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Aug 3 2011

Arbiter of Mediation 
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Hong Kong has strengthened its standing as the region’s arbitration hub with the recent alignment of its arbitration system with international practice 

London-based international law firm Ashurst set up a dispute resolution practice in Hong Kong, to supplement its existing presence in Singapore, partly in response to rising demand for arbitration services in the region. This growing appetite for arbitration is likely to be further stimulated by Hong Kong's new legislation, which further strengthens Hong Kong’s arbitration system and keeps it at the forefront of international practice. 

The Arbitration Ordinance, which took effect in June, removes the distinction between domestic and international arbitrations in Hong Kong. It also limits the power of Hong Kong’s court system to intervene in arbitration, gives the parties greater autonomy, particularly in domestic cases, and crucially, it codifies the obligation to keep information in arbitration cases confidential, along with the awards made to either party. 

“The law resolves a lot of uncertainties and complications that previously existed between the domestic and international regimes,” said Gareth Hughes, who heads Ashurst’s Hong Kong disputes team. “When choosing the seat of the arbitration, parties want to know what the underlying law is and that the courts will support the process. The new law provides additional comfort to the parties that Hong Kong ticks all of the right boxes,” he said. 

Given Hong Kong’s geographical proximity to the Chinese mainland, where the legal system is still developing, the city is the ideal place for arbitration. “When you overlay onto the pro-arbitration legal framework the fact that the infrastructure and convenience of Hong Kong are first rate, the advantages are evident,” Mr Hughes added. 

Long Overdue 

Gareth Hughes was recently appointed by Ashurst to head its new Hong Kong dispute resolution practice

Changes to Hong Kong’s arbitration law have been long in the making, according to Chiann Bao, Secretary General of the Hong Kong International Arbitration Centre (HKIAC). Ms Bao said a working group, established more than 10 years ago, focused on updating the arbitration ordinance and making it more user-friendly by unifying the international and domestic regimes. “The government worked closely with the arbitration community to draft a state-of-the-art piece of legislation,” she said.

Hong Kong’s role for China is important, because today “there are more and more contracts, more and more business, and in order for foreign investors to manage their risk – the risk that a contract can go bad – they want to see certain things when they are considering going in – not just the presence of the institution but an independent, reputable institution that can handle the arbitration process,” Ms Bao said. 

The unification of the dual regimes, she added, “means that parties, whether from Hong Kong or abroad, follow one system, which is based on the UNCITRAL Model Law. People know what they are getting into. The structure of the ordinance is such that each provision that deviates from the norm is highlighted and captured in the provisions of the law.” 

Neutral Ground

Chiann Bao, Secretary General, Hong Kong International Arbitration Centre

Set up in 1985, the HKIAC is the region’s leading international dispute-resolution services provider. The non-profit body offers an independent forum for resolving international business disputes, by offering a range of services, including free information, arbitration and mediation, as well as specialised dispute resolution services. It also operates a panel of arbitrators, made up of globally renowned local and international experts. 

Last year, the HKIAC handled 624 dispute resolution cases, including 291 arbitration matters. Of those, 175 involved were international and 116 were domestic. Arbitration is increasingly seen as the preferred option over litigation because it ensures confidentiality and the freedom to choose arbitrators, and importantly, its enforceability, unlike court judgments, beyond borders. 

“Arbitration normally takes place in a neutral venue so that parties don’t have to go to each other’s home court. Neither side has the advantage of one court over another,” Ms Bao said. “That is the key.”

According to Ms Bao, changes to Hong Kong’s arbitration laws strengthens the city’s reputation as “Asia’s premier regional centre.” It’s a sentiment echoed by other legal experts. 

“Hong Kong already has the advantage of an independent judiciary…and institutions such as the HKIAC, which is renowned for transparency and independence,” James Kwan, an international arbitration experts at law firm Baker & McKenzie, told the South China Morning Post. “Having user-friendly legislation can only bolster Hong Kong’s reputation as an arbitration hub.”

August 8 2010

From O'Melveny & Myers China Practice Group

Lifestyles of Chinese Officials Scrutinized under New Anticorruption Measures

The Chinese government recently released two new measures aimed at tightening oversight of the lifestyles and finances of Chinese government officials and their family members. The measures are designed to expose evidence of misconduct within the bureaucracy by expanding the scope of personal data that officials must report to their superiors, extending the reporting obligations to a much broader category of officials, and increasing the penalties for non-compliance. The measures were jointly issued by the General Office of the State Council, the top executive organ of the Chinese state, and by the General Office of the Central Committee of the ruling Communist Party of China (“CPC”) as part of the central government’s continued efforts to rein in corruption among bureaucrats and personnel of State-Owned Enterprises (SOEs).

The Interim Rules on Strengthening Management of Officials Whose Spouses and Children Have Migrated Overseas, issued on May 19, 2010, address the growing phenomena of officials arranging for the immigration of their family members to facilitate the concealment of illegal wealth and to escape overseas to evade punishment for graft and other misconduct. Promotions and reassignments of so-called “naked officials” (Luo Guan), whose family members have moved overseas, must be reported to the CPC organizational departments at higher levels, as must the whereabouts of their spouses and children. Such “naked” officials must also disclose any travel to foreign countries, Hong Kong, Macau or Taiwan prior to departure.

The Regulation on Reporting Relevant Personal Matters by Cadres and Officials (the “New Reporting Regulation”), released on July 11, 2010, bolsters a reporting system first established in 1995 and revised in 1997 and 2006.

The New Reporting Regulation significantly expands the scope of officials subject to mandatory reporting requirements. Previously, only officials at the “county chief” level (Xian Chu Ji) and above were covered. The New Reporting Regulation identifies three categories of “cadres and officials” subject to mandatory reporting requirements, as follows:

“officials at the deputy county chief level and above at departments and agencies of the CPC, people’s congresses, administrative organs, committees of the Chinese People's Political Consultative Conference, judicial organs, people’s procuratorates, and democratic parties” (referring to certain political parties permitted to exist within the CPC-dominated political system);
“officials holding ranks equivalent to the deputy county chief level and above at civic organizations and public institutions,“ (such as museums); and
certain managers in “wholly state-owned enterprises and state-controlled enterprises (including wholly state-owned financial enterprises and state-controlled financial enterprises)”

Previously, the reporting obligation only applied to CPC members in the management of SOEs. Moreover, provincial level CPC committees and governments now have authority to apply the reporting regime to additional officials below the deputy county chief level. A statement issued by the CPC explains that the reporting obligations were extended to lower-level personnel because lower level officials are often more susceptible to bribes because they are dealing directly with practical issues involving personnel, finance, and materials.

The New Reporting Regulation also expands the scope of reportable information. Previously, covered cadres and officials were required to report the following information to their CPC organization departments: (1) changes in marital status; (2) ownership of passports and other travel certificates for personal matters; (3) travel outside China for personal matters; (4) the marriage of cadres and officials’ children to foreigners or residents of Hong Kong, Macau and Taiwan; (5) situations where cadres and officials’ spouses and children are living outside China; (6) personal investments in businesses and enterprises outside China by cadres and officials’ spouses and children living in the same household (7) situations where cadres and officials’ spouses and children living in the same household serve as management personnel in Chinese branches of foreign companies and Hong Kong, Macau and Taiwan companies; (8) any criminal proceedings involving cadres and officials’ spouses and children and (9) any other matters that cadres and officials think are reportable.

Beyond these existing reporting requirements, the New Reporting Regulation now mandates that covered cadres and officials also report: (1) the marriage of cadres and officials’ children to individuals “without nationality”; (2) the occupations of cadres and officials’ spouses and children (now including children who do not live together with the officials and cadres), both inside China and abroad; (3) salaries and all types of allowances and subsidies of cadres and officials; (4) cadres and officials’ incomes from all sources, including lectures, writing, consulting, editing, paintings and calligraphy, and other services; (5) ownership of real estate by cadres and officials, their spouses, or their children living in the same household; (6) financial investments by cadres and officials, their spouses, or their children living in the same household; (7) investments in enterprises by cadres and officials, their spouses, or their children living in the same household; and (8) any businesses in which the cadres and officials, their spouses, or their children living in the same household are owners or partners. The previous catch-all item of “other matters that cadres and officials think are reportable” in the 2006 regulation is omitted in the New Reporting Regulation.

The new reporting items reflect the emergence of disproportionate or sham compensation for officials’ speeches and personal services (such as calligraphy and paintings) as a means of disguising incentives, as well as the prevalent practice of holding proceeds of misconduct in family members’ names.

Under the New Reporting Regulation, the penalties for failing to report relevant personal matters timely or reporting false information now include dismissal; previously, the harshest penalty was a derogatory report or “criticism.” Although the New Reporting Regulation does not directly authorize civil or criminal penalties, the reporting system may provide the basis for prosecutions of cadres and officials for the crime of possessing substantial wealth from unknown in violation of Article 395 of the PRC Criminal Law.

The New Reporting Regulation does not, however, require any public disclosure of reported data concerning the assets, income, and lifestyles of the covered cadres and officials. Consequently, while these new measures may equip investigators from CPC’s discipline inspection commissions and law enforcement authorities with new means of unearthing evidence of corrupt conduct, the measures do little to strengthen public oversight of the bureaucracy.

For multinational enterprise active in China, these new measures serve as a reminder of the Chinese central government’s continued efforts to tackle the country’s endemic corruption. Foreign companies should be mindful of the increasing risk of scrutiny by enforcement authorities of any payments to officials for speeches and other personal services and of favors to officials’ family members.

By Nathan Bush, Bingna Guo

April 15 2009

From O'Melveny & Myers China Practice Group

PRC State Council Issues New Rules Encouraging Foreign Investment

China’s State Council has just issued the Several Opinions on Further Improving the Work of Utilizing Foreign Investment, guofa [2010] No. 9, dated April 6, 2010, reaffirming its policy to encourage foreign investment.

The Opinions contain twenty provisions that cover, inter alia, approaches to improve the quality and variety of foreign investment, to redeploy certain foreign capital to the central and western regions, and to streamline the foreign investment regulatory system and improve the efficiency of the approval process.

Of particular note, the Opinions provide that the total investment threshold for foreign-invested projects that require central level approval (i.e., by the Ministry of Commerce and if applicable, by the National Development and Reform Commission) will be raised from USD 100 million to USD 300 million for projects that fall under the “encouraged” or “permitted” categories of the Industrial Category Guiding Foreign Investment. The Opinions do not change the total investment threshold for foreign-invested projects in the “restricted” category that require central level approval; that threshold remains at USD 50 million.

Some provisions of the Opinions set out concrete new measures that will benefit foreign investors immediately. For example, certain qualified projects which fall under the “encouraged” category will be able to benefit from discounted land prices at 70% of the statutory minimum price; foreign investors which face temporary financial difficulties and cannot make capital contributions to their foreign-invested enterprises in accordance with the agreed capital contribution schedule may be able to extend such schedule.

Other provisions may simply restate known policy objectives; this appears to suggest that relevant implementing rules are on the way. For instance, the Opinions encourage multinational companies to set up regional headquarters, R&D centers, procurement hubs, financial management and other functional centers in China; foreign investment continues to be encouraged in China’s central and western regions, particularly in environmentally friendly and labor-intensive projects, and local governments may offer various preferential treatment policies (including preferential tax treatment) for such projects. The Opinions also provide that the qualifications for foreign issuers authorized to issue RMB-denominated bonds in China will be expanded to allow for a greater number of participants and that China is seeking to have more foreign-invested enterprises list on China’s domestic stock exchanges.

The Opinions provide that China will amend the current version of the Industrial Category Guiding Foreign Investment and promulgate regulations to adopt the policy goals set forth in the Opinions. We believe that the Opinions represent the prelude to a new wave of far-reaching reforms in China’s foreign investment regulatory system and the impact of the Opinions will be felt soon by practically all multinational companies operating or potentially investing in China.

Feb 04, 2010

Beijing security check needed for inventors seeking patents abroad by Ng Tze-wei

Chinese inventors hoping to seek patents abroad must go through a state security examination as Beijing tries to prevent the leak of sensitive technology, while streamlining the application process to encourage Chinese companies to take innovations abroad.

