Doing Business with China

TAGLAW - Berlin 2008 AGM

Mark Ho & Blaine Turnacliff

Presentation Points

1. Introduction2. Legal investment vehicles3. Outbound investment4. Real estate business in China

China: Big NumbersChina: Big Numbers

Coming to Grips with the Numbers and therefore Potentials

1.3 billion people 0.7 billion peasants 0.2 billion migrant workers 200m aspiring middle class 100m middle class as now 14m engineers 140k lawyers

Courtesy of The McKinsey Quarterly 2006 special edition: Serving the Chinese consumer

China’s Comparative Disadvantages: the reality about this economic gorilla

25% of the world’s population, 6% of global economic activity (28% for US)

At current growth rates, by 2050 China will be the world’s largest economy, but the average Chinese will be poorer than the average American was in 2005

Excess labourInnovation gapGovernance deficitCommercial immaturity (SOEs)

Foreign Investment Operating Structures in China

Representative Office Equity Joint Venture Cooperative Joint Venture Wholly Foreign Owned Enterprise (WFOE) Foreign Invested Commercial Enterprise

(FICE) Holding Companies

Representative Office

Quick (procedure to register is not complicated) and inexpensive way to establish a legal presence in China. Can carry out market research, render advice, collection of information, coordinate company activities in China and hire staff

No direct business activities permitted – cannot enter into sales contract, issue invoices, arrange for importing goods

no registered capital requirements Do require a leased office before registration

Equity Joint Venture

In the 80s and early 90s, was the most commonly used foreign investment structure First foreign investment structure allowed

in China Benefit to the Chinese economy - foreign

party generally provides technology, management expertise & cash

Dividends / profits based on equity shareholding of each party

Cooperative Joint Venture

Similar to Equity Joint Venture in structure but with more flexibilities because Sharing of profits may be governed mostly

by JV contract Foreign partner can obtain return of

investment in priority to Chinese partner; or early recovery of investment

Wholly Foreign Owned Enterprise (“WFOE”) 100% owned by foreign investors More and more industries are open to

WFOEs (although still some restricted industries)

Complete control of operation – no local partner

It is becoming first choice of foreign companies

Approval and registration procedure similar to Joint Ventures

Minimum registered capital –4000 USD but should be proportional to scope of business plans

Foreign Invested Commercial Enterprise (FICE)

Allowed to engage in retail, distribution, agency and franchising

First time in modern history foreign companies could undertake trading

Become very popular Franchisors need to own / operate two units

for one year in order to begin franchise business

Lower minimum registered capital (4,000 USD legally but most companies invest much more)

Exit Strategy

Need to have a plan in place that will allow you to pull out or sell your investment with minimum of difficulties and costs

Ten year minimum operational period to enjoy tax incentives

Wind up procedures are very onerous and time consuming

Offshore vehicle (SPV) enhances flexibility and presents options for both partners liability, sale of company, tax

considerations

Outbound Investment

Start of trend to invest overseas by Chinese companies that will continue for many years to come

The Chinese are Coming!

China’s appetite for commodities, natural resources, distribution networks for their products, desire to move up the value added chain

Over 1.5 trillion USD in foreign currency reserves

Fall of USD / appreciation of RMB Government policy of “going global” outbound M & A investment

4.3 billion USD in 2004 16 billion USD in 2006 24.6 billion outbound M & A in 2007

Outbound M & A Transactions

Notable Deals: 2.3 billion USD stake in Nigeria’s offshore oilfield by C

NOOC 5.6 billion USD of Standard Bank (SA) by ICBC 4.3 billion USD of Canada’s Nations Energy’s Kazakh

stan oil rightsPlus:

Recent purchase of 50 Airbus A320s for 3.3 billion Expected 280 billion USD for 2,900 planes over ne

xt 20 years

Governmental Approval

Generally 3 or 4 step process State Development and Reform

Commission (SDRC) Ministry of Commerce (MOFCOM) State Administration of Foreign Exchange

