UBILLA & CIA

Capital Contributions by Equity: Available to Foreign Invested Enterprises in China Soon

On May 4th 2011, the Ministry of Commerce (“MOFCOM”) issued a Draft of the Management Measures regarding Capital Contribution by Equity to Foreign Invested Enterprises (“FIEs”) for public comments ("Draft Measures"). The deadline for the submission of comments was May 20th, 2011.

According to the current laws and regulations, the form of capital contribution to the FIE shall only include cash and non-monetary assets which are transferable and can be economically assessed, such as tangible assets, intellectual property, land use right, etc.

On January 14, 2009, the State Administration of Industry and Commence issued Measures on the Registration of Capital Contributions by Equity, which stipulated that capital contributions by equity to Chinese domestic enterprises were allowed. However, capital contributions by equity to the FIEs were excluded in this regulation at that time.

The promulgation of the Draft Measures creates a new method of investment for local and foreign investors, which means that investors are allowed to use equity as the capital contribution to a FIE.

The main points of the Draft Measures are as follows:

1.- The Definition of Contribution by Equity

Capital contribution by equity refers to the act of using investors’ equity in domestic enterprises as the capital contribution in order to establish the FIE.

The FIE establishment includes the following scenarios:

1. Incorporating a FIE by establishing a new legal entity;
2. Changing a domestic enterprise to a FIE by increasing capital of the domestic enterprise;
3. Change the equity structure of a FIE by increasing the capital of the FIE.

2.- Requirements regarding the Equity

Under the following circumstances equity can not be used as the capital contribution to a FIE:

1. The investor’s equity to be contributed to a FIE in the Chinese domestic enterprise has not been fully paid;
2. The investor’s equity has been pledged or is legally frozen;
3. The investor’s equity is nontransferable according to the Article of Association of the Chinese domestic enterprise;
4. The equity of a FIE which didn’t apply for or pass the annual inspection;
5. The equity of Foreign Invested Investment Enterprises or Foreign Invested Equity Investment Enterprises;
6. The equity transfer has not been approved by the authorities;
7. Others.

3.- Equity Value Assessment

The equity to be contributed to a FIE must be assessed by a domestic evaluation agency established in accordance with the PRC law. Based on the value assessment of the equity reported by the domestic evaluation agency, the investors shall fix the final value of the equity and the equity amount to be contributed to a FIE.

The final value of the equity shall not be higher than the assessed amount of the equity.

4.- Proportion of Forms of Contribution

The aggregate value of the contribution by equity and other non-monetary capital contributions made by all shareholders of the FIE shall not exceed 70% of the registered capital of the FIE.

5.- Procedural Regulations

The Draft Measures also stipulate the procedural regulations including the documents to be provided for the registration change with the authorities, the authorities who are in charge of the approval of equity contribution, etc.

Conclusion

Even though the Draft Measures are only a draft for public comments and observations, they show that the Chinese government intends to further promote the development of investment by creating a new mean of capital contribution to the FIE in China. The Draft Measures also stipulate the corresponding requirements and procedures which will certainly facilitate the authorities’ examination and approval. Investors should keep a close eye on the final “Measures” which will probably be issued by the authorities in the following months.

by UBILLA & CIA

Adjustment of the Standard of Social Security Payment

Shanghai Human Resources and Social Security Bureau issued the New Standard of Social Security Payment in Shanghai (the “New Standard”) on March 31, 2011. The New Standard has come into effect on April 1, 2011 and will expire on March 31, 2012.

The New Standard increases the payment base (the “Base”), which refers to the number used to calculate the amount of the social security payments.

The new standard regarding the upper limit and the lower limit of the Base are summarized as follows:

The amount of the social security payment shall be a percentage of the Base. Since the Base is increased every year, the social security payment will be increased accordingly.

by UBILLA & CIA

Interim Rules on Implementation of a Security Review System regarding M&A Transactions Executed by Foreign Investors over Domestic Enterprises

On March 4th 2011, Ministry of Commerce (“MOFCOM”) issued the Interim Rules on Implementation of a Security Review System regarding M&A Transactions Executed by Foreign Investors over Domestic Enterprises (the “Interim Rules”), which will come into effect on March 5th, the same day the Notice on the establishment of a security review system regarding merger and acquisition (“M&A”) transactions over domestic enterprises executed by foreign investors (“the Notice”) comes into effect.