This measure is one of a number of new amendments introduced to the Implementing Guidelines of the Patent Law, which took effect on Monday. The Patent Law, passed in 1984, was also overhauled in late 2008.

Officials said this new measure is meant to simplify the procedure for Chinese companies to apply for foreign patents, since under the old rules they were required to first apply for a Chinese patent for their inventions. The problem was that the processing of the Chinese application takes an average of 25.8 months.

Now they can directly apply for foreign patents after a security examination to see if the invention contains information that involves a "defence interest" or "state security or major state interest". And under the new rules, the patent authorities must notify applicants whether they need a security clearance within four months, and must give them the results of that clearance application within six months.

Patents law professor Cao Xinming of Zhongnan University of Economics and Law said "state security or major state interest" was stipulated for the first time, and it was in line with international practice.

But Shi Yusheng , head of intellectual property for the King and Wood law firm, said formal incorporation of the security clearance procedure might make it more convenient for authorities to say no in cases of doubt. "The vague definition of what is considered security information and what is not adds uncertainty to the patent application," he said.

Other changes include raising the requirements for the level of innovation in patent applications, stepping up penalties against patent rights infringement, and lowering or cancelling fees for patent applications.

New rules in the pharmaceutical field also require the disclosure of genetic resources in inventions and add new types of compulsory licences. The number of patent applications by Chinese inventors has been on a steep rise in the past decade. According to official statistics, patent applications grew 18 per cent to nearly 1 million last year alone, of which 30 per cent are for inventions rather than utility models and designs. The number of applications from Chinese inventors also set a record and accounted for 73 per cent of all invention applications in China.

Also last year, the number of patent applications from Chinese inventors exceeded the number from foreigners. Overall, Chinese applications make up 85.8 per cent of the 3 million that have been granted.

Chinese firms are also applying for more foreign patents: in 2008, more than 6,000 foreign patent applications were filed, an 11 per cent jump from the year before.

January 22 2010

From O'Melveny & Myers China Practice Group

China Tightens Restrictions on Foreign Representative Offices

On January 4, 2010, China’s State Administration for Industry and Commerce (“SAIC”) and the Ministry of Public Security jointly issued the Notice on Further Administration of Registration of Foreign Companies’ Resident Representative Offices (the “Notice”). The Notice provides that business operations of representative offices will face higher scrutiny, companies must comply with additional requirements to establish their representative offices or renew their registration certificates, and companies will be limited in the number of representatives that they can appoint. As the Notice has implications for both new and existing representative offices, foreign companies with representative offices in China need to be aware of this development and be prepared for its ramifications.

Heightened Scrutiny on Operations

Foreign companies doing business in China should be well aware that representative offices are not permitted to “do business” in China, and are generally restricted to performing marketing or liaison functions on behalf of their parent companies. The Notice provides that local branches of the SAIC will begin to do spot checks on representative offices within three months after they have been issued registration certificates. Representative offices that are found engaging in direct operations may be subject to administrative fines. In addition, the Notice states that representative offices that are discovered to have moved without updating their registered addresses or to be operating without valid registration certificates may be subject to increased scrutiny by the authorities.

Higher Hurdles for Establishment and Renewals

Under existing regulations governing representative offices, a foreign company needs to provide an apostilled certificate of incorporation from its jurisdiction of incorporation in order to register a representative office or change a registered office’s name. The process varies somewhat from location to location, but this generally requires that the certificate of incorporation be notarized and then certified by the relevant government authority (for example, in the U.S., by the relevant state of incorporation’s Secretary of State), and then finally apostilled by the relevant Chinese embassy or consulate that has jurisdiction over the company’s jurisdiction of incorporation. The Notice now requires that the apostilled certificate of incorporation indicate that a company has been in existence for at least two years, which will provide difficulties for foreign companies that wish to establish new companies in order to handle their representative office operations.

The Notice also limits the permitted term of a representative office’s registration certificate to one year, which previously could be valid between one and three years depending on local regulations in the location of the office. In addition, the Notice adds a requirement that a foreign company must obtain and provide a new apostilled certificate of incorporation each time that it applies to renew its representative office’s registration certificate.

Restrictions on Number of Representatives

A foreign company is required to hire its representative office’s Chinese personnel through a foreign service company authorized to second employees to representative offices, but can appoint a foreign chief representative and other foreign representatives, who have to be registered with the SAIC. The Notice now restricts the number of representatives that a company is able to appoint to four individuals (including the office’s chief representative). The Notice provides that existing representative offices that currently have more than four representatives are not permitted to have any additional representatives appointed. It is silent on whether they must reduce the number of their representatives to four to comply with the Notice, but an official at the Beijing local branch of the SAIC orally confirmed that they do not have to do so, unless they apply to the SAIC to make any changes to their registered representatives.


In conclusion, foreign companies should be aware that the operations of their Chinese representative offices may face heightened scrutiny and that registration certificate renewals and changes to their existing representatives will be affected by the Notice. It should be noted that the Notice’s new restrictions do not apply to liaison or branch offices of foreign invested enterprises or to the representative offices of certain foreign professional-services firms (such as law firms). It is anticipated that the SAIC will amend the existing Administration Measures on the Registration of Foreign Companies’ Resident Representative Offices (which were promulgated by the SAIC in 1983) later this year. The amended regulations will likely contain more specific details on the information contained in the Notice and foreign companies should watch for the announcement of their issuance.

December 18 2009

From O'Melveny & Myers China Practice Group

China Adopts Controversial Vodafone-style* Extraterritorial Tax and Disclosure Rule

The PRC State Administration issued the Notice on Strengthening the Management of Enterprise Income Tax Collection of Proceeds from Equity Transfers by Non-resident Enterprises, dated December 10, 2009 and circulated to the public on December 16, 2009 (“Circular 698”). An un-official bi-lingual version of Circular 698 is attached.

The beginning of Circular 698 reads innocuously by addressing the PRC capital gains tax with respect to the sale of PRC resident entities by foreign entities. Under the PRC Enterprise Income Tax (the “EIT”), capital gains derived from the direct transfer of PRC resident enterprises by foreign entities are subject to a withholding tax of 10%, subject to reduction by applicable tax treaty (the “Capital Gains Tax”). This Capital Gains Tax is easily collected when the transferee is a PRC enterprise or individual subject to the legitimate jurisdiction of the PRC and who serve as withholding agents according to published law. Administrative collection issues arise in cases of foreign-to-foreign transfers of PRC resident enterprises which the beginning of the circular seeks to address. For example, the circular requires the foreign transferor to file in China to satisfy its Capital Gains Tax and sets out specific calculation methods and other related rules. It should also be noted that publicly listed PRC resident enterprises fall outside the scope of Circular 698.

Controversial Leap

However, Article 5 of Circular 698 then takes an amazing leap. It states that foreign entities are required to disclose all indirect transfers of PRC resident enterprises to the PRC tax authorities in cases where an intermediate holding company through which such transfers are made are located in a low tax jurisdiction or such jurisdiction exempts income tax on foreign-sourced income. In this case, the foreign enterprise making the indirect transfer must disclose the following documentation to the PRC tax authority in the location of the PRC resident enterprise within 30 days of executing the transfer contract:

i. Equity transfer agreement/contract;

ii. Representations regarding the relationship between the foreign entity and holding company being transferred in terms of “capital, operation, sales and purchase etc.”;

iii. Representation regarding the operation, employees, bookkeeping, and assets of the holding company being transferred by the ultimate foreign entity;

iv. Representations regarding the relationship between the holding company being transferred by the ultimate foreign entity and the PRC resident enterprise, in terms of “capital, operation, sales and purchases;”

v. Representations regarding the reasonable business purpose with respect to the transfer of the holding company; and

vi. Other materials requested by the tax authority.

While the term “indirect transfer” is not defined, Article 5 suggests that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. The drafting could be read to apply to all global M&A activity occurring outside of China provided the transferor indirectly holds some assets in China, no matter how small.

For example, assume Company A is an Italian private company engaging in a global automotive business covering manufacturing, parts, and distribution. Company A owns 100% of three Italian subsidiaries called Company B, C, and D, which each engage in three different lines of the automotive businesses. As a large multinational, the Company B subsidiary, which engages in the distribution business, has over twenty subsidiaries and joint ventures all over the world. Among them, Company B owns 100% of Company E, a Chinese entity which houses a small distribution outlet in Beijing representing 1% of the entire distribution business of Company B. Company A is approached by Company X to buy-out Company A’s worldwide distribution business. The transaction will be structured in the most common way by having Company X purchase all of the Company B stock from Company A. Under Article 5, Company A may be required to submit documentation for this transaction, including the global M&A contract with Company X and all other supporting materials stipulated by Article 5, to the Beijing State Tax Bureau for review. This example assumes that Company B qualifies for domestic law relief regarding the foreign source income and is thus “low taxed.” Other examples would include Company B established in ordinary tax haven jurisdictions suited for holding companies.

The above is a simplified example and there are more complex transactions which could be subject to Article 5. For example, Company B might own Company E through many levels of intermediary holding companies in different countries. In this case, Article 5 may still apply and disclosure would be required to explain the numerous levels of relationships. Article 5 may also apply outside of the multinational context. It could apply to a transfer of an interest in a fund holding foreign companies, which in turn hold indirect holdings in Chinese resident enterprises. All of these foreign entities could have an obligation to submit their M&A contracts and supporting information regarding relationships to PRC tax authorities for review. Indeed, the number and variety of transactions that Article 5 could apply to is infinite.

Extraterritorial Taxation

Not surprisingly, apart from the disclosure requirement above, Circular 698 goes on to empower local PRC tax authorities at the central government level, through submission to the SAT, to disregard intermediate holding companies, if they determine PRC tax is being avoided without a reasonable business purpose. Thus, the Capital Gains Tax could be imposed on the foreign entity serving as the indirect transferor of PRC resident enterprises. The addition of review by the SAT to the last draft of Circular 698 was welcomed as potentially tempering this second consequence.

However, the broad disclosure requirements which remained intact from prior drafts are extremely troubling at multiple levels.

Is it Legal?

Many questions posed during the drafting process remain unanswered:

(1) Is there a legal basis under any validly promulgated PRC law or administrative regulation which imposes information reporting obligations and tax with respect to such indirect transferors? How does an interpretive circular like 698 derive its PRC legal authority?

(2) Does the PRC general anti-abuse rule (“GAAR”) in the EIT grant virtually unlimited power to the PRC tax authorities concerning transactions, including matters of extraterritorial jurisdiction? How does one sentence in a quasi-civil law statute encapsulate an entire doctrine?

(3) Is there a colorable theory under international legal principles to assert extraterritorial jurisdiction over the numerous parties potentially described in Circular 698?

(4) Will the enormous administrative complexities and burdens created by the disclosure mean erratic compliance and result in grossly unfair application of the rule? Can most foreign entities comply?

(5) Will local PRC tax bureaus be staffed with the resources, training, and other administrative infrastructure to deal with those disclosure actually submitted?

*The title refers to the Vodafone Essar case currently pending in the Indian court system regarding similarly controversial extraterritorial tax concepts.

December 3 2009

From O'Melveny & Myers China Practice Group

Foreign-Invested Partnership Rules Issued: Partnership Form will Ease Foreign Investment in Industries

The door for foreign individuals and entities to invest directly in partnership enterprises in China officially opened with the issuance of the Administrative Measures for Foreign Enterprises and Individuals to Establish Partnership Enterprises in China (the “Measures”) by the State Council on December 2, 2009.

Previously, only domestic individuals and entities registered in China may be partners of partnership enterprises in China. After the Measures take effect on March 1, 2010, foreign investors will be able to set up foreign-invested partnerships (“FIP”) in China either by themselves or by partnering with domestic individuals or entities. FIPs will be governed by the Partnership Enterprise Law, issued as a general rule over partnership enterprises in 2007, and will be limited by the Foreign Investment Industry Catalogue.

In an unprecedented development, the Ministry of Commerce and its local counterparts (“MOFCOM”) seem to have stepped down from the gatekeeping role for FIPs. Historically, prior approval from MOFCOM, as the watchdog for any form of foreign investment, is a prerequisite for foreign-invested enterprises to obtain a business license issued by the State Administration of Industry and Commerce or its local branches (the “Registration Authority”). Under the Measures, however, FIPs may go directly to the Registration Authority for establishment, any subsequent change, and termination. Instead of approving, MOFCOM will only be notified by the Registration Authority after the registration is completed. Note, however, that market watchers maintain a significant amount of healthy skepticism as to whether MOFCOM would indeed allow FIPs to operate without their involvement.

