of either the offeror or offeree company are made in connection with an offer. A valuation by an independent professionally qualified valuer may be required in the case of an offer for a company with significant property interests, except with the consent of the Executive Director of Corporate Finance Division of the SFC or delegate. Generally, this refers to a company or group of companies whose book value of the property assets or consolidated property assets respectively, exceeds 15% of the book value of total assets or total group assets. The Executive Director should be consulted to determine the extent to which the requirements of Practice Note 12 should apply.

LEGAL OPINION - THE CHINESE PERSPECTIVE

One of the most important stages in the legal due diligence exercise is to vet the PRC legal opinion. Even though Hong Kong lawyers are not qualified to give formal PRC legal advice, it is paramount for Hong Kong lawyers to streamline and adapt the form and the contents of the legal opinion so as to satisfy the requirements of the Exchange.

The PRC law firm appointed must be authorized by an appropriate authority in the PRC to advise in relation to listed companies. The law firm and the lawyer must be authorized by the PRC Ministry of Justice and the China Securities Regulatory Commission to advise on matters relating to listed companies and securities laws. The law firm or the practitioner's licence number may also be disclosed in the legal opinion.

The PRC lawyer must furnish the legal opinion together with copies of any documents referred therein to the valuer prior to the completion of the valuation report, and the valuer should explain whether, and if so how, the content of the legal opinion has been taken into account in the valuation of the relevant property.

Normally, the addressees of the legal opinion should include the instructing Hong Kong law firm and its client if the Hong Kong law firm acts for the listing applicant. Sometimes it is advisable to include other parties such as the sponsors, underwriters, their solicitors and the valuers in the list.

Both the list of documents inspected and the main body of the legal opinion are usually divided into two parts: the status and qualification of the foreign investment enterprises (FIE) (that is, the land use right holder) and the Property.

Preferably, the documents inspected must be the originals or PRC notarized copies. In particular, the original State-owned Land Use Rights Certificate, Building Ownership Certificate or Real Estate Ownership Certificate must be checked to make sure that they are not in a mortgagee's possession unless the property is known to be subject to mortgage. Further, the PRC lawyer should express an opinion on the authenticity of the documents.

The legal opinion may include assumptions on the authenticity of signatures and chops, conformity of copies of documents with originals, valid execution by the parties, due authorization of the parties, completeness and accuracy of the documents and information provided, and non-contravention of laws of any jurisdiction outside the PRC. The PRC lawyer may require a certificate by the officer in charge of the client, the listing applicant, in assuming certain facts. Sometimes it may be necessary to curtail the scope of these assumptions.

It goes without saying that the substance of the legal opinion is of utmost importance. The legal opinion should deal with matters of law only and not the facts or commercial viability of the transaction in question. It must cover the existing PRC laws up to the date of the legal opinion.

One of the most important statements in the legal opinion is that the legal title to the property is vested with the relevant FIE.

You may find a legal opinion full of complicated facts or history of transactions without any "opinion" at all from the PRC lawyer. You may also find a legal opinion full of citation of law or legal principles with no relevance to the facts or without any application of the law to the facts. Of course, this is unacceptable.

The legal opinion should include the due incorporation of the FIE, whether the FIE possesses the right to hold, transfer, mortgage or lease property and all requisite licences and permits including the approval of the project proposal report, approval for the feasibility study report, approval document of the JV contract and the articles of association, approval certificate of enterprises with foreign investment, business licence, capital verification report, the foreign exchange registration certificate, and whether the above documents have been obtained and are still subsisting.

The term, user and the type of land use right obtained must comply with the law and be consistent among various title documents. Further, whether the FIE is legally entitled to freely transfer, mortgage or lease the relevant property to domestic or/and foreign individuals, enterprises and organizations without payment of any land grant premium must be stated clearly.

The crucial documents include the State-owned Land Use Rights Certificate, Building Ownership Certificate, Real Estate Ownership Certificate, Planning Permit of Construction Land, Planning Permit of Construction Project and if applicable, the Foreign-sale Permit, Pre-Sale Permit or Foreign-Sale and Pre-sale Permit (a combined certificate). The question is whether the particular certificate/permit vests with the relevant FIE and its issue is within the power of the issuing authority and in accordance with PRC law.

Other property documents include the Contract for Grant of Land Use Right, the formal agreement for sale and purchase, mortgage and lease agreement. The issues include whether the rights and obligations of the parties are valid, enforceable and protected under PRC law, whether they are validly executed, whether all legal formalities such as notarization and registration have been done and all fees and taxes have been paid.

Other material contracts, documents and information may include security interests or encumbrances, third parties' rights, pending litigation, adverse claims, notices or orders.

If the PRC lawyer is unable to deliver a clean opinion, then any qualification becomes a legal risk for the recipients of the legal opinion.

It is usual for the PRC lawyer to limit the legal opinion to the benefits of the recipients specified in the outset. However, it is advisable to agree with the PRC lawyer to expand the scope of coverage to other interested parties, such as the sponsors, underwriters, valuers, accountants and the Exchange.

With regards to registration, the PRC lawyer should investigate and confirm the identity of the registered land use right holder, and whether certain property documents that should be registered in order to take effect under the law have been registered.

It is necessary for the PRC lawyer to undertake certain enquiries, searches and investigations at the local Land Administration Bureau and the Administration of Industry and Commerce in order to verify the contents of the title deeds and documents inspected. It is also advisable to urge the PRC lawyer to go for a site visit.