The Interim Rules specify more details with respect to the procedure of national security review. The Interim Rules will play a transitional role in the establishment of national security review system because it will expire on August 31st 2011.

1. Initiation of National Security Review

The Interim Rules provide that if M&A transactions executed by foreign investors over domestic enterprises clearly fall within the national security review scope stipulated in the Notice, the foreign investor (the “Applicant”) shall apply for this review to MOFCOM. If M&A transactions are conducted by more than one foreign investor, the security review may be applied by the Applicants jointly or by only one of them.

If M&A transactions fall within the national security review scope but are not applied for the national security review to MOFCOM, the general review on M&A transactions will not be accepted by local commercial committee. The local commercial committee shall request foreign investors to apply for the national security review to MOFCOM in writing.

2. Function of MOFCOM

The Applicant should submit relevant documents to MOFCOM. If the documents are complete and meet legal requirements, the Applicant will be notified in writing that the security review application is accepted by MOFCOM within 15 working days after the reception of the application by MOFCOM.

After receiving the official acceptance of MOFCOM, the Applicant is not allowed to implement the M&A transaction within 15 working days after the written notice of the official acceptance is received by the Applicant. If MOFCOM doesn’t notify the Applicant within 15 working days, the Applicant may proceed to implement the M&A transaction.

The Interim Rules also provide that the Applicant may apply for the pre-filing consultation to MOFCOM with respect to procedural issues before officially applying for the national security review.

3. Review Decisions

The Interim Rules provide three kinds of review decisions by the joint committee (“Joint Committee”):

1. No impact on national security

   If the transaction will not impact national security after the security review, the Applicant can apply for the general M&A review and other relevant approvals according to various foreign investment regulations;

2. Potential impact on national security

   If the transaction may impact national security, the Applicant can not apply for the general M&A review or other relevant approvals until the Applicant amends the transaction plan, the application documents and re-submits them for security review;

3. Actual or potential severe impact on national security.

   If the transaction has already impacted or may severely impact the national security, the M&A transaction will be prohibited. Measures, such as share transfer and assets transfer, will be required by the authority to eliminate the impact on national security caused by this M&A transaction.

Comments

The Interim Rules specify some details on the national security review application procedure, such as documents to be submitted and the review decisions by the Joint Committee. It will facilitate the review application and increase the transparency of the review. Meanwhile, the Interim Rules stipulate the function of MOFCOM, which have clarified the uncertainty regarding the function of MOFCOM in the Notices and will help MOFCOM to better supervise the M&A transactions.

The Interim Rules will expire on August 31, 2011. Any suggestion or comments from the public are encouraged to provide to MOFCOM until April 10 2011, and MOFCOM may adjust the Interim Rules according to the public’s suggestion or comments after the expiration of the Interim Rules. This arrangement in the Interim Rules clearly indicates that MOFCOM and the relevant authorities will evaluate the review procedure system established in the Interim Rules during the effective period and improve the specific regulations in the Interim Rules later.

by UBILLA & CIA

Notice on the Establishment of a Security Review System regarding M&A Transactions Executed by Foreign Investors over Domestic Enterprises

Notice on the establishment of a security review system regarding merger and acquisition (“M&A”) transactions over domestic enterprises executed by foreign investors (“the Notice”) was issued by China's State Council on February 3, 2011, which will come into effect on March 5, 2011.

In order to establish a formal process for reviewing national security issues in international M&A transactions, China will launch an inter-ministry foreign investment security review committee (the “Committee”) which will be led by the State Council.

The security review will be required when the following conditions concur simultaneously:

1. Review Scope

The domestic enterprise involved in the security review shall be:

1. A military or military-related enterprise, enterprise physically surrounding a key or sensitive military infrastructure or other military-related units;
2. A key national security-related enterprise regarding agricultural products, energy and resources, infrastructure, transportation, technology industries, or equipment manufacturing.

