China's Foreign-invested Companies: A Standardization of Practices

The Opinion provides clear and specific rules concerning issues such as organizational structure, incorporation form, timing and documentary requirements pertaining to approval applications, registration and capital contribution of FICs, as well as approvals and registration of amendments. Among other aims, the stated purposes of the Opinion include "the precise application of law; conducting the work of administering foreign investment approval and registration work in a standardized, convenient and efficient manner; [and] promoting the healthy development of foreign-invested enterprises".

Despite its broad circulation, the Opinion generated both sufficient confusion and insufficient local response to warrant issuance by the SAIC, on May 26 2006, of the Circular on the Implementation of the <Implementing Opinions on Several Issues Concerning the Application of the Law in the Administration of the Examination, Approval and Registration of Foreign-invested Companies> (Circular). Despite these developments, bringing nationwide uniformity to local approval and registration standards and practices will likely remain an elusive aspirational goal for some time to come. Nonetheless, the Opinion and the Circular represent an important step forward to help unify the application of foreign-invested enterprise law, the Company law, and related administrative regulations.

Legal authority governing FICs

The Opinion expands on the basic rules found in Article 218 of the Company Law on the applicability of the laws to FICs.² With respect to FIC company registration matters:

i. FICs are governed by the Company Law and the Registration Rules;

ii. if FIE laws³ provide otherwise, the subject provisions of FIE laws will govern;

iii. if neither the Company Law, the Registration Rules nor FIE laws address a given issue, then the relevant administrative regulations governing FIEs, decisions of the State Council and other regulations of the state governing foreign investment apply.

This pronouncement, among other things, would appear to leave little room for purely provincial or local rules and practices to fill any gaps in national level laws and regulations. An important question, then, is whether significant gaps remain, and whether remedies for countering local protectionist practices are adequate if they would have the effect of inhibiting foreign investment.

Rectification of names

Even if the Opinion fails to achieve its stated goals, it may herald the extinction of the term 'foreign-invested enterprise' in favour of 'foreign-invested company'. The Opinion and Circular consistently refer to various forms of FIC, but only use the term FIE in connection with legacy FIE laws. This is consistent with the general principle that the Company Law should govern foreign direct investment in China, unless pre-empted by FIE laws,⁴ and may foreshadow the phasing out of an FIE specific legal regime at some point in the foreseeable future.

When it comes to classifying FICs, the Opinion drafters display the instincts of a zoologist documenting biodiversity. The Opinion confirms detailed categories and sub-categories of FICs according to the legal form of the company and the nature of the foreign investor. In total, there are 13 different designations for FICs formed as limited liability companies (LLCs) and 10 distinct designations for FICs formed as foreign-invested companies limited by shares (FICLS). The business licenses of FICs established on or after January 1 2006 must reflect one of these classifications, and when pre-existing FICs undergo any changes requiring amendment of their business license, they should also follow suit (see List of Designations).

Corporate governance

On corporate governance issues, the Opinion also confirms the extended application of the Company Law to FICs.

According to the Opinion, the ultimate management authority of equity joint ventures (EJVs) and cooperative joint ventures (CJVs) formed as LLCs is vested in the board of directors,⁵ rather than the shareholders' meeting. Other organizational structures may be established in the articles of association, based the EJV law, the CJV law and the Company Law. The Opinion is silent, however, on CJVs that are not organized as legal entities.

By contrast, the Opinion confirms that the organizational form of wholly foreign-owned enterprises (WFOEs) and FICLS should comply with the Company Law and their articles of association.⁶ This entails statutory governance structures including the shareholders' meeting, board of directors and board of supervisors, as well as exemptions for LLCs with a few shareholders and sole shareholder. Current provisions contained in the articles of association of FICs, established prior to January 1 2006, are exempt and such FICs may choose whether not to amend their articles of association to reflect Company Law requirements.⁷

An important implication of the Opinion for WFOEs in matters of corporate governance is the appointment of one or more supervisors⁸ in accordance with Article 52 of the Company Law. Anecdotal reports indicate that various local Administrations of Industry and Commerce (AICs) are already requiring newly established WFOEs to appoint supervisors. Since most WFOEs are presumed to be companies with a small number of shareholders, they need not establish a board of supervisors, but may suffice in appointing only one or two supervisors. What is less clear, however, are the qualifications of these supervisors, other than the fact that senior managers and directors may not also serve as supervisors.⁹

Single shareholder WFOEs

In previous versions of the Company Law, a single-shareholder company was prohibited, except in the case of State-owned enterprises. This restriction has been lifted in the revised Company Law, thereby bringing WFOEs more fully within the scope of the Company Law. The Opinion imposes some requirements and restrictions on sole-shareholder WFOEs as follows:

i. minimum registered capital equivalent to Rmb100,000 (US$12,500) is required;¹⁰

ii. a single natural person may only establish one single shareholder WFOE, and WFOEs wholly owned by a natural person may not reinvest in another sole-shareholder company;¹¹

iii. the business license of a WFOE established by a natural person issued after January 1 2006 will bear a notation indicating ownership by a foreign natural person,¹² and

iv. although restrictions are not applicable to WFOEs established before January 1 2006, they should comply with the above referenced requirements in the event of a capital increase and reinvestment.¹³