A pipeline of detailed rules on FIPs must follow to supplement these sixteen-article-long Measures from various practical standpoints including registration, tax, foreign exchange, bank accounts, accounting, customs, etc. It remains to be seen how the Measures will be interpreted and applied by various levels of government departments, which may affect whether and when the FIPs may be able to gain popularity against other existing forms of foreign investment, such as equity joint ventures, cooperative joint ventures and wholly-foreign owned enterprises.

Special implications for private equity funds

The Measures are of great interest to a wide range of Chinese industries that involve foreign investment. Of particular interest is the venture capital and private equity fund industries, where partnership enterprises are the preferred legal form. Currently, foreign participation in Chinese private equity funds is predominantly structured by way of indirect investments in Chinese partnership enterprises and direct investments in other Chinese vehicles (including foreign-invested venture capital enterprises). The Measures open up the possibility of having direct foreign investment (the so-called “foreign LPs”) in Chinese private equity funds in the form of partnership enterprises. Although a step in the right direction, the Measures however do not fully allow such foreign LP investment. Instead, the Measures have taken a classic tentative approach: the Measures do not carve out FIPs from the investment sector but at the same time suggest that other regulations could more properly govern this space. In addition, a set of Q&As issued by the Legal Affairs Office of the State Council explaining the Measures make specific mention of the private equity industry and indicate that a flexible approach should be taken. Interested investors should continue to follow the future rulemaking by various regulatory authorities on this topic.

April 13 2009

From O'Melveny & Myers China Practice Group

China to Launch Growth Enterprise Board

On March 31, 2009, the China Securities Regulatory Commission (“CSRC”), issued the Provisional Measures for the Administration of Initial Public Offerings of Shares and Listings Thereof on Growth Enterprise Board (the “Provisional Measures”), announcing China's launch of a long-awaited Growth Enterprise Board on May 1 as a new direct financing platform for innovative enterprises and other growth venture enterprises.

The Provisional Measures largely follow the draft measures promulgated by the CSRC on March 21, 2008 for public comment and will become effective on May 1, 2009.

Requirements for Issuers

Under the Provisional Measures, a company seeking an initial public offering (“IPO”) of shares for listing on the Growth Enterprise Board must meet the following basic requirements:

* The issuer must be a company limited by shares (as opposed to a limited liability company) and have an operating history of at least three years;1
* The issuer must have been profitable for the most recent two years with accumulated net profits no less than RMB 10 million and there must have been continuous growth in its profits. Alternatively, the issuer must (i) have been profitable for the most recent year with net profits of at least RMB 5 million and revenues of no less than RMB 50 million and (ii) the rate of its revenue growth for either of the most recent two years must have been no less than 30%;
* The issuer must have net assets no less than RMB 20 million at the end of the most recent accounting period and have no uncovered losses; and
* The issuer must have a total registered share capital no less than RMB 30 million after an IPO.

In addition to the basic requirements discussed above, the following requirements for an issuer are of particular importance:

* The issuer must engage in one main business and the proceeds to be raised through an IPO must be used for such main business;
* There must have been no major changes to the issuer's main business, directors or senior managers, and there must have been no changes to the actual controlling parties of the issuer for the most recent two years;
* The issuer must enjoy independence in respect of its business, personnel, financial matters and organizational structure; and
* The issuer must not compete or carry out any obviously unfair connected transactions with its controlling shareholder(s), actual controlling parties or any other enterprises under the control of the actual controlling parties.

Approval Process and Timetable

Applications for IPOs for listing on the Growth Enterprise Board are subject to the approval of the CSRC. An application for such approval includes the following procedures:

* Initial CSRC review of the application documents.
* Growth Enterprise Board Public Offering Review Committee review.2
* Approval of the IPO.

The CSRC is required to decide whether to accept application documents for review within five working days of receipt of such documents. If the CSRC accepts an issuer's application documents, it is required to decide whether to approve the application within three months of such acceptance.

More Stringent Duties for Sponsors

Since the Growth Enterprise Board is being established to support innovative enterprises and other growth venture enterprises, the Provisional Measures require that a sponsor involved in a Growth Enterprise Board listing issue an opinion regarding the issuer's growth potential based on the sponsor's due diligence and prudent judgment. Subject to supporting rules and implementing regulations of the Provisional Measures to be further issued or revised, a CSRC spokesman indicated during a press conference on March 31, 2009 that a sponsor will also be required to undertake duties in respect of the sponsorship, supervision and guidance of issuers on the Growth Enterprise Board for longer periods, as compared to listing on one of China's main boards.

Stricter Requirements for Controlling Shareholders and Actual Controlling Parties

The Provisional Measures impose stricter requirements on controlling shareholders and actual controlling parties of issuers seeking listing on the Growth Enterprise Board than those would apply to listing on China's main boards. The Provisional Measures provide that as a precondition for a Growth Enterprise Board listing, the issuer together with the controlling shareholder(s) and actual controlling parties of the issuer must not have committed any material illegal acts detrimental to the lawful rights and interests of investors or the public interest during the most recent three years. Further, in addition to the issuer and all of its directors, supervisors and senior managers, the controlling shareholder(s) and actual controlling parties of the issuer are required to confirm the prospectus for the Growth Enterprise Board listing and to sign and seal the prospectus.

Market Entry Qualification System for Investors to Be Established

Subject to further clarification by supporting rules and complementing regulations of the Provisional Measures to be issued or revised, the Provisional Measures require the Growth Enterprise Board market to establish an entry qualification system for investors based on investors' capability to take investment risks.

Silence on Lockup Period Requirements

The Provisional Measures are silent on lockup period requirements for shareholders of an issuer in the case of a Growth Enterprise Board listing. The Shenzhen Stock Exchange, where the Growth Enterprise Board is to be established, is expected to set forth additional lockup period requirements in its listing rules applicable to companies listed on the Growth Enterprise Board. These rules will be issued soon. Currently, the PRC Company Law provides for a one-year lockup period.


1. In the case of a company limited by shares that is converted from a limited liability company, by a conversion into shares at the original book value of the net assets of the limited liability company, the operating history may be counted from the date on which the limited liability company was established.

2. According to a CSRC spokesman who spoke to reporters on March 31, 2009, the CSRC will establish a Growth Enterprise Board Public Offering Review Committee in charge of the examination and approval of applications for IPOs for listing on the Growth Enterprise Board.

March 19 2009

From O'Melveny & Myers China Practice Group

MOFCOM Amends Outbound Investment Rules

The Ministry of Commerce ("MOFCOM") recently issued the Administrative Measures on Regulation of Outbound Investment1 ("Outbound Investment Measures"), which will become effective on May 1, 2009, aiming to further regulate the ever-increasing outbound investment activities by enthusiastic PRC investors2.

De-centralization of Certain Approval Authority

Article 6 of the Outbound Investment Measures requires both central-level and local-level PRC investors to secure approval from MOFCOM for outbound investments ("Article 6 Outbound Investments"):

* in countries that have no diplomatic relationship with China;
* in other specific countries/areas (list to be provided jointly by MOFCOM, the Ministry of Foreign Affairs and other relevant authorities);
* of no less than USD100 million;
* involving interests of multiple countries/areas; and
* involving incorporation of offshore special purpose vehicles3 ("SPVs") by PRC investors (this development reiterates MOFCOM's focus in the PRC M&A Rules on regulation of offshore SPVs incorporated by PRC investors).

Article 7 of the Outbound Investment Measures requires local-level PRC investors to secure approval from competent provincial commissions of foreign trade and economic commission ("COFTECs") for outbound investments ("Article 7 Outbound Investments"):

* between USD10 million and USD100 million;
* in energy and mineral resources sectors; and
* to be promoted within China to solicit prospective PRC investors.

Article 8 of the Outbound Investment Measures requires that, for outbound investments other than Article 6 Outbound Investments and/or Article 7 Outbound Investments ("Article 8 Outbound Investments"), central-level PRC investors4 must secure approval from MOFCOM while local-level PRC investors5 must secure approval from competent COFTECs.

Previously, for outbound investments, central-level PRC investors were supposed to secure approval from MOFCOM while local-level PRC investors were required to secure approval from competent COFTECs. MOFCOM's intention behind the Outbound Investment Measures clearly aims to tighten its control over outbound investment activities of significant value or sensitivity. Please note that, based on our further telephone enquiry with MOFCOM on a no-name basis, outbound investments in energy and mineral resources sectors of no less than USD100 million shall still be subject to MOFCOM approval while all other energy and mineral resources outbound investments must secure approval from competent COFTECs, regardless of the total investment amount thereof.

Simplification of Certain Approval Process

The Outbound Investment Measures provide a much simplified "form review approach" for Article 8 Outbound Investments, in contrast to the previous "substance review approach", which will only take three working days for competent approval authorities to determine whether to approve it after receipt of the application. However, for Article 6 Outbound Investments and Article 7 Outbound Investments, competent approval authorities will still apply the "substance review approach" to determine whether to approve it within fifteen working days after accepting the application.

Subsequent Changes to and Termination of Outbound Investments

Subsequent changes to approved outbound investments must be approved by the original approving authorities, including transfer of equity interests held by PRC investors in previously approved offshore companies among such PRC investors.

For termination6 of approved outbound investments, PRC investors shall file accordingly with the original approving authorities and return the respective outbound investment approval certificates to such original approving authorities.

Further Regulation of Outbound Investments

Pursuant to the Outbound Investment Measures, PRC investors must seek prior approval from competent government authorities before contracts or agreements in respect of outbound investment take effect. Further, PRC investors must report to the original approving authorities for business operations of previously approved outbound investments and file with the original approving authorities for further offshore investments by previously approved offshore companies controlled by such PRC investors within one month after closing of such further offshore investments.

Notwithstanding the foregoing discussions, it is worth of noting that the primary approval authority for outbound investments by PRC investors shall be the National Development and Reform Commission ("NDRC") (and its provincial counterparts). The Outbound Investment Measures shall have no effect on the NDRC approval authority, which is still subject to the Tentative Measures on Administration of Approval for Outbound Investment Projects ("NDRC Measures"), effective as of October 9, 2004. Pursuant to the NDRC Measures, PRC investors would need to seek approval from NDRC for natural resources-type outbound investments with a total investment amount of no less than USD30 million or other type outbound investment with a foreign currency usage amount of no less than USD10 million. Approval from competent provincial counterparts of NDRC would be sufficient only for natural resources-type outbound investments with a total investment amount less than USD30 million or for other type outbound investments with a foreign currency usage amount less than USD10 million.


1. An outbound investment refers to the following: (i) incorporation of offshore non-financial companies by PRC investors or (ii) acquisition of offshore non-financial companies by PRC investors in order to obtain ownership, control or management rights in respect of such offshore non-financial companies.
2. PRC investors refer to enterprises duly organized and validly existing under the PRC law.
3. An offshore special purpose vehicle refers to an offshore company directly or indirectly controlled by PRC investors for the purpose of an overseas listing of ownership interests held by such PRC investors in the PRC domestic companies.
4. Central-level PRC investors refer to state-owned enterprises directly supervised by the State Assets Supervision Administration Committee.
5. Local-level PRC investors refer to all PRC enterprises other than central-level PRC investors.
6. Termination of approved outbound investments refers to the situation under which previously approved offshore companies no longer exist or PRC investors no longer hold any interests in such previously approved offshore companies.

March 13 2009

From O'Melveny & Myers China Practice Group

PRC Food Safety Law
Issuing Authority: Standing Committee of the NPC
Date of Issuance: February 28, 2009
Effective Date: June 1, 2009

This law supersedes the Food Hygiene Law which was promulgated in 1995. It applies to food-related activities including (1) food production, processing, sale and service; (2) production and operation of food additives; (3) production and operation of packing materials, containers, detergent, disinfectant, tools and equipment that are used for the production and operation of food; (4) use of food additives and relevant products by food producers and operators; and (5) safety control on food, food additives and food-related products.