2. M&A of a Domestic Enterprise by Foreign Investors

The M&A of a domestic enterprise by foreign investors is defined as follows:

1. Foreign investors purchase the equity of a domestic enterprise or subscribe to the capital increase of this domestic enterprise;
2. Foreign investors purchase Chinese shareholders’ equity of a foreign-invested enterprise (the “FIE”) or subscribes to the capital increase of the FIE;
3. Foreign investors set up a FIE, and use the FIE to purchase the assets of a domestic enterprise or purchase the equity of this domestic enterprise;
4. Foreign investors directly purchase the assets of a domestic enterprise and use these assets to set up a FIE.

3. Actual Control of a Domestic Enterprise

The actual control of a domestic enterprise by foreign investors means that foreign investors become the controlling shareholders or actual controllers of a domestic enterprise after the M&A transaction takes place, which includes:

1. The foreign investor, its controlling parent company or its controlled subsidiary holds more than 50% of the equity of the new enterprise after the M&A transaction;
2. Two or more foreign investors totally hold more than 50% of the equity of the new enterprise after the M&A transaction;
3. Although the foreign investor holds less than 50% of the equity of the new enterprise after the M&A transaction, the foreign investor’s voting right as the shareholder of the new enterprise will significantly influence the decisions of shareholders’ meeting or board of directors of the new enterprise;
4. The foreign investor controls the important matters of the new enterprise after the M&A transaction, including business decision-making, finance, human resource or technology, etc.

4. Review Standard

1. The impact of the transaction on national security, including the domestic production capacity, domestic service capacity and related equipment and facilities for the purposes of national security;
2. The impact of the transaction on China's economic stability;
3. The impact of the transaction on basic social order;
4. The impact of the transaction on research and development capacity of key technology regarding national security.

5. Committee

According to the Notice, the Committee mentioned above is co-chaired by the National Development and Reform Commission (“NDRC”) and the Ministry of Commerce (“MOFCOM”). Other relevant government departments will be involved in the review, depending on the industry fields involved.

The major responsibilities of the Committee include the following:

1. Analyzing the national security impact of M&A transactions;
2. Researching and coordinating major issues during the review;
3. Conducting the M&A transaction review and making a decision accordingly.

6. Procedures

1. The foreign investor shall apply to MOFCOM for the review over every M&A transaction that falls within the “Review scope”. If the transaction falls into the scope of national security review, MOFCOM will submit the application to the Committee for national security review within 5 working days.
2. The Committee shall first conduct a general review of the M&A transaction submitted by MOFCOM. The Committee shall send a notice of the application to the relevant departments within 5 working days. Relevant departments shall provide their opinions in writing within 20 working days. If the M&A transaction is deemed not to have impact on national security, the Committee will send its opinion to MOFCOM based on the opinions of the relevant departments within 5 working days.
3. If a M&A transaction is not passed after the general review, a special review shall be conducted subsequently within 5 working days after receiving the written opinions from relevant departments. The Committee shall complete the special review within 60 working days after the launch of the special review.
4. Where the M&A transaction has had or may have a material impact on national security, the Committee shall require MOFCOM, together with the relevant departments, to terminate the transaction or transfer relevant equities/assets or take other effective measures to eliminate the impact of the M&A transaction on national security.

Comments

• The scope of the key national security-related enterprises is broad, and the category related to “energy and resources” is extremely wide.
• The Notice does not clearly establish how a foreign investor can be clear about whether his/her project needs review.
• The Notice does not clearly specify the standard for evaluating impact on national economic stability and basic social order.
• The Notice does not clearly define the function of the five-day review by MOFCOM, or the difference of its review from the general review by the Committee.
• The Notice does not establish the penalties for violating the Notice.

by UBILLA & CIA

Shanghai Municipality Issues Measures for the Launching of a Pilot Foreign-Invested Equity Investment Enterprise Project in Shanghai

Implementing Measures for the Launching of a Pilot Program for Foreign-Invested Equity Investment Enterprises in Shanghai (the "Measures") were issued jointly by the Shanghai Municipal Financial Services Office, Shanghai Municipal Commission of Commerce and Shanghai Municipal Administration of Industry and Commerce on January 12th, 2011. The Measures will be effective on February 1st, 2011.

The main contents of the Measures are as follows:

1. Establishment of a Foreign-Invested Equity Investment Management Enterprise ("FEIME")

A FEIME is a foreign-invested management enterprise or a partnership mainly carrying out the following business:

1. Sponsoring the Foreign-Invested Equity Investment Enterprises;
2. Managing the investment of the Foreign-Invested Equity Investment Enterprise and providing related investment services; and
3. Giving advice on the equity investment.