ROLE OF LAWYERS IN HONG KONG

The PRC legal due diligence process cannot be underestimated. Hong Kong lawyers are essentially the bridge of communication between the PRC lawyer, valuer and the Exchange. A good working relationship between the parties throughout the process is essential to the success of the transaction in question.

The client may expect the Hong Kong lawyer to advise and/or comment on the PRC legal opinion and make sure that it complies with the Exchange's requirements even though it is ultimately the PRC lawyer who finalizes and signs the legal opinion. It is imperative to liaise early and agree with the PRC lawyer the general format and contents of the legal opinion with the requirements of the Listing Rules in mind. The PRC lawyer may hold strong views in regard to certain issues that are contrary to the Exchange's. Further, the PRC lawyer may try to limit the scope of and keep his or her liability to a minimum in the legal opinion. It the role of the Hong Kong lawyer to explain the intricacies of the requirements of the Exchange to the PRC lawyer, and stretch the limit of the legal opinion as much as possible.

The PRC lawyer is usually introduced and instructed by a Hong Kong law firm. Before the PRC lawyer starts working, it is important to agree with him or her, and confirm by the client in writing, the hourly charge rate and the estimated total costs and disbursements in respect of the preparation of the legal opinion. Disbursements may include investigation fees, travelling and accommodation expenses. The Hong Kong law firm should be notified at once if the estimated total costs and disbursements are likely to exceed a certain limit because the ultimate liability to pay the PRC lawyer may lie with the instructing Hong Kong law firm.

In any correspondence with the PRC lawyer, it is prudent to include a warning which states that the contents of the correspondence may contain confidential information of the client and therefore cannot be used in any way other than in the course of the preparation of the legal opinion and disclosed to any third parties without prior written approval.

As mentioned earlier, the valuer must rely on the PRC legal opinion and summarize the material information in the valuation report. Our role is to check through the PRC legal opinion and the valuation report and make sure that they are consistent at the end. Synchronizing the work of the PRC lawyer and the valuer can sometimes be a very difficult task. The key is to communicate and organize early.

Whether or not the valuer can ascribe a value to the particular property depends on the PRC legal opinion. Again, it is advisable to agree the format and contents of the valuation report with the valuer and the Exchange as early as possible. Bear in mind that the values of the properties can be one of the main determinants of the offer price and an investor's decision to invest, especially if most of the listing applicant's assets consist of land and buildings.

In a way, the Exchange is like a judge in a court and we have to present our case coherently and convincingly. Given that Practice Note 12 and the Clarification Announcement are still too general to cover every possible case, the Exchange is entitled to make the call for additional requirements from time to time. Any precedent case approved by the Exchange may be of limited value. One cannot expect the Exchange to vet every single title deed and document that you present, and know or fully understand the massive and ever-changing PRC legislation and policy. The Exchange must rely to a certain extent on the PRC legal opinion and our representation and professional judgment.

A systematic way to deal with our own client is also essential. Sometimes it is no easier to deal with the client than the Exchange, bearing in mind that the transaction in question usually involves a complex corporate structure and a lot of personnel such as the director, company secretary, in-house accountant, in-house counsel and project manager. They may have self-interests and their objectives and requirements may not coincide with those of the company. In cases where the property interests are held by a JV, the Chinese party's personnel may also have to be consulted and informed. Therefore, it is important to identify the person to whom you are to seek final instruction and report to.

Where the legal due diligence is on a property that has already been acquired by the client but the legal procedures have not been strictly followed (perhaps through past relationship or guanxi with the Chinese authorities), we may encounter difficulties in convincing the client to remedy the defects in question. For instance, the client might have acquired the land use right through a private concessionary arrangement with a local government without payment of the land grant premium a long time ago or the local government had exceeded its authority in granting the land use right. As a result, the State-owned Land Use Right Certificate is not available or the land is subject to forfeiture. However, the client had subsequently erected buildings or installed expensive equipment on the premises and somehow obtained a Building Ownership Certificate. The client may become adamant if a clean legal opinion cannot be obtained and values of properties cannot be ascribed. We can only tell the client in a subtle way that Title Certificate is a must after the Clarification Announcement or that central government's approval may have to be obtained retrospectively. Before the Clarification Announcement, the Exchange may actually accept, in some cases, the inclusion of the value of the buildings without the State-owned Land Use Rights Certificate by obtaining some secondary documents such as a Contract for Grant of Land Use Rights together with a PRC legal opinion which states that, "the issuance of the State-owned Land Use Rights Certificate is merely procedural and the company intends to obtain the State-owned Land Use Rights Certificate as soon as possible. There is no legal impediment in obtaining the State-owned Land Use Rights Certificate". However, this may not work after the clarification Announcement.

Inevitably, Hong Kong lawyers may have to give legal advice on PRC matters to their clients from time to time. It is advisable to include either of the following disclaimers when 'advising' clients on PRC transactions:

"Finally, we are obliged to point out that we are not qualified PRC lawyers and cannot provide formal advice or opinion on PRC law. The contents of this [letter/report] set out our understanding of PRC law as it relates to [the transaction]. If you require a formal opinion from a PRC lawyer, please let us know and we will make the necessary arrangements on your behalf".

"The above is based on our understanding of the relevant PRC law and practice and our experience in representing foreign investment enterprises in their business activities in the PRC. As foreign lawyers, we are not authorized to practice law in the PRC and cannot express a formal legal opinion on Chinese law. The application of Chinese laws and policies regarding the acts of foreign investment enterprises in the PRC is constantly evolving. Accordingly, this 'advice' is necessarily preliminary and subject to confirmation from a PRC lawyer or/and the relevant Chinese authority".