Client Alert

China Law Bulletin - May 2006

5/1/2006

Feature Articles

Other Recent Developments

Ear to the Ground

 

Feature Articles

FIE Liaison Offices to Be Phased Out

Foreign-invested enterprises (“FIEs”) have frequently established liaison offices rather than branch offices due to the more flexible tax treatment that liaison offices receive.  However, it is reported that the State Administration for Industry and Commerce (the “SAIC”) will soon issue a guiding opinion prohibiting the establishment of new FIE liaison offices and requiring existing liaison offices to be deregistered or reestablished as branch offices upon expiration of their current registration licenses.  In practice, local Administrations for Industry and Commerce (“AICs”) have already adopted this policy as of the beginning of 2006.

This change in policy is based on the rationale that the recently amended "Company Law of the People’s Republic of Chinaand its implementing regulations do not specifically address FIE liaison offices.  Therefore, the SAIC does not have a regulatory basis to permit the establishment or renewal of such offices.

In an attempt to assuage foreign business community concerns, SAIC officials have made statements to foreign industry associations that existing liaison offices that are deregistered but not reestablished as branch offices will be permitted to continue operating as long as they are not engaged in “business activities,” an as yet undefined term.  We would recommend that FIEs with existing liaison offices carefully consider the practical implications of this new development and consult with their legal advisors on possible risks involved in operating a liaison office without registration documentation. 

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Circular Further Regulates Grants of Mining Rights

On January 20, 2006, the Ministry of Land and Resources of the PRC (the “MOLAR”) issued the "Notice of Further Regulating the Administration of the Grant of Mineral Rights," Guo Tu Zi Fa [2006] No. 12; (the “Notice”) to standardize procedures for the granting of exploration and mining rights.  The Notice specifically repeals existing rules governing the invitation to bid, auction and listing of mineral rights, as stipulated under Articles 7, 8 and 9 of the "Measures for the Administration of Invitation to Bid, Auction and Listing of Exploration Rights and Mining Rights" (for Trial Implementation), Guo Tu Zi Fa [2003] No. 197; (“2003 Measures”) issued by MOLAR on June 11, 2003.  The other provisions of the 2003 Measures remain effective.  For a detailed discussion please refer to our recently issued PRC Legal Update (http://www.mofo.com/news/updates/files/update02180.html).

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China Implements RoHS Measures

The "Administrative Measures on the Control of Pollution Caused by Electronic Information Products" (the “EI Products Measures”) were promulgated on February 28, 2006, and will be effective beginning March 1, 2007.  As the EI Products Measures have been issued in tandem with the directives of the European Commission on the restriction of the use of hazardous substances in electrical and electronic equipment known as “RoHS”, these measures are often referred to as “China RoHS”.

China RoHS was drafted by the Ministry of Information Industry (“MII”) in conjunction with six other regulatory agencies.  These agencies are jointly responsible for implementing and enforcing requirements under China RoHS.  Requirements under China RoHS will apply to manufacturers, importers, distributors and retailers of electronic information products.

Key features under China RoHS are as follows:

  • China RoHS broadly covers all electronic information products and their accessories (“EI Products”).  MII is expected to issue a detailed catalogue of these products based on the "Sector Classification Catalogue for the Electronic Information Industry" published by the National Bureau of Statistics of China.
  • The use of six hazardous substances (lead, mercury, cadmium, hexavalent chromium, Polybrominated biphenyls (“PBB”) and Polybrominated diphenyl ethers (“PBDE”)) in EI Products will be subject to restrictions.  The standards under which such restrictions will be determined and the methodologies for determining those substances (the “Standards”) have yet to be issued by MII.
  • All EI Products are required to comply with the Standards.  When an EI Product is first offered for sale in or imported into China, it must be labeled with the following information:

Environmentally Safe Period – a period within which the EI Product can safely be used without any hazardous substances leaking or mutating.

Hazardous Substances – whether the EI Product contains any hazardous substances and, if so, the names and concentration of such substances and which part of the EI Product contains such substances.

Recyclable – whether the EI Product is recyclable.

  • Packaging materials for EI Products must also comply with the Standards.  Manufacturers and importers of EI Products are required to clearly identify the materials used to make such packaging materials.
  • MII will issue and annually update a catalogue for certain key EI Products (the “Catalogue”) based on whether current technologies can provide affordable replacements for any restricted hazardous substance contained in such products.  The Catalogue will define the classes of key EI Products and will precisely describe restrictions and/or phase-out periods regarding particular hazardous substances contained in such key EI Products.  These key EI Products must go through a testing process to obtain China Compulsory Certification before they are permitted to be offered for sale in or imported into China.