The State Council will set up a food safety commission, the duties and responsibilities of which will be specified by the State Council. The Ministry of Health (MOH) will be responsible for the assessment of food safety risk, formulation of food safety standards, issuance of food safety information, recognition of the qualifications of food inspection and examination institutions and organizing the treatment of and response to serious food safety accidents. In addition, the General Administration of Quality Supervision, Inspection and Quarantine, State Administration for Industry and Commerce and the State Food and Drug Administration will be responsible for supervising food production, food sales and food and beverage services, respectively. The local counterparts of the aforementioned governmental authorities shall, under the organization, instruction and coordination of the People's Government at and above county level, supervise and administer the local food safety work separately.

According to this law, an enterprise engaging in the food production and operation business is required to obtain several permits, including licenses for food production, food sales and for food and beverage service. Similar licensing requirements apply to enterprises engaged in the manufacture of food additives. It also requires food manufacturing enterprises to establish a management system with respect to the health condition of its employees. In addition, a food recall system will be established by the government authorities. Food manufacturers are required to stop production of any food that cannot meet the relevant safety standards, recall all substandard food from the market, notify the relevant producers and consumers, adopt remedial procedures and report to the quality supervision department. The Administration of Quality Supervision, Administration of Industry and Commerce and the State Food and Drug Administration department will require food manufacturers to recall and stop production of unqualified food if the food manufacturers do not do so.

Regulations on Travel Agencies
Issuing Authority: State Council
Date of Issuance: February 20, 2009
Effective Date: May 1, 2009

The Regulations on Travel Agencies ("Regulations"), which will supersede the Regulations on the Management of Travel Agencies issued in 1996, provide detailed rules for the establishment and operation of travel agencies within the territory of the PRC.

The Regulations set forth the conditions and procedures for applying to engage in domestic tourist business, entry tourist business and exit tourist business. The criteria for setting up a travel agency are: (i) a fixed operational site, (ii) necessary business facilities, and (iii) registered capital of no less than RMB 300,000. All applicants should apply with the tourist administration department for an operational permit before registering with the Administration of Industry and Commerce. For foreign invested travel agencies, approval from the commerce department is also required. Pursuant to the Regulations, travel agencies shall register with the Administration of Industry and Commerce and report to the tourist administration department when setting up branch offices or service sites. The Regulations specify the amount of quality assurance funds that the travel agency is obligated to deposit into the designated bank account and the circumstances under which the tourism administration department may utilize the quality assurance funds. According to the Regulations, foreign invested travel agencies are prohibited from engaging in overseas tourist business with tourist destinations located outside of mainland China (including Hong Kong, Macao and Taiwan) unless otherwise provided by laws and treaties.

The Regulations also specify the requirements for travel agencies to properly conduct their tourist business. For example, the Regulations provide for the items that the contract between the travel agency and the tourist should contain, including among others, details regarding shopping arrangements and sightseeing tours that require extra charges. In addition, the Regulations prescribe the liabilities for failure to comply with the relevant provisions.

Supplemental Provisions for the Administrative Measures on Foreign Investment in the Commercial Sector (IV)
Issuing Authority: Ministry of Commerce of the People's Republic of China
Date of Issuance: February 5, 2009
Effective Date: February 5, 2009

Based on the Supplemental Notice V to the Mainland and Hong Kong Closer Economic Partnership Arrangement and the Supplemental Notice V to the Mainland and Macau Closer Economic Partnership Arrangement permitted by State Council (the "CEPA"), the Supplemental Provisions for the Administrative Measures on Foreign Investment in the Commercial Sector (IV) addresses certain additional benefits available to service providers from Hong Kong and Macau. In particular, the Provisions allow Hong Kong and Macau service providers with more than 30 shops in the mainland to set up wholly-owned commercial enterprises for the sale and distribution of medicines, pesticides, chemical fertilizer, sugar, cotton, etc. when the products are from different suppliers.

Other aspects of the investment by Hong Kong and Macau service providers shall comply with the Administrative Measures of Foreign Investment in the Commercial Sector.

SAT Notice on the Issuance of the Administrative Measures on the Final Settlement of Enterprise Income Tax for Non-resident Enterprises
Issuing Authority: State Administration of Taxation
Date of Issuance: January 22, 2009
Effective Date: January 1, 2008

Foreign non-resident enterprises that have a permanent establishment ("PE") in China are required to prepare and submit annual final enterprise income tax ("EIT") returns to the tax authorities within five months from the end of each calendar year. By establishing this new annual reporting and settlement system for PEs, the Chinese tax authorities seek to enhance EIT tax management of non-resident enterprises. According to the Notice, subject to certain exemptions, all PEs should submit: 1) annual filing returns; 2) annual financial statements; and 3) other documents required by the tax authorities in their annual final settlement filings. Non-compliance may result in a fine of RMB2,000 to RMB10,000 and interest if there are overdue tax payments. The tax authorities may also assess EIT and require immediate tax payment if PEs fail to file and report within the prescribed time limit. As the Notice takes effect from January 1, 2008, PEs should complete their first annual filing procedure for the taxable year 2008 before May 31, 2009.

Provisional Measures on the Administration of the Taxation of Contracted Projects and Provision of Services by Non-Residents
Issuing Authority: State Administration of Taxation
Date of Issuance: January 20, 2009
Effective Date: March 1, 2009

According to these Measures, foreign non-resident enterprises that engage in contracted projects with a Chinese party or that provide certain types of services in China have an obligation to register with the relevant tax authorities within 30 days upon signing an agreement or contract and to deregister within 15 days after completion of the contracted project or service. The domestic Chinese party or service recipient who signed the agreement or contract with the non-resident enterprise or individual should file a report together with the relevant contract(s), non-resident's tax registration information and a written explanation regarding the arrangement with the competent tax authorities within 30 days after signing the contract. Any modification to the agreement or contract should also be filed by the domestic Chinese party or service recipient with the tax authorities within 10 days of such revisions. In addition, the domestic Chinese party or service recipient should conduct withholding agent registration within 30 days of the commencement of its withholding obligation.

The Measures sets forth in detail the tax filing requirements for non-resident enterprises and individuals in respect of enterprise income tax, business tax and value added tax and clarify the withholding obligations under various circumstances. Among other things, a non-resident enterprise that does not constitute a permanent establishment in China under a tax treaty should apply with the tax authorities in advance in order to enjoy preferential tax treatment and treaty benefits under the treaty. Otherwise, it will have to file a tax return and pay enterprise income tax according to the domestic tax law.

The tax authorities will set up a filing system for non-residents and adopt various measures to manage tax related issues in connection with the registered contracted projects and services. Tax authorities may require certification issued by a foreign notary or CPA to support any payment invoice received by the domestic Chinese party or service recipient which the tax authorities deem suspicious. The tax authorities can notify the foreign exchange administration to stop foreign exchange payments of a non-resident if such non-resident has tax payments in arrears. For certain contracted projects or services with a total contract amount of over RMB50 million, the tax authorities may exercise close supervision over those contracts and initiate an information exchange mechanism and tax avoidance investigation or audit if they find it necessary.

Shanghai to Promote Financing by Means of the Pledging of Intellectual Property Rights 上海下月将推广知识产权质押融资
Issuing Authority: Shanghai Intellectual Property Administration ("SIPA") 

Chen Zhixing, director of SIPA, stated on February 15, 2009 that SIPA will promote financing by means of the pledging of intellectual property rights ("IPR") for small and medium-sized technology enterprises in Shanghai. Detailed regulations regarding financing by pledge of IPR are expected to be promulgated at the end of March 2009. Under the proposed regulations an enterprise desiring to secure a loan by means of pledging of its IPR will need to apply to the intellectual property authorities at the county or district level. SIPA will evaluate and determine the value of the enterprise's IPR and file such information with the bank which may then provide a loan. Currently, financing by pledge of IPR for small and medium-sized technology enterprises is carried out as a pilot program in the district of Pudong.

Additionally, it has been reported that Shanghai is going to issue a series of IPR-related policies to support small and medium-sized enterprises this year, which include "Guidelines for IPR Services for Small and Medium-sized Enterprises" and a "Plan for Responding to Major Foreign-related IPR Disputes."

Notice on Strengthening Supervision of Trust Operations in Places Other Than a Trust Company's Place of Registration (Draft for Comments)
Issuing Authority: China Banking Regulatory Commission ("CBRC")
Date of Issuance: February 19, 2009

According to news reports, the China Banking Regulatory Commission recently released a Notice on Strengthening Supervision of Trust Operations in Places Other than a Trust Company's Place of Registration (Draft for Comments), although this notice is not currently available to the public.

The Notice reportedly provides that the CBRC will be responsible for regulating the trust business activities of trust companies conducted in places other than their place of registration. The Notice requires that before a trust company begins to promote and sell trust products in such places, it must report to the local branch of the CBRC in the place where it wishes to carry out trust business. A trust company is also required to disclose information regarding its promotion and establishment of trust plans to its principals after such trust plans have been established, and report the same to the local branches of the CBRC.

The Notice further requires that trust companies desiring to carry out trust business in places other than their place of registration should have complete and strict internal control procedures so as to ensure the effectiveness of its internal control system and establish specific employee incentives and restraint mechanisms to avoid operational or moral risk.

Notice on Simplified Assessment of the Actual Foreign Tax Burden of Foreign Enterprises Controlled by PRC Resident Shareholders
Issuing Authority: State Administration of Taxation
Date of Issuance: January 21, 2009
Effective Date: January 21, 2003

According to Article 45 of the Enterprise Income Tax Law undistributed profits or decreased distribution of profits in a foreign enterprise should be included in the income of its PRC shareholders if the foreign enterprise is set up in a country where the actual tax burden is definitively lower than the PRC income tax rate and the distribution decision is based on reasonable business operations. However, according to this notice, if a PRC resident enterprise or individual functioning as a controlling shareholder can provide documentation proving that the controlled foreign enterprise of which he is a part is set up in the U.S., U.K., France, Germany, Japan, Italy, Canada, Australia, India, South Africa, New Zealand or Norway, such provision will not apply.

Provisional Administrative Measures Regarding Non-Resident Enterprise Income Tax Withheld at the Source
Issuing Authority: State Administration of Taxation
Date of Issuance: January 9, 2009
Effective Date: January 1, 2009

A non-resident enterprise under these measures refers to an enterprise established in accordance with the law of a foreign country (or region), whose actual management organization is not in China, and which has no establishment in China but has China-sourced income, as well as an enterprise which has an establishment in China but whose income is not actually connected with that establishment.

These measures require that income tax payable by non-resident enterprises on China-sourced investments such as dividends and profits, interests, rents, royalties, and income obtained from the transfer of assets should be withheld by the payer. The payer must file with the relevant tax authorities within thirty days every time it enters into a contract (including any amendment, supplement or extension of such contract) with a non-resident enterprise in connection with the income taxable under these measures. The materials required to be submitted by the payer include a Contract Filing Form for Withholding Income Tax, a photocopy of the contract and other relevant materials.

In case the payer fails to, or is unable to, withhold income tax, the non-resident enterprise must file such tax with the tax authorities in the place where the income arises within seven days after the date when the income is paid or is due to be distributed. In the event of an equity transfer between two non-resident enterprises, the seller is required to file the requisite income tax forms with the tax authority in the place where the onshore target company is located, and the onshore target company is required to provide assistance to the tax authority in the tax filing.

Trial Measures on Applying for Shanghai Permanent Residence by Shanghai Residence Permit Holders
Issuing Authority: Shanghai Municipal Government
Date of Issuance: February 12, 2009
Effective Date: February 12, 2009

According to the measures, a holder of a "Shanghai Residence Permit" is qualified to apply for permanent residency in Shanghai, if the holder has:

1. held a Shanghai Residence Permit for seven years;
2. participated in Shanghai's social security program for seven years;
3. paid income taxes in Shanghai according to law;
4. relevant professional certification at the middle-level or higher; and
5. abided by the country's and the city's family planning policy, has no criminal record or any other record of misconduct.