Capital contributions

Timing

Under the prior version of the Company Law, in the case of non-FIEs, capital contributions were required to be paid in a single lump-sum payment.¹⁴ The revised Company Law now permits subscribed registered capital to be contributed in separate instalments, emulating capital contribution requirements under the FIE laws, but with some differences. The Opinion provides some specific guidance by using the Company Law as the general basis and adding some specific requirements for FICs.

For FICs formed as LLCs, including single shareholder companies, the initial capital contribution by an individual shareholder or multiple shareholders must comply with the requirements of corresponding laws and regulations. Capital contribution by a single lump-sum payment should be made not later than six months after the establishment of the FIC. If registered capital is contributed by instalments, the first instalment must be not less than the minimum statutory registered capital and also not less than 15% of the approved registered capital. In addition, the first instalment should be paid in no later than three months after establishment of the FIC. The timing of contribution of the remaining registered capital should be in accordance with the Company Law, FIE laws and the Registration Rules. Overall, the balance must be paid in within two years after the establishment of the FIC and within five years after the establishment of an investment company.¹⁵

Capital contributions of FICLS should comply with the requirements of the Company Law. Specifically, if the company is established by promotion, the promoters' initial capital contribution must be not less than 20% of the total registered capital. The balance must be contributed within two years from the establishment date, but within five years after the establishment of an investment company.¹⁶

When applying for registration of capital increase of LLCs and FICLS established by promotion, the minimum amount of capital contributions to be made must be not less than 20% of the newly increased capital.¹⁷

Currency of registered capital

The Opinion explicitly permits registered capital to be denominated in either renminbi or other freely convertible currency. However, if the contribution is made in a different currency, the middle exchange rate announced by the People's Bank of China on the day of contribution will be applied,¹⁸ limiting investors' ability to lock in an exchange rate in advance.

Non-cash contributions to registered capital

Pursuant to the Opinion, methods of capital contribution by shareholders of FICs should comply with Article 27 of Company Law, Article 14 of the Registration Rules and the Provisions on the Administration of Registration of Company Registered Capital. These various authorities permit registered capital to be contributed in the form of currency, tangible assets, intellectual property rights, land use rights or other intangible assets whose value can be stated as money equivalent and may be legally transferred. Contributions in the forms of labour, credit, name of natural persons, goodwill, franchising rights or encumbered property are prohibited. Until such time as the SAIC and other relevant departments issue regulations on the subject, any permitted in-kind (non-cash) registered capital investments in forms other than currency, tangible assets, intellectual property and land use rights should be appraised and verified by lawfully established appraisal firms within China. Investors in EJVs may, however, agree between themselves on the valuation of contributions of tangible assets, industrial property rights and other permitted non-monetary forms.¹⁹

Funding registered capital with loans

Prior to the Opinion, the Regulations Concerning Respective Capital Contributions by Investors in Equity Joint Ventures provided that the subscribed registered capital of a joint venture should take the form of the investors' 'self-owned' funds or unencumbered tangible assets or industrial property rights owned by them. This placed a cloud over the fairly common practice of foreign investors using offshore debt to fund their capital contributions. Under the Opinion, debt raised by shareholders of an FIC is now also deemed to be 'self-owned' funds.²⁰

FIC registration requirements

The Opinion in various places clarifies, adds to or simplifies numerous requirements of FIC registration, and makes changes to items within the scope of registration.

Appointment of agent

Under the Opinion, foreign investors are now required to appoint an agent in China for purposes of receiving service of legal documents. In addition to documents required by Article 20 or Article 21 of Registration Rules, the foreign investor(s) should submit a power of attorney appointing an agent for service of process to the approval and registration authorities. The agent may be a branch established by the foreign investor(s) in China, the prospective FIC, or other entities or individuals in China.²¹

Documentation requirements

The certificate of incorporation of a corporate foreign investor or identification for natural person investors must be notarized and legalized by both local notarial authorities and PRC consular authorities in the foreign investor's home country. However, local notarization is sufficient if the investor is from Hong Kong, Macao or Taiwan.²²

Pursuant to the Opinion, the joint venture contract and creditworthiness certification of investors is no longer required for company registration, equity transfer or other changes to registration.²³

Primary registration application

An FIC formed as an EJV is governed by the registration time limits found in Article 20 of the Registration Rules and therefore should apply for initial registration no later than 90 days after the approval date. However, the Opinion requires that an FIC formed as a CJV or a WFOE should apply no later than 30 days after the approval date. If the relevant time limit is exceeded, the applicant should request confirmation from the approval authority that the approval remains valid, or resubmit the application for approval.²⁴

