FIEs, 25% or Less!

The Circular imposes more restrictions on Special FIEs than Regular FIEs. For example, a foreign investor investing in a new Regular FIE has a grace period to make an actual investment. Such grace period generally is not less than one year after the FIE receives its business licence. In the case of a Special FIE, such grace period becomes three months for cash investment and six months for investment in kind.

The Circular leaves many questions unanswered. As mentioned above, some Special FIEs were registered as domestically invested enterprises, and provisions regarding the qualification of FIEs' shareholders did not apply to such Special FIEs. Do they now need to comply with these regulations? Under both current regulations and new Provisional Rules on Foreign Debt Regulation effective March 1 2003, a FIE can incur foreign debt without SAFE approval in an aggregate amount not exceeding the difference between its approved investment amount and its registered capital. A non-FIE needs SAFE approval to incur foreign debt. Can a Special FIE incur foreign debt without SAFE approval?

Establishing FIEs through Acquisition

More and more foreign investors now make investments in China by acquiring an equity interest in pre-existing enterprises, as opposed to setting up new enterprises. To facilitate the reform of state-owned enterprises and to attract foreign investment, the government recognizes and encourages such acquisitions, as we've seen in recent regulations.³ The Circular provides that in the case a foreign investor acquires equity in an enterprise, such enterprise shall be converted into a FIE through the FIE examination and approval process. Furthermore, the Circular generally requires a foreign investor to make full payment of the purchase price within three months after the FIE receives its FIE business licence. The Circular also provides that before a foreign investor makes full payment of the purchase price for the acquisition, it shall neither take control of the FIE's management nor shall it consolidate its financial reports with the FIEs. If the foreign investor is a listed company and its domestic laws mandate consolidation of financials for public disclosure, it could have a serious problem before it pays the full purchase price.

No Grandfather For Pre-existing FIEs

The Circular requires all existing Special FIEs to comply with the examination, approval and registration process pursuant to the EJV Law within six months after the effectiveness of the Circular. In addition, the Circular expressly provides that a Special FIE is subject to ongoing compliance with the EJV Law with respect to amendments to its EJV contract and articles of association.

Individuals as Investors of FIEs

The Circular follows the law's traditional uneasiness with individuals forming FIEs. It expressly prohibits Chinese residing in China from setting up new FIEs or acquiring equity to form FIEs. The Circular does grandfather Chinese investing in FIEs under limited circumstances. If a Chinese individual has been a shareholder of a company for more than one year before the company is converted into a FIE, such Chinese individual can remain as an investor in the converted FIE. The one-year limitation is probably intended to close the door to Chinese individuals circumventing the Circular by acquiring equity in a company immediately before such company's conversion into a FIE. However, what about those other shareholders who own their shares for less than one year? How this will be handled remains an open question.

By Wantao Yang and Sidney Qin

Llinks Law Office

Endnotes

1 See Christopher Han & Sidney Qin, "FIE Status and the 25% Rule," China Law & Practice, 15(10), December 2001/January 2002, p. 106.

2 Under the Foreign Investment Issues Related to Listed Companies Several Opinions issued by MOFTEC and the China Securities Regulatory Commission (CSRC) on November 5 2001, if the IPO of a Regular FIE causes the foreign equity share to fall below 25%, the listed company will lose its FIE status and the FIE approval certificate will be revoked. It is not clear whether the Circular supersedes such a provision.

3 There are two additional recent regulations regarding such market practice: the Issues Relevant to the Transfer of State-owned Shares and Legal Person Shares in Listed Companies to Foreign Investors Circular issued by the Ministry of Finance (MOF), the CSRC and the State Economic and Trade Commission (SETC) on November 1 2002; and the Using Foreign Investment to Reorganize State-owned Enterprises Tentative Provisions, issued by the SETC, MOF, SAIC and SAFE on November 8 2002.