Foreign-invested Construction Rules in the PRC: Building the Future?

Construction Industry Standards in the PRC

Since 2001 the MOC has issued a series of regulations and industry standards in an attempt to give a facelift to the regulation of the PRC construction market. The MOC first issued the Administration of the Qualifications of Construction Enterprises Provisions (Construction Enterprises Provisions). This was followed by the Classification Standards for the Qualification of Construction Enterprises (Construction Industry Standards), which provide for industry standards for construction contractors or sub-contractors in 85 specialities. Both the Construction Enterprises Provisions and Construction Industry Standards came into effect on July 1 2001.

Under the Construction Enterprises Provisions, a construction company must apply for classification qualification. The Construction Industry Standards provide for the specific requirements for the classification qualification of each construction speciality. Under the Construction Industry Standards, construction firms in the PRC will be classified based on factors including minimum registered capital requirements, net assets and turnover, minimum number of managers and technical personnel, and past performance. Generally there are three classes in each construction speciality, although some specialities have four classes (with premier class being the highest).

Under current construction industry standards, a construction firm can only undertake construction projects falling into the permitted scope in relation to its approved qualification. Any newly established construction firm must be verified as the lowest class for at least a year before it is eligible for applying for a higher class of qualification. Therefore, the capacity of a construction firm to undertake construction work is substantially determined by its class of qualification.

Construction WFOEs Permitted

The Foreign Construction Provisions allow WFOEs in the field of construction to be set up in the PRC. However, they are silent on whether construction WFOEs are immediately permitted upon the regulations' effectiveness. Under China's WTO commitments, construction WFOEs will be permitted within three years after China's WTO accession. According to our conversation with officials at the MOC, MOFTEC and the MOC may decide to allow construction WFOEs to be established at any time ahead of the timetable set in the WTO commitments.

Recently at a seminar sponsored by the China Construction Association in Beijing, an official from the MOC further revealed that applications for the establishment of construction WFOEs will be accepted after December 1 2002. According to the official, this indicated that China is opening its construction market to foreign investors at a faster pace than is required by the country's WTO commitments. This is no doubt good news for foreign construction companies wishing to maintain complete control over the management and technology of their subsidiaries in the PRC.

National Treatment

Unlike the previous regulations on foreign investment in construction, minimum registered capital requirements and a temporary lowest class of qualification are no longer included in the Foreign Construction Provisions. Given the recent developments in the legal framework governing the construction industry as discussed above, naturally a sensible question is whether construction FIEs will be subject to the construction legal framework and if so, to what extent.

The Foreign Construction Provisions explicitly provide that the qualification of construction FIEs will be subject to the requirements in the Construction Enterprises Provisions. At the recent Beijing seminar mentioned above, the MOC official confirmed that, in order to reflect the principle of national treatment under the WTO rules, except for those otherwise provided in the Foreign Construction Provisions, the Construction Enterprises Provisions and the Construction Industry Standards will be equally applicable to construction FIEs.

However, a careful examination of the Construction Enterprises Provisions and the Construction Industry Standards leads one to think that the minimum requirements for some construction specialities, if applied to construction FIEs, would present significant regulatory hurdles. For instance, the minimum requirements for registered capital and turnover, and the minimum numbers for management and technical staff, will deter some small (but highly-specialized) foreign construction firms from entering the PRC market. Furthermore, even if some construction FIEs satisfy the minimum requirements, given the lowest class of qualification requirement for a newly-established construction firm and that the class of a firm will directly impact upon the scope of the construction projects it is eligible to undertake, construction FIEs might lose their competitive advantages in technology and management when they vie with domestic construction companies in bidding for construction work in the PRC.

Foreign Majority Ownership Clarified

The Foreign Construction Provisions clarify certain issues that were left open in China's WTO commitments. While China's WTO commitments permit, for example, foreign majority ownership in construction joint ventures, it is unclear whether there is any restriction with regard to the majority ownership of a foreign investor in a joint venture.

Under the Foreign Construction Provisions, it is explicitly specified that the contribution of Chinese parties may not be lower than 25% of the registered capital of a construction FIE. Hence, in a Sino-foreign construction equity joint venture, while a foreign investor's proportion in the registered capital may not be less than 25% according to relevant joint venture laws, the maximum ownership of a foreign investor is capped at 75% of the registered capital of the construction joint venture. This appears to be an indication that the PRC regulatory authorities have discretion to impose further restrictions on market access by foreign companies to the extent permitted by China's general WTO commitments.

