Bidding for Real Estate Projects in China

Public Auction – where anyone can bid to develop the site, and the sole determinant is highest price;

Listed Land Grants – similar to a Public Auction where the highest price wins, but where bids are submitted over a longer period of time. Listed Land Grants are the form of bid process most commonly used in Shanghai in respect of high quality, large scale real estate developments.

Bid Process

The first official announcement of a tender is when the local authority posts details of the development and bid process on its website.

Details may include location and size of the development site, minimum bid price, designated usage (commercial, residential, industrial), floor area ratio, construction density, investment density (RMB/m²), timetable for the bidding process as well as qualification requirements of potential bidders. One such qualification requirement is for each bidder to remit an amount of money – designated as 'surety money' – into a special PRC bank account where it will remain for the duration of the bid process.

The timetable set by the local authority may be very tight. A developer therefore may have only a few weeks in which to build a financial model, calculate a bid price, find a strategic local partner (if needs be), draft building designs and submit its bid proposal.

In addition, there are no specifications set by law as to how a bid committee should appraise a bid or determine the winning tender. The time between bid deadline and announcement of the winning tender may be surprisingly short – as little as 10 days. This suggests that a local authority may have a good idea of the leading candidates even before the bid deadline. It is recommended therefore for a prospective developer to establish good links with the local authority and other government or municipal bodies well in advance of a bidding process.

Development Vehicle

PRC law requires that a foreign real estate developer operate through a PRC foreign-invested enterprise – a foreign-invested real estate enterprise (FIRE). It is important to note however that the establishment of a FIRE will not be approved until some time after a bid has been won. Consequently, during the bid process and immediately after a tender is awarded, a foreign developer (or its Chinese partner) will act on behalf of the FIRE until its establishment is approved.

Permission to bid and deposit of surety money

To enter the bidding arena a foreign developer will first need special permission from the local land authority (however, where a tender is by invitation, permission will be deemed to have been granted).

Having obtained local land authority consent, a foreign developer should next apply to the local State Administration of Foreign Exchange (SAFE) for approval to open a special foreign exchange bank account with a designated domestic bank. The foreign developer should then remit foreign currency to the special bank account equal to the amount of surety money as specified on the local authority's website. The bank will issue a certificate evidencing to the local land authority payment of the surety money by the foreign developer. Only if the surety money is remitted within the deadline specified in the tender announcement will the foreign developer obtain full qualification to participate in the tender process.

SAFE will closely supervise the operation of the special bank account and restrict its application to either: i) payment of the deposit payable in respect of the land grant premium in the event that the foreign developer wins the bid; or ii) remittance of the money out of China if the foreign developer fails in its bid.

Surety Money v. Deposit

Prior to a tender being awarded, money remitted by a bidder into the special bank account is designated as 'surety money'. After having won the tender, the project developer pays the local authority an initial tranche of money in accordance with the Land Use Rights Grant Contract – which is now designated as a 'deposit'. 'Surety money' and 'deposit' are legal terms that receive different treatment under PRC law.

A deposit is a type of security, whereas surety money is not. If a party pays a deposit and subsequently defaults, it is not entitled to any reimbursement of the deposit; and if the party receiving the deposit defaults, it is obliged to refund double the deposit amount. No such default conditions attach to surety money.

During the tender process, the local authority merely wants comfort that a bidder is committed to the bidding process, and therefore requires nothing more onerous than the remittance of surety money. As contractual relations have not at that stage been established between the parties, it would be inappropriate to ask the bidders to pay the 'deposit'. It would clearly be commercially unattractive if there was any risk that a losing bidder might not automatically be reimbursed any advance payment.

Winning the Bid

After the tender is awarded the winning bidder must enter into a Land Use Rights Grant Contract with the local authority within the time limit set out in the 'Tender Award Confirmation Letter' and then pay the deposit.

Land Use Rights Grant Contract

The Land Use Rights Grant Contract contains industry standard terms and conditions governing the development process of the site and the relationship between the local authority and the project developer. The contract is governed by PRC law and any dispute may be conducted either through the courts or arbitration, but in both instances in the PRC. It is generally not a negotiable document. A new form of terms and conditions came into effect on 1 July 2008.

The Land Use Rights Grant Contract also governs payment of the Winning Bid Price. The Winning Bid Price covers two principal costs: i) land grant premium; and ii) relocation costs and other preliminary development costs. The cost of relocating the former occupiers of the land will have been borne by the local authority, and the process of relocation and site clearance should have been completed prior to completion of the bidding process.