Applicants will be given preferential treatment in obtaining permanent residency if they meet certain conditions, including, among others, (i) the holder has been honored for making significant contributions to Shanghai, (ii) the holder has worked in the education or health sector in the outer suburban regions of Shanghai for at least five years, or (iii) income tax paid by the applicant in relation to his direct investment in Shanghai surpasses a certain threshold for three consecutive years.

Chinese Insurance Companies Allowed to Invest in Real Estate

Chinese insurance companies may invest in real estate in China when the Amendments to the People's Republic of China Insurance Law (the "Amendments"), recently passed by the legislature in China, become effective on October 1, 2009.

On February 28, 2009, an Order of the President, issued by President Hu Jintao, announced that the Standing Committee of the 11th National People's Congress had passed the Amendments as a new law, taking effect on October 1, 2009.

Investment in Real Estate

One of the most significant changes under the Amendments is that Chinese insurance companies will be permitted to invest insurance funds in real estate other than for self use. Such a change could release significant funds into the real estate market and open up investments in infrastructure projects (a major focus of the Chinese government's stimulus package). It would also assist Chinese insurance companies with diversifying their investment portfolios to achieve higher returns on their insurance assets in order to deal with increasingly difficult solvency scenarios. Currently, a Chinese insurance company is not allowed to invest in real estate other than for self use unless granted special approval by the China Insurance Regulatory Commission ("CIRC"), the regulatory body for insurance companies in China. Historically, PICC, China Life, and Ping An, all listed on overseas stock markets, have obtained special approvals.

Other Highlights of the Amendments

The Amendments also reflect China's recent policy of allowing Chinese insurance companies to invest in marketable securities, such as company stocks and securities funds.

Additionally, the Amendments include provisions to tighten the supervision of and raise the risk management standards for investments by insurance companies to better protect policyholders and shareholders, as part of the measures in the Amendments to provide increased protection for insurance policy holders and further improve the corporate governance of insurance companies.

January 26 2009

More SPVs are Being Challenged: China Brings the General Anti-Avoidance Rules from Concept to Reality by O’Melveny & Myers LLP.

Historically, PRC tax authorities have generally respected the legal form of transactions and rarely disregarded the legal form based on the underlying substance. This is not true anymore. The doctrines of economic substance and business purpose embedded in the general anti-avoidance rules of the new PRC Enterprise Income Tax Law (“EIT”) are now a part of administrative practice in China.

Anti-avoidance Rules

Article 47 of the EIT law provides that: “where an enterprise implements any other arrangement with no reasonable business purpose to reduce the amount of its taxable income, the tax authority shall have the right to make adjustments through reasonable means.”

On January 8, 2009, the State Administration of Taxation issued the long-awaited Implementation Regulations for Special Tax Adjustments (Trial) to interpret the general anti-abuse clause. Among other things, it provides that the tax authorities may initiate a general anti-avoidance investigation to enterprises with the following tax avoidance arrangements: (i) abuse of tax incentives; (ii) abuse of tax treaties; (iii) abuse of a company’s legal form; (iv) tax avoidance through a tax haven; and (v) other arrangements without bona fide business purpose. The tax authorities will consider the following factors based on the “substance over form” principle in determining whether a transaction is arranged for tax avoidance purposes:

* Form and substance of the arrangement;
* Conclusion time and execution period of the arrangement;
* Connection between each step or part of the arrangement;
* Changes of financial status of each party involved in the arrangement; and
* Tax consequence of the arrangement.

Two Significant Cases

In two recent tax cases (discussed below), PRC tax authorities either disregarded or denied treaty benefits to an offshore special purpose vehicle that they found to lack substance. Although not specifically stated in the cases, tax practitioners generally believe that the general anti-abuse clause in the new EIT law (i.e., Article 47) was the underlying rationale and legal basis in deciding the following two cases.

* Chongqing Case - Legal Form of SPV Disregarded

The Chongqing Yuzhong district-level State Tax Bureau published a tax case in late November 2008 in which the PRC tax authorities looked beyond the legal form of a transaction and disregarded a Singapore special purpose vehicle (“SPV”).

According to the published case, Chongqing tax authorities imposed a withholding tax on capital gains derived by a Singapore holding company from the sale of its shares in a wholly-owned Singapore subsidiary (i.e., the SPV) to a Chinese buyer. The SPV held a 31.6% equity interest in the Chinese target company. The Chongqing tax authorities found that the SPV had no real business other than holding the 31.6% equity interest in the Chinese target company and the total capital of the SPV was only 100 Singapore dollars. Based strictly on the legal form of the transaction, China did not have tax jurisdiction over the Singapore holding company. However, Chongqing tax authorities looked beyond the legal form of the transaction and decided that this transaction was a transfer of Chinese onshore stock through the SPV in substance and therefore the SPV should be disregarded for tax purposes.

* Xinjiang Case - Barbados Tax Treaty Benefits Denied

A Barbados-based SPV, established by a US company, derived capital gains from the sale of its equity interests in a Chinese company located in Xinjiang. In general, such capital gains are protected by the China/Barbados income tax treaty and should not be taxed in China. However, in this case, PRC tax authorities denied the benefits of the Barbados income tax treaty and imposed tax on the SPV because the tax authorities found that the purported seller had no substance in Barbados.

The following facts were identified by the tax authorities as suspicious: the Barbados SPV purchased the equity interest in the Chinese company only after one month of its formation and sold the equity interest after approximately one year from the date of the purchase; the SPV’s return on its investment in the Chinese company was 36%, which was not achieved by business operation of the Chinese company but instead was based on a pre-arranged contractual arrangement as if the SPV had made a disguised loan rather than an equity investment; and, all directors of the Barbados SPV were US citizens.


With the new Implementation Regulations and the two recent cases discussed above, it is clear that PRC tax authorities will look beyond the legal form of a transaction in assessing whether a transaction is a tax-avoidance arrangement. Investors are advised to review their current structure to assess whether they are vulnerable to the application of the anti-avoidance rules. In particular, investors should closely examine their offshore special purpose vehicles. If the two cases discussed above are indicative of PRC tax authorities’ position on offshore special purpose vehicles, then those that lack substance will likely be completely disregarded or denied treaty benefits. More generally, investors should be aware of the risks involved in engaging in transactions that may be perceived as tax avoidance arrangements.

January 7 2009

China (PRC) Issues Partnership Tax Circular - Paves the Way for Pass-through Tax Treatment of Onshore Partnerships and Certain RMB Funds by O'Melveny & Myers LLP

The Ministry of Finance ("MOF") and the State Administration of Taxation ("SAT") jointly issued a crucial tax circular addressing the unified tax treatment of partnership enterprises on December 23, 2008. Following discussion by authorities and various commentators for some time with regard to the revised Partnership Enterprise Law (revised as of June 1, 2007), the circular represents an important step towards the further development of partnership tax law in China. The new circular is entitled Notice on Issues Concerning Income Tax for Partners in Partnership Enterprises, Caishui [2008] No. 159 and is effective retroactively to January 1, 2008.

The most significant aspect of this circular is that it confirms partnership enterprises are entitled to pass-through tax treatment, irrespective of whether the partners are natural persons or legal persons (incorporated entities). A partnership enterprise (as defined) will not be subject to tax and, instead, each of the partners will be liable for tax only in their separate and individual capacities. Natural person partners will be liable for individual income tax and legal person partners will be liable for enterprise income tax on the income they recognize from the “production, business operations and other activities” of such partnership enterprise.

These pass-through principles are articulated by adopting the expression “allocate first, then tax,” as is found in a flurry of local tax guidance issued by many localities that are promoting the formation of RMB funds in their jurisdictions. This circular also clarifies that partners will recognize income from partnership enterprises on an annual basis irrespective of whether they receive an actual distribution.

Taxable income will be calculated in accordance with existing tax circulars governing certain sole proprietorships, industrial and commercial households, and partnership enterprises in existence before the Partnership Enterprise Law was revised in 2007. Citation to those circulars is curious since they only addressed individual income tax matters and are not compatible for legal person partners.

In addition, the following rules of priority will be applied to determine the appropriate allocation of income to partners:

(i) allocated according to the written partnership agreement;

(ii) allocated according to a subsequent agreement among the partners in the event the partnership agreement is silent or unclear;

(iii) allocated based on partners’ capital contributions; and

(iv) allocated based on the number of partners pro rata.

Interestingly, provisions of a partnership agreement that operate to shift income entirely to or away from any specific partner(s) (this was purposely added out of concerns for abuse) are prohibited according to the circular and, furthermore, losses generated by the partnership enterprise will not be recognized by partners to offset their income from other sources.

While the circular leaves many issues of partnership tax mechanics unaddressed, it represents a very significant step forward.

September 22, 2008

China Issues Implementing Regulations for Labor Contract Law By O'Melveny & Myers LLP

On September 18, 2008, China passed the long awaited Implementing Regulations for the Labor Contract Law, which became effective immediately. The Regulations facilitate implementation of the law; however, although they were issued after extensive consultation more than 9 months after the principal law became effective, they address fewer issues than anticipated. It is possible that supplemental legislation will be promulgated at national or provincial/ municipal level to deal with outstanding issues in the future, but in the meantime employers face continuing uncertainty regarding the application of the law.

Key Provisions

* In order to ensure that written employment contracts are implemented, the Regulations provide that if an employer fails to enter into a written employment contract one month after the employment start date, the employer must pay double salary to the employee until the time when the written contract is signed. If an employer fails to enter into a written employment contract within one year, a non-fixed-term contract is deemed to exist after one year at which time the double pay penalty ceases to toll. The Regulations also provide that if an employee refuses to execute a written employment contract during the first month of employment, the employer can terminate the employee without severance pay. If the employee refuses to enter into a written employment contract after he has worked for one month, the employer can terminate the employee, but must pay severance.

* The Labor Contract Law provides that an employee can request a non-fixed-term employment contract after 10 years of continuous service with an employer. The Regulations clarify that the clock for the 10 year service period starts to run when an employee is first hired by an employer. This is intended to prevent employers from buying out employees' service years prior to the effective date of the Labor Contract Law and resetting the clock from January 1, 2008.

* The Regulations clarify that if employees are transferred to a new employer by their existing employer (such as in an M&A transaction), the employees' service years must be carried over to the new employer. Service years do not need to be carried forward, however, if the employees have agreed with their previous employer that the latter will compensate them for their previous service and that employer does so.

* The Regulations confirm that parties cannot include termination provisions in employment contracts that are not specifically provided for by statute and list the situations when parties can terminate employment contracts.

* The Labor Contract Law provides on its face that if, after the parties have performed two fixed term employment contracts, the contract is renewed, it must be renewed on a non fixed term basis. The law appears to give both parties the right to determine whether to renew the contract. By contrast, the Regulations state that in such circumstances if the employee wishes to renew the contract, unless the parties otherwise agree, the parties must enter into a non-fixed term contract. While the position is not crystal clear, this could support the position that an employee has the right to demand a non-fixed-term contract upon the completion of the second fixed term, regardless of whether the employer agrees to a contract renewal. It is hoped that further clarification will be forthcoming on this issue.

* The Regulations confirm that training fees include training costs supported by legal receipts, travel expenses incurred during the training period and other direct costs. The definition of “special training fund” included in the previous draft has been removed, apparently giving employers flexibility to determine the structure and amount of training funds.

* The Regulations clarify that severance payments should comprise an aggregate of an employee's salary, average bonuses, stipends and allowances.

* The Regulations clarify that if an employer terminates an employment contract illegally, the employee's damages for such termination are limited to the amount of damages specified under the Labor Contract Law (which in certain circumstances caps damages) and that an employer will not be required to pay additional damages.

Please note that this Newsflash outlines key issues, but does not contain a comprehensive analysis of the law.

September 3, 2007

NPC Standing Committee Enacts Antimonopoly Law By O'Melveny & Myers LLP

On August 30, 2007, the Standing Committee of the National People's Congress (NPC) adopted China's first comprehensive competition statute, the Antimonopoly Law . The final draft reflects over a decade of debate and redrafting, tussling over regulatory turf by rival ministries and commissions, and unprecedented dialog with foreign antitrust enforcement officials, scholars, and practitioners.