Scope of Projects for Construction WFOEs

Under the Foreign Construction Provisions, a construction WFOE can only undertake the following four types of construction projects:

• construction projects wholly financed by foreign investment and/or grants;
• construction projects financed by loans of international financial institutions and awarded through international tendering according to the terms of loans;
• Sino-foreign jointly constructed projects with foreign investment equal to or more than 50%; and Sino-foreign jointly constructed projects with foreign investment less than 50% but technically difficult to be implemented by Chinese construction enterprises alone; and
• Chinese-invested construction projects, which are difficult to be implemented by Chinese construction enterprises alone, jointly undertaken by Chinese and foreign construction enterprises with the approval of a provincial government.

Dual Approval for Foreign-invested Construction Companies

Like previous regulations, under the Foreign Construction Provisions construction FIEs will continue to be subject to dual approval, i.e., by the authorities in charge of construction and foreign investment, respectively. But unlike previous regulations, the Foreign Construction Provisions provide that procedurally:

• an application to establish a construction FIE must be first submitted to MOFTEC or its provincial counterparts, which will then send the application to the MOC or its provincial counterparts for their review, and then MOFTEC or its provincial counterparts will, based on the construction authority's review, determine whether or not to approve the application;
• after the establishment of a FIE is approved, the FIE will then need to register with the SAIC or its local counterparts; and
• after obtaining a business licence, the FIE will need to apply to the MOC or its provincial counterparts for construction qualification certificates.

Under the Foreign Construction Provisions, it will take about 100 days to obtain an approval from MOFTEC or its local counterparts for the establishment of a construction FIE, and a construction FIE should obtain a business registration within 30 days of approval of its establishment. It will take about 60 days to obtain a construction qualification certificate.

Foreign Construction Companies Undertaking Contracted Projects in the PRC

Since 1994, some foreign construction companies have undertaken contracted construction projects in the PRC on a project-by-project basis. In order to be able to engage in a construction project in the PRC, a foreign construction company must apply from the relevant construction authorities for a Foreign Enterprises Undertaking Contracted Projects Qualification Certificate (Qualification Certificate), which is valid for five years.

Under the Foreign Construction Provisions, if a foreign construction company that has obtained a Qualification Certificate wishes to establish a construction FIE, it is permitted to apply for the relevant construction qualification for the FIE based on its performance records for the contracted construction projects it has undertaken in the PRC. This means that if a foreign construction firm with a valid Qualification Certificate wishes to establish a construction FIE, instead of being initially classified at the lowest class, the FIE may be classified based on the performance records of a foreign construction company in the PRC. This is good news for foreign companies that have already had performance records in the PRC.

However, the above-mentioned regime under which foreign companies undertake contracted projects in the PRC on a project-by-project basis will be abolished on October 1 2003. At the Beijing seminar, the MOC official revealed that between now and October 1 2003, those foreign companies planning to undertake contracted projects on a project-by-project basis may continue to apply for Qualification Certificates to undertake contracted projects in the PRC.

After October 1 2003, foreign construction companies will not be able to undertake contracted projects on a project-by-project basis by virtue of the Qualification Certificates. If foreign construction companies wish to undertake construction work in the PRC, they must set up subsidiaries (either joint ventures or WFOEs) in the PRC. However, according to an MOC official, for ongoing projects that are expected to be completed after October 1 2003, Qualification Certificates holders will be permitted to carry on and complete the projects.

Conclusion

There is no doubt that the Foreign Construction Provisions represent a significant step toward the liberalization of the regulatory framework for foreign investment in construction in the PRC. Further, they offer great potential, especially at a time when foreign construction firms are seeking entry to the PRC market given Beijing's hosting of the 2008 Olympic Games and China's plans to develop other national projects. For foreign construction companies that wish to establish a construction WFOE in the PRC, it is good news that the PRC has decided to open the market to foreign companies ahead of the timetable given in its WTO commitments.

However, before they try and enter the PRC market, foreign construction firms need to examine carefully the limitations on the scope of projects a construction FIE in a particular field may undertake. With the upcoming abolishment in October 2003 of the project-by-project vehicle for foreign construction firms to undertake construction work in the PRC, foreign construction firms may no longer structure their business presence in China on a short-term basis.

Given the above-mentioned stringent requirements for minimum capital, turnover, the minimum number of management and technical personnel, and the restrictions imposed on the scope of construction projects for different classes of construction companies, small foreign construction firms (or even some larger ones) may find that the prospects promised by the Foreign Construction Provisions may not be as favourable as expected. Unless the PRC regulatory authorities further clarify and relax the applicability of the construction industry requirements and standards to construction FIEs, the Foreign Construction Provisions will remain a regulatory hurdle for foreign construction companies that are strong in construction technology and management, but are comparatively smaller in terms of both personnel and capital.

The author would like to acknowledge the assistance of Wang Jiangang of Beijing Zheng, Liu, Yuan & Zhou Law Office in clarifying some issues discussed in this article.