State Council Clamps Down on Fixed Return Projects

The promulgation of these rules has produced mixed results. A number of projects have been forced to restructure and a few cases have been reported in which foreign investors encountered difficulties remitting abroad their guaranteed fixed returns. Nevertheless, guaranteed fixed returns still persist, prompting the issuance of the recent State Council Circular. The Circular both reiterates the previous ban and calls for remaining projects to be "rectified" by January 1 2003. The current Circular provides specific measures and methods for handling fixed return projects, as described below.

Amendment

The joint venture contract may be amended to replace a fixed return provision with a legally enforceable arrangement, particularly for projects whose fixed returns are paid out of income derived from the projects themselves. If the fixed return is guaranteed in a separate agreement and the guarantee is provided by a local government authority, the agreement and guarantee must be rescinded.

Additional options are available for projects that are loss making, that have income insufficient to meet the guaranteed fixed return, or where the guaranteed fixed return to the foreign party is not paid.

Purchase

The Chinese party may purchase the entire equity interest of the foreign party, terminating the relevant contracts and agreements, and convert the joint venture into a domestic enterprise. Matters involving the purchase of foreign exchange are to be handled by SAFE in accordance with the relevant regulations.

Conversion

For projects that have the means to repay foreign debts, the parties may convert the original foreign investment into the Chinese party's foreign debt and have the project converted into a domestic enterprise. Upon approval by the State Development Planning Commission (SDPC) and in conjunction with the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and SAFE, procedures for debt registration can be completed.

Dissolution

The joint venture contract may be terminated and the enterprise liquidated if it has incurred heavy losses or is unable to continue operations and is eligible for dissolution as specified in the contract and articles of association.

Significantly, the Circular specifically states that it does not apply to power projects in which the sole project revenue is derived from power purchase agreements. The Circular states that such projects will be handled in the future within the framework of the State's power sector reforms.

From January 1 2003, foreign exchange banks will no longer be able to handle foreign exchange purchase and remittance without SAFE approval if a fixed return project's income received by the foreign party exceeds the distributable revenue and other lawful income of the project. In addition, cases where the rectification procedures cannot be resolved through negotiations with the foreign investor are to be reported to MOFTEC and the SDPC. The Circular offers few specifics on the liability for projects that continue to be in violation of the new rules, only stating that those entities in breach of the provisions of the Circular are subject to "severe punishment" and shall have their contract or agreement rendered null and void.

Previous rules, as mentioned earlier, have been issued with limited success in an attempt to eradicate guaranteed fixed returns. However, unlike the earlier notices, the current Circular outlines detailed, specific measures for the restructuring of projects that guarantee fixed returns and as such may prove more effective in ultimately eliminating such practices.

By Tarrant M. Mahony and Leland Fong

Freshfields Bruckhaus Deringer,

Beijing