The Antimonopoly Law targets three types of monopolistic conduct anti-competitive "monopoly agreements" between multiple firms (such as price-fixing and market-allocation agreements); "abusive" commercial practices by dominant firms; and potentially anti-competitive concentrations, such as certain mergers and acquisitions. (Article 3). Most provisions derive from foreign antitrust laws, chiefly German and European Commission (EC) practices. The final text may be construed to conform with prevailing international antitrust principles and practices. However, it remains to be seen whether foreign concepts embedded in the law will be applied with imported analytical techniques, interpretations, and policy judgments.

Though the Antimonopoly Law 's promulgation is a substantial milestone in the evolution of Chinese competition policy, the final text leaves unanswered many fundamental questions about China's substantive antitrust policies and the structures and procedures for enforcing the new law. The NPC delegated many controversial decisions to the State Council, most notably the designation of the primary "Antimonopoly Enforcement Authority," the composition of the "Antimonopoly Commission" to coordinate competition policy, and the definition of the thresholds for determining whether a transaction must be notified to the Chinese authorities for antitrust review.

Similarly, the final text declares that the substantive antitrust rules do not apply to legitimate exercises of intellectual property rights but do apply to "abuses" of intellectual property rights; it does not reach the underlying question of distinguishing anticompetitive abuses from valid, pro-competitive exercises of intellectual property rights.

Most details of the final text are unsurprising in light of past drafts. However, the final text does feature new articles targeting the involvement of trade associations in organizing price cartels. In response to widespread criticism, the final text confirms that presumptions of market dominance based solely on the market shares of the allegedly dominant firm may be refuted with evidence disproving the possession market power. In addition, the final text explicitly warns that transactions with "national security" implications will face separate reviews on national security grounds pursuant to other laws and regulations (not the Antimonopoly Law ) in addition to the merger review on competition policy grounds.

Another controversial aspect of the new law is the prohibition of "administrative monopoly"– essentially, the anticompetitive misuse of official power to protect or promote favored firms. The final text contains detailed rules addressed to government instrumentalities prohibiting many discriminatory and anticompetitive tactics of "administrative monopoly." Problematically, government agencies are responsible for policing their own subordinate departments and agencies for violating the rules against administrative monopoly. Aside from acting as an advocate and watchdog, the antimonopoly authority will lack power to compel compliance by other government agencies.

The Antimonopoly Law outlines the investigatory powers of the enforcement agencies and the basic elements of the new merger control system, which is expected to replace the current merger review process under the Regulations on the Mergers & Acquisitions of Domestic Enterprises by Foreign Investors and apply to Chinese and foreign parties alike (unlike the current merger review rules).

Penalties for entering monopoly agreements and abuses of dominance include confiscation of illegal gains, fines of 1 percent to 10 percent of the offenders' total turnover from the preceding year, and orders to cease the offending conduct. Unlike China's existing merger control rules, the Antimonopoly Law authorizes substantial penalties for failure to report mergers or consummating disapproved transactions; the enforcement authorities may order corrective measures to restore pre-transaction conditions and impose fines up to RMB 500,000. The mandatory minimum fines are worrisome, particularly since some officials have suggested that the fines should be calculated based on annual worldwide turnover.

In the eleven months remaining before the Antimonopoly Law takes effect on August 1, 2008, the State Council and relevant ministries and commissions are expected to address some of the outstanding issues through new decisions, implementing regulations, and guidelines. Nevertheless, significant questions will likely persist beyond August 1, 2008. In the end, the substance of Chinese antitrust will depend on the institutional capacity, motives, and political clout of China's new antitrust authorities.

March 8, 2007

Unofficial translation courtesy of Squire, Sanders & Dempsey LLP

Antitrust Investigation Office of Ministry of Commerce of the People’s Republic of China

Shang Fa Jingzheng Letter No.11 of [2007]

Notice of Meeting

To Whom it May Concern:

With a view to improving the work for antitrust review on merger and acquisition of enterprises and improving the efficiency for such review, the Antitrust Investigation Office of the Ministry of Commerce proposes to convene a seminar at the Ministry of Commerce on March 28, 2007 to discuss the relevant issues concerning amendment to the Guidelines for Antitrust Review Filing for Merger and Acquisition of Domestic Enterprises by Foreign Investors.

Please assign one person to take part in the meeting and provide the name of the personnel attending the meeting to the Antitrust Investigation Office of the Ministry of Commerce before close of business on March 27. The language of the meeting shall be in Chinese, please accompany a translator if necessary.

Time of the Meeting: AM 9:00-PM 17:00 March 28, 2007
Place of the Meeting: Room 1419 of the Ministry of Commerce, No.2 East Chang’an Street
Contact Persons: Lin XIE; Tao JIANG
Contact Tel.: 65198680/8728
Fax: 65198905

Attachment: Enrolment Form of the Seminar
Antitrust Investigation Office of the Ministry of Commerce (with the seal of the Department of Treaty
and Law of Ministry of Commerce)

March 26, 2007 - Unofficial translation courtesy of Squire, Sanders & Dempsey LLP

Enrolment Form of the Seminar

Entity Contact Person Tel (Telephone/Mobile Phone)
Fax Email
Unofficial translation courtesy of Squire, Sanders & Dempsey LLP

Guidelines for Antitrust Filing for Merger and Acquisition of Domestic Enterprises by Foreign Investors
(Draft for Comments)

According to the Regulation on Merger and Acquisition of Domestic Enterprises by Foreign Investors (Promulgated by Order No.10 [2006] of the Ministry of Commerce), which was jointly promulgated on August 8, 2006 by the Ministry of Commerce, State-owned Assets Supervision and Administration Commission of the State Council, State Administration of Taxation, State Administration for Industry and Commerce, China Securities Regulatory Commission, and State Administration of Foreign Exchange, any merger and acquisition of enterprises meeting the prescribed standard shall be reported to the Department of Treaty and Laws of the Ministry of Commerce (Antitrust Investigation Office) in advance. In order to facilitate the filings by the parties, we hereby release the guidelines as follows:

I. Filing Party
The filing party shall be the merging/acquiring party in principle, and may also be the merged/acquired party as the case may be. The filing party may report in its own name or have a Chinese law firm acting on its behalf, in which case, it shall be reported by a lawyer who is qualified to practice in China.
II. Time for Filing
The time for antitrust filing for merger and acquisition (“M&A”) shall be made after the M&A agreement related thereto is signed and before the M&A transaction is completed. If the acquisition is made through a tender offer in the stock market, the antitrust filing shall be made after the release of the offer.
III. Filing Materials
A filing party shall submit written materials in duplicate, together with an electronic version thereof (we suggest it be a CD). All the filing materials shall be made in Chinese, except for any attachment to such materials or as otherwise required in these Guidelines. If the originals of such materials are made in foreign languages, their Chinese translation shall be attached. Materials submitted shall include the following:
(i) Report letter. The contents of the report letter shall be in brevity with one or two pages of A4 paper. The report letter shall be signed by the filing party or its attorney-in-fact.
(ii) Power of attorney and attorney letter. If the filing is made by an entrusted agent, a power of attorney signed by the filing party and the letter of the intermediary institution where the attorney-in-fact works (an attorney letter in general) shall be provided. The power of attorney and the attorney letter shall be originals.
(iii) Identity certificate or registration certificate of the filing party. A filing party outside China shall also have the certificates notarized or certified by local notary public office.
(iv) Basic information of each party to the M&A, which shall include but not limited to: name, registration place and business scope of the enterprise, corporate form (company, partnership or any other forms); name, title and ways of contact of the contact person; sales volume of each party to the M&A in recent one fiscal year (including global sales volume and sales volume within China), company scale, position of the company in the industry, historical information on the establishment and any change of the company, and etc..
(v) Name list of the enterprises affiliated with each party to the M&A and brief introduction of each of them. The scope of the name list of enterprises shall include but not limited to the following:
1. All the enterprises or individuals that directly or indirectly control each party to the M&A;
2. All the enterprises that are directly or indirectly controlled by each party
to the M&A;
3. All the other enterprises other than the merging/acquiring party that are directly or indirectly controlled by the enterprises or individuals as defined in item 1 above. An organization chart or chart may be used to illustrate the equity structure, actual control and other affiliated relationships among the aforesaid enterprises.
(vi) Name of the foreign-invested enterprises established by each party to the M&A within China.
(vii) General information regarding the M&A transaction, including: nature and ways of the transaction (e.g., assets acquisition, stock acquisition, merger, and establishment of joint venture enterprises), subject matter and amount of transaction, M&A transaction process, estimated date for Unofficial translation courtesy of Squire, Sanders & Dempsey LLP completion of the M&A transaction, the control relationship among relevant companies after completion of the M&A transaction (the company control structure may be showed with a chart, if necessary), and the industry or main products involved in the M&A transaction, as well as the motivation, the purpose and the economic rationality of the M&A transaction.
(viii) Defining of Scope of Relevant Market. The defining of the scope of the relevant market shall include in general the defining of the product market and the regional market. Explanations shall be made on the reasons for defining or not defining the relevant market. In defining the relevant product market, such factors as the replace-ability, competition conditions, price, price flexibility upon the change of demand and supply, and etc. shall be taken into consideration. In defining the relevant regional market, such factors as the nature and characteristics of the relevant product, access barriers, consumer’s preferences, exceptional differences in market shares or actual prices of the enterprise in different regional markets, and etc. shall be taken into consideration.
(ix) Sales volumes and market shares of each party to the M&A in the relevant market within recent two fiscal years, and the data sources and calculation basis shall also be explained.
(x) Names and market shares of the top five competitors in the relevant market, whose contact persons and ways of contact shall also be provided.
(xi) Supply structure and demand structure of the relevant market, including the name list of the major upstream and downstream enterprises and their ways of contact.
(12) Information on Competition in the Relevant Market. The information on market competition shall include without limitation the following:
1. Market access analysis.
(1) The total cost for entering the market by means of a scale identical with that of existing major competitors, e.g. costs for establishing a distribution system, promotion, advertising and services.
(2) Any statutory or de facto barriers to market access, e.g. governmental permission or compulsory governmental standards in any form. Unofficial translation courtesy of Squire, Sanders & Dempsey LLP
(3) Restrictions arising from patent, proprietary technologies and other intellectual property rights and restrictions arising from the process of licensing such rights.
(4) The extent to which the parties to the M&A are the licensors or licensees of any patent, proprietary technologies or other intellectual property rights.
(5) The importance of scale economy for relevant product manufacturing; (6) Information on sourcing channels, e.g. sources for raw materials.
2. Existence or non-existence of any horizontal or vertical cooperation agreements between operators in the relevant market, e.g. Research and Development Agreement, Agreement on Assignment of Patent Use Right, Collaborative Manufacturing Agreement, Specialization Agreement, Distributorship Agreement, Long-term Supply Agreement and Information Exchange Agreement.
3. Information on import product substitution in the relevant market.
4. Major market entry or exit events over the recent three years, including the names and contact method of the enterprises that have entered or exited the market.
(13) M&A Agreement. If any agreement is written in a foreign language, a Chinese translation or a substantial Chinese abstract thereof shall be submitted concurrently.
(14) Audited financial statements for the previous financial year of the parties to the M&A. If any financial statement is written in a foreign language, a Chinese translation or a substantial Chinese abstract thereof shall be submitted concurrently.
(15) Information on the review of any filing with respect to the proposed M&A in other countries or economic communities.
(16) Other information required to be furnished to the competent authority.
(17) A statement on the authenticity of the filed information and/or the accuracy of information sources signed by all parties to the M&A or their authorized representative.
IV. Time Limit for the Review
The time limit for the M&A review shall be thirty (30) business days, commencing on the date of receipt of a complete set of filed documents. If the parties to the filing have not received any notice of further review upon the expiration of the 30-business-day period, the review of the filing may be deemed as passed. If the parties to the filing have received such a notice, the parties to the filing shall furnish further information or make further elaboration to the competent authority as required in the notice, with the limitations period for review to be extended in view of specific circumstances.
V. Pre-filing Consultations
In order to improve efficiency, and ensure the transparency and predictability of review, the Antitrust Investigation Office encourages the filing party and its entrusted agent to contact the Office, on an informal basis prior to the official filing, for consultations on such matters as whether any filing is necessary or how the relevant market shall be defined. Whether or not any consultations have been made prior to filing shall not affect the conclusion of the antitrust investigation.
(1) Time Limit and Method for Submitting Pre-filing Consultation Request The consultation applicant shall submit a request for pre-filing consultations to the Antitrust Investigation Office one month of official filing. Within one week before official filing, the Antitrust Investigation Office will cease to accept any request for prior-filing consultations. The pre-filing consultation request shall be
made in writing and faxed to the Antitrust Investigation Office. (Fax No: 65198905)
(2) The consultation applicant shall furnish relevant documents to the Antitrust Investigation Office, including introduction to transaction background, overview of the relevant industry and the relevant market and the potential effect of the proposed transaction on market competition. If the consultation
applicant does not contest the necessity for filing, it may directly provide a draft of the M&A Report as the basis for consultations and discussions. Any objections to the necessity for filing shall be presented in the stage of consultations. The Antitrust Investigation Office suggests that the consultation applicant adequately disclose all relevant information likely to impact market competition and use its best efforts to furnish relevant documents.
VI. Confidentiality
If the filing party does not intend the filed information to be published or disclosed, it shall present its request for confidentiality when submitting the documents and shall briefly state the reasons for not disclosing or publishing each document to be kept confidential.
VII. Time and Place for Document Submission
The filing party shall submit the documents to be filed to the Antitrust Investigation Office of the Ministry of Commerce during the office hours of the Ministry of Commerce. For convenience of prompt registration and acceptance, please make the submission at any time between 8:30-11:0 am or 1:30-4:00 pm. Address of the Antitrust Investigation Office of the Ministry of Commerce:
Room 3516, Ministry of Commerce, No. 2, East Chang’an Street, Beijing
Antitrust Investigation Office,
Department of Treaty and Law,
Ministry of Commerce