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Draft Labor Contract Law Circulated

On March 20, 2006, the National People’s Congress (the “NPC”) released a draft "Labor Contract Law of the People’s Republic of China" (the “Draft Law”) inviting comments from the general public.  The Draft Law, which is intended to supplement the Labor Law of the People’s Republic of China (the “Labor Law”), has been scheduled for consideration under the NPC’s 2006 legislative plan.  If enacted as drafted, the Draft Law will increase employee rights in a number of areas.

Use of Fixed-Term Labor Contracts Discouraged

Employers have often found it more advantageous to enter into fixed-term labor contracts with employees, given the many restrictions on terminating open-term labor contracts under the Labor Law.  The Draft Law would make the use of fixed-term labor contracts less attractive.  First, employers would have to pay severance compensation to fixed-term employees if their contracts were not renewed after expiration.  Such compensation would be at least one month’s salary for each year of service.  Second, the Draft Law would eliminate employee incompetence and several other reasons as legitimate grounds for early termination of fixed-term contracts.

Non-Competition Provisions Further Restricted Over Current Law and Practice

The Draft Law would statutorily recognize post-employment non-competition obligations, but would limit their enforceability to:

(1)     the geographical area where actual competition may reasonably occur and

(2)     a maximum duration of two years. 

Current law and practice does not impose a geographic restriction and permits such obligations to last up to three years.

The Draft Law would further provide that non-competition obligations be enforceable only after the affected employee is fully compensated with an amount not less than his or her annual income, a significant increase from current law and practice.

Company Rules May Not be Adopted unless First Discussed with Employees or Their Representatives

Under the Draft Law, employers would not be allowed to implement company rules and policies that affect the “livelihood of employees” unless they are first discussed with a labor union, through an interim employee representative conference, or through “fair” negotiations with employees.  The current Labor Law imposes no such requirement.

Representative Offices May Directly Contract with Employees; Limitation on Use of Labor Service Agencies

Under the Labor Law, foreign representative offices (“ROs”) are required to hire staff through labor service agencies such as the Beijing Foreign Enterprise Service Group Co., Ltd. (“FESCO”).  Under the Draft Law, ROs and all other employer entities would be required to enter into direct employment agreements with their staff after their first year of service.  This requirement would lessen the ability of employers to reduce liability through the use of labor service agencies.

Action Points

Given the potential impact this law could have if promulgated, FIEs are advised to consider taking the following proactive steps:

(1)     Reassess company rules, regulations and policies for legal compliance.

(2)     Reevaluate existing labor contracts and non-competition agreements.

(3)     Adjust human resource budgets in light of potential increases in severance payments.

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Other Recent Developments

Revised Rules Streamline Company Registration

The State Council promulgated on December 18, 2005, the revised "Regulations of the People’s Republic of China for Company Registration" (the “Regulations”), effective January 1, 2006, in an effort to streamline company registration.

Company registration applications may now be submitted by facsimile, email or electronic means as well as in person.  Set timeframes are now established for when local AICs must render decisions on applications.  Uniform requirements are established regarding what supporting documentation must be provided, and registration fee rates have been lowered.  It is anticipated that the SAIC will soon be releasing "Guiding Opinions" regarding certain technical aspects of the registration process.

Reflecting the recently amended "Company Law of the People’s Republic of China" (the “Company Law”), the Regulations further require shareholders of foreign-invested limited liability companies (such as joint ventures and wholly foreign-owned enterprises (“WFOEs”)) to complete their registered capital contributions within two years of the company’s establishment or within five years if the company is an investment company.

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FIE Establishment Procedures Streamlined

On November 14, 2005, the Ministry of Commerce (“MOFCOM”) issued the "Public Announcement on Relevant Matters Concerning Delegating Administrative Authority for Filing for the Record and Issuing Approval Certificates of Foreign Invested Enterprises, and Further Streamlining Approval Procedures" (“Announcement No. 59”), which became effective on January 1, 2006.

