Issues in Foreign Investment in Audio and Video Products Distribution

The Regulations are applicable to the publication, production and reproduction, importing, wholesale, retail and rental businesses of pre-recorded cassette tapes, phonograph records, and audio and video compact discs. All institutions and individuals must possess an audio and video business permit before they are allowed to engage in the above business activities in China. The publication authorities in China are in charge of regulation and administration of publication, production and reproduction, and the MOC is in charge of regulation and administration of the import, wholesale, retail and rental businesses of audio and video products. The two authorities are responsible for setting out the national plans in their areas as regards market participants, location and structure. It remains to be seen how national plans shall be developed, updated and implemented.

The Administrative Procedures have substantive requirements for granting wholesale business permits, such as registered capital, business area and staffing. If a chain store form is used in a wholesale, retail or rental business, the registered capital shall be no less than Rmb5 million (and Rmb30 million if operating nationwide), and the business shall have at least 10 chain stores. The chain stores can be established either by direct investment or by franchising. If the retail or rental business is conducted over the internet, the same requirements as to wholesale business shall be applied. Further clarification shall be sought as to whether all the 10 chain stores shall be opened according to a certain timeline. This 10-minimum chain store rule seems to go against the rationale governing the chain store business, in that chain stores would always be opened on a gradual expansion and due assessment basis. It would be difficult particularly for new market entrants to run a business in this way if they do not have ready assessment capabilities and experience in a new market. An alternative is provided in the Administrative Procedures whereby a wholesaler can apply to open chain stores if it has operated for two years and its business practice proves sound. However, a "sound" practice is not defined; this lends some uncertainty to the process and is a factor to be considered when a business plan is formulated.

Foreign Investment

In the recently promulgated Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录) , which was revised primarily based on the Chinese government's commitments per its WTO entry, distribution of audio and video products (other than movies) is listed as a restricted industry sector. Only Sino-foreign cooperative joint ventures are allowed in this sector, and the Chinese party shall hold not less than a 51% equity interest in the venture. The CJV Procedures basically follow these changes.

The establishment and development of a CJV in an audio and video distribution business shall conform to the national audio and video market development plan, which as explained above shall be administered by the MOC. As it is unclear how such a plan will be formulated and updated, the determination of whether or not a CJV will be approved remains discretionary. As the development of a CJV shall rely on a national plan that may be updated from time to time, the investors in a CJV will find it difficult to assess the market and policy risks associated with their investments.

IP Protection

The new regulations have given some attention to protection of intellectual property rights (IP). A new IP authentication verification mechanism is spelled out in the CJV Procedures, and offers some protection to CJVs and other distributors, given that CJVs and other distributors are generally liable for distribution of illegal products. However, this mechanism is simplistic and it remains to be seen how it will work in practice.

By Roy Zhang

Llinks Law Office,

Shanghai

Endnotes:

1 Jointly promulgated by the Ministry of Culture (MOC) and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) on December 10 2001 and effective on January 10 2002.

2 Promulgated by the MOC on March 28 2002 and effective on April 10 2002.