(SAFE) If State Owned Enterprise, also State

Assets Supervision and Administration Commission

Bank Financing Issues Chinese domestic companies cannot borrow

from offshore so must obtain funding in China

Can be easy if borrower is large co, but difficult if smaller

Foreign competitors often label the Chinese financing as government subsidies

In future, will likely see the rules on overseas borrowing loosen

Legal Services in China

Legal Services are relatively new in China 1989 was first year private law

firms allowed mainly very young, inexperienced

lawyers, mostly 20 or 30s Few have experience dealing with

western companies

Real Estate Business in China

Real Estate Business in China

Chinese real estate sector is increasingly attracting foreign investment (300% property appreciation in the past 10 years or so); plusForeign business requires acquisition of real estate properties for operations

One Big Project

Property Ownership in China

No private land ownership, Only:(i) State or (ii) Collective Ownership Collective – rural areas or countryside State – urban areas or cities Concept that land ownership is separate

from land use rights; types of use rights: Allocated land use rights Granted land use rights

Different Types of Land Use Rights

Allocated Land Granted Land (introduced post-1988)

Term Indefinite term Set term – usually 40 to 70 years

Use Granted for designated purpose – usually agricultural or military or infrastructure use

Granted for a range of designated uses

Consideration normal or nil consideration paid to the State

Land grant premium to be paid to the local Land and Property Bureau

Transferability Not transferable (and therefore technically cannot be mortgaged)

Transferable subject to restrictions

Ownership of Buildings

May be privately owned May be mortgaged, sold or leased May be for an indefinite term Subject to a term of land use rights Subject to registration and

certification Subject to zoning regulations

Property Protection and Risks

Recording, Registration and Certificates property ownership is recorded at different

levels of government and there may be discrepancies in records for old buildings (municipal vs. district)

Most cities have open records to the public Shanghai is at municipal level Foreign ownership permitted but restricted

New Law

July 2006 Regulations– Opinion on Regulating Entry Requirements and Administration of Foreign Investment in the Real Estate Markets (Circular No. 171)

Implications of New Laws

Can no longer use offshore company to directly purchase RE in China So must pay China taxes on sale or

transfer If want to invest in Chinese RE, must

set up a RE Development Company Total Investment minimum – 10 million

USD 5 million USD to be invested upfront

Establishing a Foreign Invested RE Development Company

Essentially two methods:

Project Development Company bid and purchase land use rights

Acquire / merge with an existing Chinese Property Development Company

Project Development Company

Must participant in a public auction to obtain land Generally pay bond to be eligible to

participate If win the bid, sign a Land Grant Contract

with local government (Land Bureau) Land Use Certificate is granted for a term

depending on types of development purposes (40-70 years)

Set up WFOE / JV

Merge/Acquire Property Development Company

Due diligence and deal documentation Financial and legal Execution of M&A documentation

Application to Ministry of Commerce for approval

If approved, share transfer will be registered with local government

A Business license is issued

Use of non-RE FIE to Invest

Foreign Entities established in China can purchase RE only for “self use”

Self use means business or housing for staff/employees

Purchase of “excessive” residential units become grey area

Purchase of 100 units likely “excessive”

Lease of Chinese Real Estate Office Lease: typical 2 year term Facilities Lease: 20 year maximum Retail Lease: 20 year maximum Housing Lease: typical 1 year subject

to renewal Leasing Pitfalls: zoning, granted land;

existing mortgage, etc.

Mark Ho mark.ho@jzfz.cn

Blaine Turnacliff blaine.turnacliff@jzfz.cn

Address: 10/F, Longfeng Tower

No. 1566 Yan’an W. Road

Shanghai 200052, ChinaTel: (86 21) 5258-2666

Fax: (86 21) 5258-7968 Website: www.jzfz.cn

THANK YOU!

Q & A