Registration of changes and amendments application

Timing of the application for registration of changes and amendments should generally follow application deadlines as provided in the Registration Rules. For amendments requiring approval, an application should be made within 30 days after the date of approval. If the time limit is exceeded, the applicant should request confirmation from the approval authority that the approval remains valid or resubmit the application for approval. Under circumstances such as variation of registered capital and expansion of business scope, approval documentation issued by the original approval authority before amendment and the approval certificate reflecting such an amendment should also be submitted, in addition to documentation required by the Registration Rules. ²⁵

Cancellation of registration application

FICs should submit documents for cancellation of registration according to Article 44 of the Registration Rules, which stipulate that the certification of tax registration cancellation, certification of customs registration cancellation or certification of default of customs registration should be attached to the liquidation report. In addition, approval from the original approval authority is also required for early termination of FICs.²⁶

Reinvestment in China

Pursuant to Articles 5 and 6 of the Provisional Regulation on Investment in China by Foreign-owned Enterprises, FICs could not reinvest in China until the registered capital had been fully paid and the enterprise had become profitable, and the aggregate amount of reinvestment was not allowed to exceed 50% of the company's net assets. Such requirements and restrictions have been lifted.²⁷ The Opinion also provides that qualification certification for FICs to reinvest in China issued by the company registration authorities is no longer required.²⁸

Branches and representative offices

Application for registration of opening or closing of branches of FICs should be made to the local AIC of the city where the branch is located or to be opened and no longer needs to be approved by the original registration authorities of the head office. Such an application must be made within 30 days after the date of approval (if approval is required).²⁹

Domestic representative offices of FICs are a unique type of entity distinct from a branch company, which is permitted to engage in such indirect business activities as market investigation and liaison for FICs. Under previous regulations, the representative office had to go through registration formalities after being approved; however, the Opinion abolishes such requirements. From now on, registration will not be granted for representative offices of FIC, and existing FIC representative offices will be cancelled or converted into branches upon expiration of their current registration. The Circular clarifies that FICs are free to set up unregistered 'liaison' offices as may be required by their business. However, they may not engage in substantive operations in the name of the liaison office.³⁰

Closing observations

The Opinion addresses various other subjects that are likely to be of concern to FICs and their investors at some point or another in the course of the FIC's formation, existence and evolution in China. Together with the Circular, it should be mandatory reading for both legal practitioners and company secretaries alike. Although local and provincial AICs and approval authorities have not yet universally embraced its provisions, the issuance of the Circular indicates that the widespread and consistent implementation of the Opinion is a high priority. Early indications are that certain provinces are already taking its requirements seriously. If the SAIC is successful in this endeavour, there will be greater certainty and cost savings realized by foreign investors, their advisers and FICs that have historically been faced with the daunting task of ascertaining local administrative requirements.

Endnotes

* Peter Neumann can be contacted at [email protected].

1 The Opinion consistently uses the term "foreign-invested company" (?ÃÕðµ´À? and not the traditional term "foreign-invested enterprise" (?ÃÕðÛ"?.

2 Paragraph 1 ibid.

3 FIE laws include, primarily the basic laws, passed by the National People's Congress, governing EJVs, CJVs and WFOEs.

4 Paragraph 1 of the Opinion.

5 Paragraph 3 of the Opinion; Paragraph 1 of the Circular.

6 Paragraph 3 of the Opinion.

7 Paragraph 1 of the Circular.

8 Where an LLC has relatively few shareholders, it may appoint one or two supervisors and is exempted from establishing a board of supervisors (one-third of whom would need to be labour representatives). See Article 52 of the Company Law.

9 Ibid.

10 Paragraph 2 of the Opinion states that the Company Law must be followed for single shareholder companies. See Article 59 ibid for specific rules.

11 Ibid.

12 Paragraph 3 of the Opinion.; see also Article 60 of the Company Law.

13 Paragraph 2 of the Opinion.

14 Article 27 of the Company Law (2004).

15 Paragraph 9 of the Opinion.

16 Paragraph 3 ibid.

17 Paragraph 15 ibid.

18 Paragraph 8 ibid.

19 Paragraph 10 ibid.

20 The Opinion replies to this question by stipulating that funds raised by shareholders of FICs through loans borrowed in the shareholder's name are deemed to be 'self-owned' funds and may be used as capital contribution upon issuance of capital verification certification. See Paragraph 11 ibid.

21 Paragraph 5 ibid.

22 Ibid.

23 Ibid.

24 Paragraph 4 ibid.

25 Paragraph 13 ibid.

26 Paragraph 23 ibid.

27 Paragraph 2(3) of the Circular.

28 Ibid; Paragraph 7 of the Opinion.

29 Paragraph 24 ibid.

30 Paragraph 4 of the Circular.