August 10, 2006

PRC Government Amends M&A Code - O'Melveny & Myers LLP

On August 8, 2006, the PRC Ministry of Commerce (“MOFCOM”), the State Assets Supervision and Administration Commission (“SASAC”), the State Tax Administration (“SAT”), the State Administration for Industry and Commerce (“SAIC”), the China Securities Regulatory Commission (“CSRC”) and the State Administration of Foreign Exchange (“SAFE”) adopted the Regulations on Acquisition of Domestic Enterprises by Foreign Investors (the “M&A Code”). Compared with the Temporary Regulations on Acquisition of Domestic Enterprises by Foreign Investors issued by MOFCOM, SAT, SAIC and SAFE (the “Temporary Code”), the M&A Code contains the following important changes:

FIE Status - If an offshore entity established or controlled by a PRC company or resident (the “PRC Controlled Offshore Entity”) acquires an affiliated PRC domestic company (the “Affiliated Domestic Company”), the resulting foreign invested enterprise (an “FIE”) will not enjoy the benefits available to other FIEs, unless such acquisition takes the form of additional equity investment in the Affiliated Domestic Company in an amount equal to or greater than 25% of its registered capital or unless the investment in the PRC Controlled Offshore Entity by foreign investors other than such PRC company or resident equals 25% or more of the registered capital of the FIE.

MOFCOM Approval - Acquisition by a PRC Controlled Offshore Entity of an Affiliated Domestic Entity is subject to approval by MOFCOM. No person may circumvent such requirement by making domestic investment through an established FIE or other means.

Nature of Target Company - A report is required to be filed with MOFCOM if a proposed acquisition by foreign investors relates to a “key sector”, affects or may affect the “national economic security” or results in a change of control of domestic companies that have “famous trademarks or traditional Chinese brands”.

Affiliates - The parties involved in an acquisition need to explain if any of them are affiliated. If two parties are actually controlled by one person, the identity of such person needs to be disclosed to the approval authorities. An explanation should be made as to the purpose of the acquisition and as to whether valuation of the acquisition price is consistent with fair market value. No person should circumvent these requirements through trust or nominee arrangements or other means.

Share Swaps - The foreign investors may use their shares in an offshore company, and an offshore company may issue news shares, as consideration for purchasing a PRC entity. Unless permitted under the SPV Provisions (summarized below), the shares used for such consideration should be shares of a listed company.

SPV Provisions - An SPV is defined as an offshore company which is directly or indirectly controlled by a PRC domestic company or resident for the purpose of listing on an overseas stock market its interest in a PRC domestic company actually owned by such PRC domestic company or resident.

Shareholders of an SPV are permitted to use their shares in the SPV, and the SPV can issue additional shares, as consideration for acquisition of PRC domestic entities (the “Share Swap”).

The Share Swap is subject to approval by MOFCOM.

If the SPV fails to complete an IPO within one year after approval, the parties must unwind the Share Swap and return the shareholding of the relevant domestic entity to its original status.

The listing of an SPV on an overseas stock market is subject to approval by the State Council department in charge of securities regulation (meaning CSRC).

Anti-trust Review - The relevant language in the M&A Code essentially has remained the same as that in the Temporary Code, except that effects on "national policy and people's livelihood and economic security" have been eliminated from the list of factors to be considered in evaluating domestic transactions.

Individual Shareholder - If the foreign investors acquire an interest in a PRC domestic company and as a result convert it into an FIE joint venture, the PRC nationals who were shareholders of the domestic company prior to the acquisition can remain shareholders of the FIE joint venture after the acquisition.

* * * * * * *

The M&A Code will take effect on September 8, 2006. As the basic regulation governing foreign related mergers & acquisitions in China, it will have significant impact on future activities in this area, especially as it relates to mergers & acquisitions by the PRC Controlled Offshore Entities of the Affiliated Domestic Companies and the listing of the SPVs.

April 14, 2006

Hong Kong And Mainland China To Implement New Arrangement On Reciprocal Enforcement Of Judgments In Commercial Matters - By O'Melveny & Myers LLP

A new arrangement between the Hong Kong Special Administrative Region and Mainland China for the reciprocal enforcement of judgments in commercial matters (the “Proposed Arrangement”) is expected to be implemented later this year. The Proposed Arrangement has important implications for businesses operating in the Greater China region. Importantly, parties to commercial agreements will need to pay close attention to the framing of their jurisdiction or “choice of court” clause, as this will determine whether any court judgments arising from disputes between the parties can benefit from/be subject to reciprocal enforcement.

Although details are yet to be finalized, it is understood that the key elements of the Proposed Arrangement will be as follows:

Application to money judgments arising from commercial contracts only

The scheme will only apply to money judgments arising from commercial contracts. In this regard:

(1) judgments other than money judgments, such as orders for specific performance or injunction, will not be covered;
(2) the definition of “commercial contracts” remains to be clarified, but it is understood that contracts such as those relating to matrimonial matters, wills and successions, bankruptcy and winding up, employment and consumer matters will not fall within the meaning of “commercial contracts”.

Finality requirement

Further, the Proposed Arrangement will only apply to judgments which are “final and conclusive”. In gist, an application for reciprocal enforcement may only be made if the parties have agreed not to appeal the judgment or the time for filing an appeal has passed.

In respect of the enforcement of Mainland judgments in Hong Kong, it is proposed that a certificate of “final judgment” must also be submitted to the Hong Kong court by the party seeking enforcement. This is to avoid any doubt as to the finality of the Mainland judgment.

Exclusive jurisdiction requirement

Reciprocal enforcement will only be permitted where the parties to the commercial contract have agreed to an exclusive jurisdiction clause in which either the Mainland courts or the courts of Hong Kong have sole jurisdiction to deal with any dispute under the contract.

The Proposed Arrangement does not apply in circumstances where the parties have not made a prior express agreement on choice of court.

The requirement for adopting an exclusive choice of court clause by the parties aims to minimize the risk of parallel proceedings being instituted in the courts of both places, which may give rise to complications as to whether one of the judgments is final.

Application to judgments of designated courts only

The Proposed Arrangement is expected to cover only the money judgments of certain designated courts:

(1) in respect of Hong Kong judgments, the District Court or higher;
(2) in respect of Mainland judgments, the Intermediate People's Court or higher, as well as certain designated Basic Level People's Courts.

No retrospective application

It is understood that the Proposed Arrangement will not have retrospective application on those choice of court agreements entered into before the Proposed Arrangement comes into force.


The Proposed Arrangement will provide a number of safeguards against the enforcement of judgments that are considered to be “unsafe”. It is understood that enforcement may be refused if any of the following circumstances arise:

(1) the choice of court clause is invalid in accordance with the law of the place of enforcement;
(2) the judgment has been fully executed;
(3) the court of the place of enforcement has exclusive jurisdiction over the dispute or has made a prior judgment on the same cause of action;
(4) the losing party had not been given sufficient time to defend its case;
the judgment was obtained by fraud;
(5) enforcement of the judgment is contrary to the social and public interests of the Mainland (where enforcement is sought in the Mainland) or to the public policy of Hong Kong (where enforcement is sought in Hong Kong).

Implications for businesses

The Proposed Arrangement follows a similar arrangement between the Macau SAR and the Mainland, which came into force recently (see China Law & Policy, April 7). These arrangements will no doubt have significant implications for businesses operating in the Greater China region.

When entering into new commercial contracts, businesses will need to consider carefully the benefits and potential pitfalls arising from the Proposed Arrangement, and decide whether they wish to (and can) benefit from, and similarly be subject to, the reciprocal enforcement scheme. If so, appropriate drafting of the choice of court clause is required to ensure the agreement falls within the scope of applicability of the Proposed Arrangement.

Way forward

The Proposed Arrangement is expected to come into force later this year, once the requisite legislative backing in both Hong Kong and the Mainland are obtained.

A further update will be provided closer to implementation.

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February 27, 2005

Time to Fix China’s Arbitration - by Jerome A. Cohen

For a long time, I believed in the ability of the China International Economic and Trade Arbitration Commission (CIETAC) to deliver fair verdicts for foreign companies embroiled in business disputes with local partners and counterparties. This faith in the body that still handles the bulk of the international commercial arbitrations conducted in China was largely based on my positive initial experiences. However, more recent encounters have shaken my confidence. Now I fear that without a concerted effort at reform, the credibility of China’s leading arbitration institution will slip away.

Back in the mid-1980s, when CIETAC did not yet allow foreigners to serve as arbitrators, I became the first foreign lawyer to appear before it as a dailiren, or advocate, for a foreign company. The Chinese law professor representing the local party to the dispute immediately challenged my right to do so, on the ground that I was not licensed to practice law in China. (As a foreigner, I could not be.) The presiding arbitrator, however, promptly rebuffed the challenge, admonishing my counterpart to read CIETAC’s Arbitration Rules, which clearly permitted anyone—Chinese or foreign, lawyer or non-lawyer—to serve as an advocate.

Perhaps such an encouraging start colored my view of that arbitration and subsequent CIETAC proceedings. Before the first hearing, I had not known what to expect. Of course, I hoped that CIETAC would prove to be a better alternative than the courts. In those days, foreigners knew little about Chinese courts, but generally believed, as did many Chinese, that the courts suffered from both lack of professional competence and the distorting influences of guanxi, local protectionism, corruption and politics. The arbitrators before me offered a refreshing contrast, for they seemed to be competent, fair, honest and independent.

Over the next decade, experience with CIETAC as both advocate and arbitrator reinforced that favorable impression, which I often voiced in both publications and lectures. Being an optimist, I thought that if an institution called an “arbitration commission” could establish apparently admirable dispute-resolution tribunals in China, perhaps an institution called a “court” could some day do the same.

Occasionally, some foreign and Chinese lawyers politely hinted that my positive appraisal of CIETAC was naive. But understandably, no one sought to refute me in public when to do so would involve him in controversy and perhaps damage his “rice bowl.” Frankly, however, I had neither the time nor the inclination to look into the matter, since I had not yet personally encountered any disillusioning experience with CIETAC and had several friends working there. Moreover, foreign legal scholars have tended to focus on the troublesome problems of enforcing an arbitration award in Chinese court rather than on the institutional and procedural problems of obtaining a fair award in the first place.

Unfortunately, in recent years my CIETAC experience, as both advocate and arbitrator, has dimmed my earlier optimism. There is a pressing need to undertake a comprehensive investigation of CIETAC’s practice—not merely its rules—in order to enhance transparency and thereby speed the process of reform.