The announcement provides that if a foreign investor has obtained approval from another Ministry for the establishment or change of registration of an FIE, then it is no longer necessary to obtain MOFCOM approval. The FIE must simply file the official notice from the relevant Ministry together with the joint venture contract and articles of association in the case of a joint venture, or articles of association in the case of a WFOE, with the provincial MOFCOM, and the provincial people’s government will issue the FIE’s certificate of approval.  A newly established FIE that requires verification by a Ministry under the State Council must submit a joint venture contract and articles of association to the provincial people’s government for approval and issuance of a certificate of approval.  The announcement does not affect MOFCOM’s approval authority in the case of projects designated under the State Council Investment System Reform Decision as requiring MOFCOM approval.

The announcement also streamlines non-material changes in an FIE’s joint venture contract, articles of association, change of name, change of investors’ names or change of business address by simply requiring that these changes be filed with the original approval authority, which will then issue an updated certificate of approval.

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SAIC Registered Capital Registration Provisions Amended

Reflecting changes in the recently amended Company Law, the SAIC amended the "Provisions for the Administration of Registration of the Registered Capital of Companies" (the “Amended Capital Registration Provisions”) on December 27, 2005.  The Amended Capital Registration Provisions took effect at the same time as the amended Company Law on January 1, 2006.  The Amended Capital Registration Provisions apply to domestic Chinese companies and are also applicable to FIEs unless PRC law provides otherwise.

The Amended Capital Registration Provisions track the changes made in the Company Law relating to the registered capital of companies, including:

  • lower capital threshold requirements for setting up companies (RMB 30,000 for a limited liability company; RMB 100,000 for a sole member limited liability company; and RMB 5,000,000 for a joint stock company);
  • larger percentage allowed for non-cash capital contributions to registered capital (up to 70%); and
  • increased flexibility in terms of timing of capital contributions (registered capital does not need to be paid in full before registration, but only 20% initially with the remainder to be paid within two years for an ordinary company and five years for an investment company). 

The Amended Capital Registration Provisions also address several issues that are not expressly covered in the amended Company Law:

  • Paid-in Capital Registration: Not only the registered capital of a company needs to be registered with the SAIC, but the actual paid-in capital must also be filed with the SAIC.  If there is a decrease in the actual paid-in amount of capital, the company is required to register both the change in registered capital and the change in actual paid-in capital.
  • Forms of Capital Contribution: While the Company Law specifically lists certain forms of capital contribution that are permitted, the Amended Capital Registration Provisions specifically exclude labor services, credit, names of natural persons, goodwill, franchise licenses or mortgaged assets as valid forms of capital contributions.  One notable omission from both the Company Law and the Amended Capital Registration Provisions is whether securities, such as stocks or promissory notes, can be used as valid and registrable forms of capital contribution. 
  • CSRC’s Approval for Capital Increases in Public Companies: The Amended Capital Registration Provisions require that any capital increase by a joint stock company in the form of public offering or any private placement of any listed company receive approval from the China Securities Regulatory Commission (the “CSRC”).
  • Capital Payment Verification: The Amended Capital Registration Provisions also set forth the relevant contents that must be included in a capital payment verification report for the initial capital contribution upon establishment of a company or any subsequent changes to the registered capital and paid-in capital. 

 

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MOFCOM Delegates Power to Approve Commercial FIEs

MOFCOM promulgated on December 9, 2005 the "Circular of the Ministry of Commerce on Delegating the Examination and Approval Authority to Local Counterparts Concerning Foreign Invested Commercial Enterprises" (the “Circular”) which came into force on March 1, 2006.

The Circular requires foreign investors applying to set up foreign-invested commercial enterprises (“FICEs”) to file their applications with MOFCOM’s provincial branches rather than central-level MOFCOM. This is subject to several exceptions provided in the Circular. For example, wholesale and retail sales of important materials such as steel and iron ores remain subject to central-level MOFCOM’s jurisdiction.

The Circular also authorizes MOFCOM’s provincial branches to examine and approve the applications filed by FICEs for opening new stores within the province or within a national economic and technological development zone located in the province, subject to several exceptions provided in the Circular — e.g., stores with an area over 300 square meters remain subject to central-level MOFCOM jurisdiction.

The Circular further clarifies that if an FICE is to be created by a foreign company acquiring a domestic company, and if the domestic company and the foreign company will be controlled by the same management staff, then the application to establish the FICE is subject to central-level MOFCOM’s jurisdiction. 