The requirements of the establishment of a FEIME are as follows:

1. At least one investor who/which has the business scope relating to equity investment or equity investment management;
2. At least two senior managers with more than 5 years' experience in equity investment or equity investment management, more than 2 years' experience in a senior manager position and relevant experience in China-related equity investments or Chinese financial institutions;
3. The registered capital shall be at least USD 2 million and the contribution shall be in the form of cash.

2. Establishment of a Foreign-Invested Equity Investment Enterprise ("FEIE")

The FEIE is partnership enterprise with foreign investment primarily engaging in the following business:

1. Investing with its own capital in private equity to the extent permitted by laws, including establishing new enterprises, investing in existing enterprises, etc.; and
2. Providing management consulting services to the enterprises in which the FEIE invested.

The requirements of the establishment of a FEIE are as follows:

1. The registered capital shall be at least USD 15 million and the contribution shall be in the form of cash;
2. If the investors include the limited partners, each limited partner shall contribute at least USD 1 million.

Moreover, the FEIE shall not conduct the following activities:

1. Investments in prohibited industries;
2. Investments in public stocks and corporate bonds in the secondary market;
3. Investments in futures and other financial derivative transactions;
4. Direct or indirect investments in the real estate for non self-use;
5. Investments by using capital other than its own capital; or
6. Loans or guarantees to third parties.

3. Qualification of a Pilot Enterprise ("Pilot Enterprise")

A Pilot Enterprise is defined as a FEIME or FEIE (the "Applicant") which have the corresponding qualification to receive special treatment for matters such as currency exchange, etc. This qualification is granted by a special joint committee led by the municipal finance office ("Joint Committee").

In order to be qualified as a Pilot Enterprise, the Applicant shall meet the following requirements:

1. The proprietary assets of the Applicant shall be at least USD 500 million or assets under management of the Applicant shall be at least USD 1 billion during the past fiscal year before the application;
2. The Applicant has the good corporate governance structure and internal control system;
3. The foreign investor of the Applicant shall have at least 5 years' experience of relevant investment;
4. The Applicant hasn't been subject to any judicial or regulatory penalties during the past two years.

Qualified as a Pilot Enterprise, a FEIME is entitled to convert the foreign currency capital into RMB, as the capital contribution to the newly established equity enterprise. The contribution of the FEIME can not be more than 5% of the equity of the invested enterprises. However, this part of the foreign investment will not change the nature of the new invested enterprises.

For a FEIE qualified as a Pilot Enterprise, the Measures do not provide for a quota system that permits the currency conversion of its capital between a foreign currency and RMB.

The capital contribution of the Pilot Enterprise shall be managed and supervised by the custodian bank according to the relevant regulations.

4. Comments

The implementation of the Measures will open the Chinese private equity market to foreign investors, especially the long term institutional investors. The Measures specify the substantial requirements and operational procedures of the establishment of a FEIE, FEIME and Pilot Enterprise, which will facilitate the foreign investment with respect to the private equity in China. Meanwhile, the Measures are expected to benefit foreign investors that invest in new strategic industry, high-technology area and other encouraged industries.

However, some outstanding issues are still needed to be further clarified in practice, such as currency conversion, fund repatriation, national treatment, etc. Furthermore, Shanghai Municipality indicates that it obtained US$3 billion quota for the Measures. The allocation of the quota will also be an important element of the implementation of the Measures.

by UBILLA & CIA

Tianfu Group Wins the Lawsuit against Pepsi Cola Regarding Intellectual Property Right Dispute

On December 30, 2010, Chongqing No.5 Municipal Intermediate People's Court issued a decision on the Pepsi Cola – Tianfu Cola case, establishing that Pepsi shall cease to use Tianfu group’s technology secrets and know-how (including Tianfu Cola’s component, formula and business secrets with respect to the production), return the formula, as well as all the documents with respect to Tianfu group’s technology secrets and know-how.

Brief Introduction

In 1994, Tianfu group (a Chinese beverage company with a famous brand “Tianfu Cola”) and Pepsi signed a joint venture agreement (“JV”) and set up Chongqing Pepsi-Tianfu beverage Ltd Co (“Pepsi-Tianfu”) to produce soft drinks under both the Tianfu and Pepsi brands.

