Chinese individuals become shareholders of Pudong FIEs

Although an exception existed for the establishment of FIEs by means of merger and acquisition – where Chinese individual shareholders of a target company were allowed to retain shareholder status after completion of a share acquisition by foreign investors – this led to limited applications. Chinese individuals still could not become shareholders of newly incorporated FIEs, but were forced to firstly set up a domestic company as an investment vehicle. This not only restrained the combination and exchange of outbound capital, management experience and domestic residents' technology, but also does not conform with the principles of national treatment.

Remarkably, this issue has been realised by the Chinese government. Following the seeking of permission for Chinese individuals to directly do business with foreign parties in the form of partnership, from March 2010 Shanghai enacted the Pilot Measures.

Pursuant to the Pilot Measures, which comprise 10 sections, Chinese natural persons are allowed to directly invest in and establish FIEs (including China-foreign equity JVs and China-foreign cooperative JVs) with foreign companies, enterprises, and other economic organisations or individuals. They can become shareholders of FIEs subject to the following regulations and restrictions:

(i) Personal qualification. The Pilot Mea- sures require that Chinese individual investors shall hold PRC resident identity cards and satisfy certain conditions. These include having full capacity for civil conduct and complying with other conditions of natural person shareholders under PRC relevant regulations;

(ii) Industry limitation. The industries en- gaged in by FIEs incorporated by domestic residents and foreign investors, according to the Pilot Measures, shall only fall into the encouraged or permitted industries as provided by the Foreign Investment Industrial Guidance Catalogue.

(iii) Capital contribution. Capital contributions can be provided in the form of cash or in kind, intellectual property rights, or other non-currency property that can be evaluated in currency and be transferred in accordance with the law. This is subject to the limitations provided by the Company Act that at least 30% of the registered capital must be contributed in cash.

(iv) Change of equity structure. The Pilot Measures provide that, where the alterations of FIEs result in domestic natural persons becoming shareholders of FIEs, the Pilot Measures shall apply. Hence, domestic natural persons may not only invest in the newly established FIEs, but also hold the shares of the established FIEs through share transfer.

(v) Limited application. It is notable that the Pilot Measures, issued by Pudong New District, a subordinate region of Shanghai, is just regarded as a local rule with relatively low hierarchy and can only be applied within the territory of Pudong New District. Furthermore, a two-year trial period is set in the Pilot Measures.

(vi) Governmental approval. The Pilot Mea- sures prescribe that the approval and registration of FIEs invested and established by domestic natural persons in Pudong New District shall be granted by the Commerce Commission of Pudong and Pudong Company Registry respectively within their own authorities.

Notwithstanding the limited scope governed by the Pilot Measures, a legal channel or an opportunity can now be awarded to Chinese individuals to directly establish FIEs. This will save administration costs and time for Chinese individuals to make joint investments with foreign investors.

Provided that the Pilot Measures are acceptable to, and work for, the economic growth of China, then they are expected to be extended after the expiration of their trial period. It could even be expected that the permission under the Pilot Measures will be expanded throughout the PRC in the future.