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New Measures for Electronic Banking

The "Administrative Measures for Electronic Banking" (the “E-Banking Measures”), promulgated by the China Banking Regulatory Commission (the “CBRC”), became effective on March 1, 2006.  Under the E-Banking Measures, all financial institutions in China (both purely domestically owned and foreign-invested) intending to provide services in China through which customers may engage in self-service banking transactions (“E-Banking Services”) via the Internet, fixed-line telecommunications networks, mobile or wireless networks, or other electronic services or networks, must:

(1)   comply with CBRC reporting, approval, and filing requirements; and

(2) meet certain risk management, internal control, and data security standards, including:

  • application of the same risk management and internal control systems used for traditional banking services to E-Banking Services;
  • ensuring the security of data transmissions;
  • employing firewall, anti-virus, anti-intrusion, and encryption technologies for transactions conducted over open networks; and
  • concluding an E-Banking Services Agreement with each customer.

Foreign-invested financial institutions are subject to the following additional rules:

  • Central-level CBRC approval must be obtained before providing or expanding E-Banking Services (whereas purely domestic financial institutions may obtain certain approvals from local branches of CBRC); and
  • A PRC operating entity must be established, although servers through which such financial institutions provide transaction services may be located outside the PRC.

Financial institutions that were already providing E-Banking Services prior to March 1, 2006 without specific government approval must apply for approval prior to September 1, 2006. 

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Measures on Strategic Investment by Foreign Investors in Listed Companies

On December 31, 2005, MOFCOM, the CSRC, the State Administration of Taxation (“SAT”), the SAIC and the State Administration of Foreign Exchange (“SAFE”) jointly issued the "Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors" (the “Strategic Investment Measures”), which became effective on January 31, 2006. 

The Strategic Investment Measures provide for the first time a regulatory framework for foreign investors (including investors from Hong Kong, Macao and Taiwan) to acquire “A” shares of PRC-listed companies.  “A” shares are tradable shares denominated in Renminbi that were previously only available to Chinese individuals and entities. 

An investment in A shares by a foreign investor is subject to a number of conditions, including that the issuer of such shares must have implemented reforms to convert non-tradable, state-owned shares into tradable shares in accordance with the "Administrative Measures for the Reform of the Segmented Share Structure of Listed Companies,"  which were published on September 4, 2005.

In addition, the strategic investment is subject to the approval of MOFCOM. If the strategic investment involves the purchase of newly issued shares, the foreign investor must also obtain approval from the CSRC. Furthermore, a no-objection letter from the CSRC will be required if the foreign investor takes control of the domestic listed company as a result of a share transfer to the foreign investor.

According to the Strategic Investment Measures, the general requirements applicable to investment in domestic companies by foreign investors, such as anti-monopoly restrictions, will apply to any strategic investment in A shares.  Foreign investors must also satisfy, among others, the following requirements:

  • be a duly incorporated legal person or other entity;
  • hold not less than 10% of the issued shares of the invested company after completion of the strategic investment, unless the invested company is in a restricted industry or the government grants a special exemption from this requirement;
  • undertake not to sell the acquired A shares for a period of three years;
  • own total assets of at least US$100 million or manage total assets of at least US$500 million outside the PRC (or its parent company must satisfy this requirement);
  • have not received any material punishment from any regulatory authority in any jurisdiction within the last three years; and
  • following the strategic investment, satisfy all applicable reporting and other obligations under the "PRC Securities Law" and the related regulations issued by the CSRC.

If a foreign investor makes a strategic investment through a wholly-owned subsidiary which is incorporated outside the PRC, then the investor must report any sale of such subsidiary to MOFCOM.  The purchaser must also satisfy the requirements set forth above and assume the rights and obligations of the seller and/or its parent to the relevant listed company.

Interestingly, the Strategic Investment Measures also provide that an investment made pursuant to the Strategic Investment Measures will be subject to the jurisdiction of the PRC courts or arbitration within the PRC. 

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Circular on the Administration of Foreign Exchange in Bonded Logistics Parks

The "Circular of the State Administration of Foreign Exchange on the Administration of Foreign Exchange in Bonded Logistics Parks" (the “Circular”) was promulgated on December 20, 2005 by the SAFE and took effect on the same day.

The Circular confirms that foreign exchange matters in bonded logistics parks should be handled according to the "Measures for the Administration of Foreign Exchange in Bonded Areas" and that a company (a “Park Company”) in a bonded logistics park must apply for a Registration Certificate of Foreign Exchange in Bonded Logistics Parks, which is similar to a Registration Certificate of Foreign Exchange in Bonded Areas.