According to the JV agreement, Tianfu group contributed the land, factories and production facilities valued at about USD 7,320,000 and held 40% shares of Pepsi-Tianfu. Pepsi contributed USD 10,707,000 in cash and held 60% shares of Pepsi-Tianfu.

However, the intellectual property (the formula and some manufacturing know-how) owned by Tianfu group were not included in the contribution to the JV agreement. Neither Pepsi-Tianfu nor Pepsi ever paid Tianfu group anything for using them during the existence of the JV agreement.

In 2006, Tianfu group sold its 40% shares in Pepsi-Tianfu to Pepsi and quitted from Pepsi-Tianfu because Pepsi-Tianfu had made losses for 12 years after its establishment.

On October 28, 2009, Tianfu group sued Pepsi-Tianfu for illegally occupying its technology secrets and know-how. Tianfu group requested Pepsi-Tianfu to stop using the technology secrets and know-how and return them to Tianfu group. The case was formally accepted and heard by Chongqing No.5 Municipal Intermediate People's Court.

Comments

When Pepsi-Tianfu was set up in 1994, Tianfu group didn’t contribute the technology secrets and know-how to Pepsi-Tianfu, which means that the technology secrets and know-how are still owned by Tianfu group. Meanwhile, no agreement relating to the transfer of the technology secrets and know-how from Tianfu group to Pepsi or Pepsi-Tianfu was signed. Therefore, even though Pepsi purchased the shares of Tianfu group in Pepsi-Tianfu, the technology secrets and know-how were not included in this transaction. Pepsi or Pepsi-Tianfu shall pay the compensation to Tianfu group after 2006.

However, as a general comment we may say:

1. It is advisable to expressly regulate all IP matters in the JV agreement, including some important “positive and negative facts” regarding the contribution and use of each party’s know-how, trade secrets and so forth.
2. In the implementation of a JV it is important to keep record by any means including board resolutions, of the facts related to how the JV is being implemented, and which technologies and IP rights are being used.

by UBILLA & CIA

New Regulations on Foreign Representative Offices in China

The State Council of PRC issued the Regulations on Administration of Registration of Resident Representative Offices of Foreign Enterprises(the "New Regulations") on November 19th, 2010 and the New Regulations will take effect on March 1st, 2011.

The New Regulations make some changes mainly in the following respects:

1. The New Regulations specify the operational activities which the representative office (the “Rep Office”) can engage in:
   1. The market survey, exhibition and promotional activities in relation to the foreign enterprise’s products or services;
   2. The liaison activities in relation to the product sales, service provision, domestic sourcing and investment of the foreign enterprise.
2. The New Regulations require two new requirements for the establishment registration:
   1. The legalized certificate of the foreign enterprise’s domicile;
   2. The legalized certificate of the foreign enterprise’s business operation for more than two years;
   3. The Article of Association or organization agreement of the foreign enterprise.
3. Both the Measures on the Administration of the Rep Office (issued in 1983, the “Old Regulations”) and the Circular on Further Strengthening the Registration Administration of the Rep Office (issued in January of 2010, the “Circular”) stipulated one year’s resident period (duration) in the Registration Certificate of the Rep Office. However, the New Regulations only stipulate that the duration of the Rep Office can not exceed that of the foreign enterprise. Though the Old Regulations is abolished, the Circular which established one year’s duration and the extension of the Rep Office is still applicable. Therefore, whether one year’s duration of the Rep Office will be applied in practice needs to be further clarified by the authorities in future.

The New Regulations indicate that the administration of the Rep Office is becoming stricter than before, both in respect of the establishment and the practical operation. In other words, the cost of establishing and operating a Rep Office will be increased accordingly. Besides, during the year 2010, various regulations have also been issued in order to strengthen the supervision and management of the Rep Office. It seems to be a clear trend that the role of a Rep Office is being limited in China. Foreign investors who want to enter into China market by setting up a Rep Office or have engaged in the activities via a Rep Office in China may consider restructuring their business into other alternatives such as a Wholly Foreign-Owned Enterprises (“WFOE”).

by UBILLA & CIA