The Land Use Rights Grant Contract is intended to be between the local authority and the project developer. As mentioned above, where the developer is a foreign-invested entity, the FIRE will not have been established at this stage. The foreign developer or its Chinese partner (as the case may be) will therefore enter into the Land Use Rights Contract on behalf of and prior to the establishment of the FIRE. Immediately after the FIRE is established, a new Land Use Rights Grant Contract will be entered into between the land authority and the FIRE, whereby the FIRE will assume all the rights and obligations of the foreign developer or the Chinese partner under the previous (and now terminated) agreement.

Payment of the Deposit

Under the Land Use Rights Grant Contract the foreign developer pays a deposit to the local land authority. The deposit is in respect of the Winning Bid Price. To make this payment, the developer must apply to SAFE to convert the foreign currency (until that point, surety money) into RMB, after which the deposit is paid into a designated bank account of the local authority.

If the project developer subsequently fails to pay the remaining Winning Bid Price it will forfeit the deposit. Likewise, if the land authority breaches the Land Use Rights Grant Contract, it will have to refund double the deposit amount (although this rarely happens in practice).

Establishment of FIRE

Types of investment vehicle

Under Chinese law, any real estate development involving a foreign party must take place using a PRC vehicle. The FIRE may be one of i) a wholly foreign-owned entity (WFOE); ii) Equity joint venture (EJV); and iii) co-operative joint venture (CJV). A WFOE is currently the most common form of investment vehicle in the real estate market. The corporate structure offshore will chiefly be led by the tax analysis.

Any co-operation with a Chinese party may benefit from being structured at offshore level. However, practical obstacles may dictate that such a relationship may only be achieved through an EJV or CJV onshore.

MOFCOM

Having been awarded the tender, the foreign developer must then establish its FIRE. There is some urgency to setting up the FIRE, as the Land Use Rights Grant Contract will generally specify a deadline by which the remainder of the Winning Bid Price must be paid.

The foreign developer must first apply to the local Ministry of Commerce (MOFCOM) office to approve the establishment of the FIRE – approval generally takes two to three months at the end of which a temporary certificate of approval is issued. Local MOFCOM registration is also required, and should be facilitated immediately after local MOFCOM approval has been granted, which may take another one month in practice.

Business Licence

A temporary business licence will be issued to the FIRE by the local Administration for Industry and Commerce shortly after local MOFCOM approval is obtained.

SAFE

The FIRE will need to pay up its registered capital in order to transfer the remainder of the Winning Bid Price to the local authority. The registered capital will be injected from offshore. SAFE approval will be needed for:

(i) foreign exchange registration and the issue of a foreign exchange certificate;

(ii) opening a foreign exchange account with a domestic bank; and

(iii) processing foreign exchange settlement for capital accounts.

Under law, SAFE may only grant these approvals after the FIRE has successfully completed the registration process with the local MOFCOM.

Payment in full of Winning Bid Price

The FIRE will pay the remainder of the Winning Bid Price to the local authority only after it has been established, after the various foreign exchange registrations and approvals with SAFE and after the FIRE has opened a foreign exchange account with a domestic bank. The Winning Bid Price is paid entirely with registered capital – no debt may be used.

When the FIRE pays the outstanding balance of the Winning Bid Price to the local authority the FIRE will obtain a real estate ownership certificate (known as a Land Use Rights Certificate in some parts of China) (REOC). At this stage the REOC will only be in respect of the land since no buildings will yet have been erected. Upon issue of the REOC, land use rights transfer to the FIRE. Following completion of the real estate development, the REOC will be reissued to evidence ownership of the erected buildings in addition to the use rights attaching to the land.

Following issue of the REOC regarding the land use rights, the FIRE may apply for a permanent certificate of approval and permanent business licence.

Ongoing Finance

It is worth noting that any FIRE established after 1 June 2007 may not obtain foreign currency loans. The only sources of funding for such a FIRE are its registered capital or borrowing from domestic financial institutions. Domestic debt is not easy to draw down – utilization may only be authorized on delivery of certain construction permits issued at specific stages of the construction process, and provided that the FIRE's registered capital is fully paid up and the REOC (regarding the land use rights) has been issued.

Conclusion

The regulatory landscape for real estate projects is changing and growing, albeit not as quickly as the skylines over China's tier 1 cities. To complicate matters further, the process whereby bids are awarded may differ hugely between cities. Last, and by no means least, it remains unclear exactly what impact the global downturn will have on the Chinese real estate market.

What remains constant, however, is the benefit to a foreign developer of having on-the-ground local knowledge – usually through partnership with domestic parties – with which to penetrate the tangle of governmental and quasi-governmental rules, regulations and relationships. Whilst the bid process is complex and can be fraught with timetable pressures and bureaucratic hurdles, the potential upside of these developments is clear for all to see.