In addition to the above general principle, two additional points are worth noting:

(1)  If the goods in a trade transaction do not belong to the Park Company but to a company located outside the relevant bonded logistics park, the relevant warehousing agreement or entrustment agreement identifying the Park Company as the warehousing service provider must be presented to the bank when the payment formalities for import are carried out. 

(2)  Where a Park Company with foreign trade rights handles customs declarations for the import or export of goods, the Park Company needs to (i) be registered in the roster of import entities that make foreign exchange payment to offshore entities, and (ii) be registered in the archives of verification for export.  In addition, the Park Company is required to have the relevant import declaration form signed by the local customs bureau in order to make a foreign exchange payment.  In the case of export, export proceeds in foreign exchange shall be made to a foreign exchange account first instead of being directly settled.

The local branches of SAFE are required to issue detailed implementing rules based on the Circular, and therefore it is necessary for a Park Company to check the local rules for detailed implementation guidance. 

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China’s New Anti-Spam Regulations

The "Administration of Email Services Procedures" (the “Email Procedures”) promulgated by MII became effective on March 30, 2006.  The Email Procedures impose restrictions on senders of email, particularly advertising email, as well as on email service providers, which are meant to work together to provide a mechanism for eliminating spam.  For a detailed discussion of the implications of the Email Procedure, please refer to our April 2006 Legal Update (http://www.mofo.com/news/updates/files/update02179.html).

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New Measures to Certify Eligibility of Software Enterprises for Incentives Under the State Strategic Plan

In 2000, the State Council promulgated "Certain Policies for Encouraging the Development of the Software Industry and Chip Industry,"  which included various incentives for software enterprises.  To clarify which enterprises would be eligible, the "Administrative Measures for Certification of Key Software Enterprises Under the State Strategic Plan" (the “Software Measures”), effective since January 1, 2006, were jointly promulgated by the National Development and Reform Commission, MII, MOFCOM and SAT (collectively, the “Authorities”). 

The Software Measures define a “Key Software Enterprise” as a software enterprise meeting one of the following criteria:

(1)      having software sales revenues in excess of RMB100 million with positive net income in a particular year;

(2)      having an annual export amount in excess of US$1 million with software exports exceeding more than 50% of sales revenues; or

(3)      being one of the top five key software developers in China. 

In order to obtain such qualification, a software enterprise must file an application annually with the China Software Industry Association by May 30, and the final decision will be published jointly by the Authorities by the end of the following October. Software companies that qualify as Key Software Enterprises will be granted a Key Software Enterprise Certificate and will be entitled to enjoy a favorable enterprise income tax of 10%, compared with the standard 33%, for the year in which they are so qualified. 

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New Enforcement Measures in the Cultural Market

The "Measures for the Administration of Administrative Law Enforcement in the Cultural Market" (the “Law Enforcement Measures”) were promulgated on March 24, 2006 and will come into effect July 1, 2006.

The Law Enforcement Measures provide law enforcement procedures that apply to all cultural activities, including commercial performances, the importation, sale, rental or public showing of A/V products, the operation of entertainment establishments, commercial displays of artistic works, distribution and public showing of films, and commercial establishments offering Internet access services, such as Internet cafes.  The Law Enforcement Measures address which law enforcement agencies have jurisdiction for enforcing laws related to cultural activities, appropriate procedures for enforcement, and methods for supervising and prosecuting violators.

The Law Enforcement Measures also provide law enforcement officials with the discretion to levy administrative fines of up to RMB 50 on natural persons and up to RMB 1,000 on companies or other legal entities.  If property is confiscated in the course of an investigation, upon conclusion of the case the property should be auctioned openly in accordance with State provisions or else destroyed in accordance with relevant regulations.

Although it is not yet possible to judge the impact of the Law Enforcement Measures, it is expected that they will provide greater consistency in handling cases involving cultural matters. 

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Ear to the Ground

ACFTU Renews Push to Unionize FIEs

The All China Federation of Trade Unions (the “ACFTU”) held forums on March 29 and April 7 to promote the unionization of FIEs.  While FIEs employ over 20 million people in China, only 33% of FIEs in China are currently unionized.  The renewed union push coincides with the current consideration by the National People’s Congress of a draft "Labor Contract Law" (discussed above).  Such law, if adopted, would significantly strengthen union power and worker protections.  According to reports, the ACFTU was heavily involved in the drafting of this proposed law. 

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