State Council Clamps Down on Fixed Return Projects

Freshfields Bruckhaus Deringer

While the Chinese central government has long prohibited the practice of "guaranteed fixed returns" whereby the Chinese party or local government guarantees a foreign investor's receipt of a minimum fixed return on its investment, this practice is common in infrastructure projects, including power plants, toll roads and water supply networks. The General Office of the State Council issued a notice on September 10 2002, entitled Issues Relevant to the Proper Handling of Current Projects with Guaranteed Fixed Returns for Foreign Investors Circular (the Circular), which indicates that the government is refocusing its attention on this issue.

In sufficiently profitable joint ventures, profit distribution to a foreign investor may not require a call for the guarantee. For projects with profits below the amount needed to provide the guaranteed return, a foreign investor would like to be able to rely upon the guarantee return in order to avoid downside risk. From the viewpoint of the Chinese government, such arrangements violate the principle of mutuality of risk sharing among joint venture parties and are therefore unacceptable. Moreover, guaranteed fixed returns are considered a form of "hidden debt" that should be registered with the State Administration of Foreign Exchange (SAFE).