My hope is that CIETAC, which has made many improvements in response to Chinese and foreign suggestions, will cooperate with both official and non-governmental efforts to address the serious problems of institutional integrity that confront it, and will not seek to suppress justifiable criticism. How CIETAC copes with these issues will determine its future reputation and its prospects in a market where it now must compete—not only with foreign arbitration organizations but also domestic ones, the best of which have shown themselves to be commendably sensitive to ethical and other institutional considerations.

Here are 10 recommendations that urgently require the consideration of CIETAC and the international business and legal communities:

* CIETAC should not use its own personnel as arbitrators. One of CIETAC’s biggest defects is its persistent selection of its own personnel as arbitrators, especially presiding arbitrator. This creates an obvious opportunity for the exercise of administrative influence and even control over the arbitration panel and its decision.

This practice can also involve its staff in conflicts of interest even when no CIETAC influence is exercised behind the scenes. The world’s best arbitration organizations, including Stockholm’s (which has often mentored CIETAC staff ), do not permit this practice. I am happy to note that the Beijing Arbitration Commission (BAC), which now handles over twice as many cases, most of them domestic, as CIETAC, also rejects this practice. Today there is no shortage of able potential arbitrators in China, both Chinese and foreign, and CIETAC should open its roster to a new generation of experts.

* A national of a third country should serve as presiding arbitrator. Many more foreign companies would select CIETAC arbitration if they believed that not more than one member of a three-person panel would be a Chinese national.

Today, some sophisticated international lawyers know that CIETAC will honor an arbitration clause that calls for the presiding arbitrator to be from a third country, but this encouraging new development is not widely known and CIETAC seems reluctant to publicize statistics regarding its use. Furthermore, unless the parties specify in their contract, the presiding arbitrator, whether appointed by agreement of the parties or by CIETAC in the absence of such agreement, is most probably going to be Chinese.

This is what worries many foreign companies, particularly those who know of cases in which the presiding arbitrator and the arbitrator appointed by the Chinese party, both Chinese nationals, have rendered decisions that could not be justified by their foreign arbitrator colleague. CIETAC would enhance its fairness and its attractiveness by amending its rules to require that the presiding arbitrator in international and foreign-related cases always be from a third country unless the parties agree otherwise.

Moreover, regardless of the presiding arbitrator’s nationality, CIETAC should do more to enable the parties to agree on the presiding arbitrator, for example, by requiring each party to submit lists of names of persons they could accept, as the BAC now does. The idea should be to diminish the arbitration organization’s role in this important selection, which would reduce the opportunity for behind-the-scenes negotiations with CIETAC that reportedly take place over this important decision.

* The presiding arbitrator should be a respected legal expert familiar with the relevant business background. The presiding arbitrator, of course, is the main figure in each arbitration. Not only is his vote often decisive on the merits, but he is frequently called upon to take the lead in important rulings in the course of the proceedings, especially during the hearing when rulings need to be made quickly. Yet I have taken part in more than one CIETAC case in which the presiding arbitrator—a CIETAC official with over a decade of administrative experience—appeared to lack a clear understanding of contract law and procedural matters, as well as the business environment of the dispute.

Of course, some CIETAC administrators have made excellent presiding arbitrators. They should continue to serve as such, not for CIETAC, but for other arbitration organizations, Chinese and foreign. Whether or not my two previous recommendations are adopted, in order to maximize confidence in the quality and fairness of the arbitration, it will continue to be crucial to appoint a presiding arbitrator who is both an acknowledged legal expert and at home in the business background of the dispute.

* CIETAC should limit the number of cases in which someone can serve as an arbitrator at any one time. An arbitrator who serves on too many cases for the same arbitration organization runs the risk of losing his independence to that organization. This is especially true if the organization appoints the arbitrator or introduces him to a party to the dispute. In those circumstances, the arbitrator inevitably becomes too familiar with the commission staff and, in order to sustain his income, too reliant on their favor.

This is wholly apart from the question of whether an arbitrator who takes on too many cases has the time and energy to do a competent job. Out of concern for this problem, the BAC now prohibits its arbitrators from handling more than 10 cases simultaneously. CIETAC should apply such a limit to foreigners as well as domestic experts. Certainly, one can debate how many cases are “too many,” but 10 a year might be an appropriate limit.

* CIETAC should prevent its arbitrators from serving as advocates in other CIETAC cases. I have served as both advocate and arbitrator before both CIETAC and other international arbitration organizations. Such alternation of roles is generally permitted in international practice. Yet I am struck by the BAC’s recent amendment of its rules to require all those who serve as its arbitrators to cease serving as advocates in other cases before it.

The new rule is based on the assumption (which reportedly reflects BAC’s experience) that allowing Chinese lawyers to alternate roles within the same arbitration organization breeds incestuous familiarity among advocates, arbitrators and commission staff. This, in turn, fosters opportunities for irregularities and diminishes institutional integrity.

This may be my most controversial suggestion, since it can drastically reduce the income of arbitration specialists, foreign as well as domestic. Yet, as BAC believes, even if foreign organizations find it unnecessary, given the nature of Chinese society and the small arbitration community, such a reform is warranted at present in order to prevent a “You scratch my back, I’ll scratch your back” ethos from damaging the impartiality of arbitrators.

* Advocates as well as arbitrators must fully disclose conflicts of interest. Not long ago I served as advocate for a foreign claimant in a Beijing CIETAC case which resulted in a hearing that my client and I deemed grossly unfair. A week later, we discovered that the advocate for the respondent, had, without public announcement, become a vice chairman of CIETAC shortly before the hearing.

That meant the presiding arbitrator, a deputy secretary general of CIETAC, was the subordinate of the other side’s advocate. Nevertheless, at the outset of the hearing, when the presiding arbitrator asked whether the parties wished to disqualify any arbitrator, neither the presiding arbitrator nor the new vice chairman thought it necessary to reveal this crucial fact.

The claimant brought this blatant impropriety to the attention of the commission by means of a memorandum demonstrating that no other major international arbitration organization in the world would countenance this practice. CIETAC then reluctantly ordered replacement of the presiding arbitrator with a very able Chinese lawyer who is not on its staff. A new hearing had to be held, which put both parties, especially the foreign claimant, to great additional expense.

To avoid repetition of this sad incident, CIETAC should require advocates as well as arbitrators to reveal in writing and in advance of the hearing all of their professional and organizational responsibilities plus any other facts that might bear upon the impartiality of the arbitrators. The guanxi net can be very wide in the relatively small group from which advocates, arbitrators and administrators are drawn.

If, for example, a law professor who serves as an advocate happens to be supervising the doctoral thesis of an arbitrator or CIETAC administrator, that surely should be revealed to the opposing party. Moreover, if CIETAC is at fault because of the negligent or intentional failure of its personnel to make a necessary disclosure, it should compensate the parties for the damage it has caused them, and the personnel involved should be appropriately disciplined.

* CIETAC should enhance the confidentiality of its proceedings. Every dispute-resolution institution must keep confidences. This is certainly true of an international commercial-arbitration organization, which promises the parties complete confidentiality unless the parties agree otherwise. An arbitration organization that fails to honor that promise fails to inspire confidence.

Yet it is extremely difficult to live up to this ideal. Discretion is an acquired discipline. Human beings like to gossip with friends, exchange information with classmates and share their problems with family. They sometimes reveal secret information for corrupt or political motives, and sometimes, fortunately, “whistle-blowers” expose wrongdoing within the organization. Whatever the reasons, I know from personal experience that CIETAC leaks, and at various levels.

But what can be done about it? Obviously, the importance of preserving confidentiality must be repeatedly brought home to leaders, arbitrators and staff. Every opportunity must be seized to remind them of their obligation, which has long been spelled out in legislation and in the commission’s rules and ethical standards.

I believe it is necessary to provide more significant sanctions than currently exist and to apply them against those who breach confidentiality without justifiable excuse. I emphasize the words “without justifiable excuse,” since CIETAC personnel should not be discouraged from continuing to reveal institutional and individual irregularities that would otherwise never be made public.

* More stringent standards should be applied to prevent arbitrators from engaging in ex parte contacts regarding their cases. A related and even more substantial challenge to CIETAC’s integrity is the illegal and unethical practice of certain arbitrators privately discussing their case with unauthorized persons, whether officials, lawyers or others.

Such contacts are usually hard to detect without the assistance of the state security or public security agencies, but it is common knowledge that they take place. A much-admired law professor told me that, rather than appear as an expert witness in a CIETAC hearing, instead he informally discussed the issues with the arbitrators. “That’s still the Chinese way,” he said with a self-conscious giggle.

Chinese lawyers working on a case in another forum in which I was serving as an arbitrator unsuccessfully tried to get me to discuss it with them. Moreover, it is even believed, based on confidential assertions made by both CIETAC staff and Chinese lawyers who have themselves served as CIETAC arbitrators, that CIETAC has on occasion ordered its Chinese arbitrators to change the outcome of their proposed award, i.e., not merely to alter the form of the award but the result!

Plainly, it is time for some higher authority to investigate the truthfulness of such disturbing allegations. But CIETAC need not await the report of such an investigation. It can immediately make clear to its arbitrators, leaders and staff that such practices will no longer be tolerated, that existing laws, rules and ethical standards will be strictly enforced and that punishments will be increased and applied to CIETAC personnel and others. And surely, CIETAC should immediately cease interfering with proposed awards.

* CIETAC staff should not draft awards for arbitrators. It is widely believed that CIETAC staff draft awards for some Chinese arbitrators, thereby enabling them to handle many more cases than they otherwise would. Although judges in many countries enjoy the help of their law clerks, and arbitrators everywhere may need confidential research and other assistance, I believe that arbitrators should draft their own awards. Otherwise, it becomes all too easy for them to make decisions without having to confront the intellectual difficulties that stand in their way.

My mentor, American Supreme Court Justice Felix Frankfurter, used to say that “some opinions simply won’t write,” meaning that one who actually has to spell out the reasons for his decision sometimes has to change his mind. Before the hearing, CIETAC does not require arbitrators to face up to the issues in dispute, as the International Chamber of Commerce does in requiring the arbitrators to agree with the parties and their advocates on highly detailed “terms of reference.” Surely, after the hearing, CIETAC should not make it easy for the arbitrators to avoid the issues by drafting the award for them. The BAC requires arbitrators to do their own work.

* CIETAC should require a dissenting arbitrator to write an opinion and make it available to the parties and their advocates. An even more important measure for assuring that arbitrators render reasoned and fair decisions is to require every dissenting arbitrator to draft an opinion supporting his views and to make it available to the parties and their advocates together with the award of the majority. Otherwise there is no effective restraint on the factual and legal assertions of the majority.

Although judicial review is possible in a proceeding to enforce or set aside an award, the scope of such review is inevitably limited, and no judge can know the case as well as an arbitrator. Moreover, the dissenting opinion, in addition to challenging the dissenter to justify his negative vote, may make possible more adequate judicial review of an award that deserves serious scrutiny.

Yet CIETAC does not permit dissenting opinions to be made available to the parties and their advocates, even if the dissenter wishes to write one. This, as I can testify from personal experience, is frustrating not only for the losing party but also for the minority arbitrator. Again, CIETAC would do well to follow the example of the BAC. Since March 1, 2004, it has required dissenters to attach an opinion to the award.

I have raised these recommendations in the good-faith belief that transparency and the criticism that it makes possible foster law reform and fair dispute resolution. I do not pretend to have all the facts or all the answers. Indeed, there are many more questions to ask.

CIETAC representatives, who have shown themselves to be extremely sensitive to criticism, will undoubtedly have much to say in response to these recommendations, as will other Chinese and foreign experts. I hope that CIETAC’s new rules, which are expected this spring, will take them into account.

In any event, I welcome a healthy discussion of the merits. It is time, in the interest of China’s economic development, its efforts to create a rule of law and its cooperation with the world, to bring these issues out of the shadows.

Mr. Cohen is a professor of law at New York University and an adjunct senior fellow at the Council on Foreign Relations. This article is adapted from a speech delivered on Nov. 4, 2004 to a conference in Xiamen sponsored by the Chinese Society of International Economic Law and Xiamen University.

*3rd Party Opinion for strict information only - you must consult with an attorney - our Chamber of Commerce is not responsible for the accuracy of the information listed here.

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