Foreign direct Investment in China

1 Foreign companies, intending to operate in China through an own office or a production facility, may usually choose from the following four legal forms:

• Representative Office
• Wholly Foreign Owned Enterprise - WFOE,
• Joint Venture – JV
• Partnership

2 A representative office is a dependent branch of a foreign company. Representative Offices can be used primarily to enter the Chinese market and to initiate and maintain contacts in China. This narrow scope follows from the fact that representative offices do not have their own legal personality and, therefore, with a few exceptions, cannot engage in direct business, buy or sell goods or accept payments in China. Furthermore, representative offices can hire local staff only through licensed recruitment agencies (such as FESCO, CIIC or China Star).

Our consulting services concerning the establishment of representative offices include:

• Eligibility review of the chosen office location
• Preparation of all necessary application documents
• Guidance on/Following through the whole establishment procedure
• Appointment and registration of the chief representative and other representatives
• Employment of other staff

3  Wholly Foreign Owned Enterprises ("WFOE") are companies incorporated under the laws of PRC by foreign companies as their wholly owned subsidiaries. In most cases, the WFOE is the most appropriate legal form for operating a foreign-invested business in China, as a WFOE is controlled by its foreign parent company alone without involvement of a Chinese partner. A WFOE is usually incorporated in the form of a limited liability company (GmbH) and the whole registration process normally takes 2-4 months. The essential steps of registration are the collection of the application documents (e.g. notarization and authentication of the business register excerpt in Germany, preparation of the Articles of Associations), the registration of the company name, the application for the business license to the local Administration for Market Regulation (hereinafter "AMR") and the registration of the WFOE with the Ministry of Commerce (hereinafter referred to as "MOFCOM"). The previous requirement to obtain approval for doing business was removed by the partial reform of the company law in the autumn of 2016. Following the reform, an approval is only required for investments in business sectors that are listed as prohibited or restricted in the current foreign investment guidance catalogue.

For the establishment of a production plant further steps are required, including an environmental impact assessment. Like the office location, the chosen production site must be too approved for foreign-invested companies.

Following the reform of the company law, the capital required to set up a WFOE can be determined in most cases by the company itself. In practice there are significant local differences in terms of registration timeframe and procedures. Before starting an establishment process, it is always advisable to first seek the dialogue with the local authorities in order to clarify in advance the fundamental feasibility of the project.

Our consulting services concerning the establishment of WFOEs include:

•         Review of the eligibility of the selected office and production facilities
•         Acquisition of land use rights for the construction of a production plant
•         Preparation of all necessary application documents
•         Guidance on/Following through the whole establishment procedure

4 A joint venture (hereinafter "JV") is an incorporation of foreign and Chinese companies. It is usually founded as a Limited Liability Company. In China, there are two forms of JV: Equity JV and Contractual JV.

The equity JV is an independent legal entity. It divides the risk, the loss and the profit among participants according to their equity shares. Investment contributions may take the form of contributions in cash or in kind or in the form of technology and know-how transfer. The equity shares of foreign investor should generally be at least 25%.

The contractual JV is a more flexible investment opportunity than the equity JV. It can be established as a legal person or as an enterprise without legal personality for a project. Greater flexibility is also achieved by the fact that the distribution of profits can be determined freely in the contract (regardless of the share ratio).

The establishment process of a JV is similar to that of a WFOE, but there are usually lengthy negotiations with the Chinese partner(s). While in the early stages of China's economic reform and opening-up since 1978, JVs were the only legal form that allowed foreign companies to operate directly in China, it is now that WFOEs are granted access to almost all sectors (major exceptions exist e.g. in automobile production). The pros and cons of a JV should therefore be weighed well before a foreign investor chooses this legal form.

Above all, the advantages of a JV are that with a suitable Chinese partner, a larger business volume can be achieved much faster than a foreign enterprise working independently. In particular, Chinese partners typically bring a workforce already familiar with the industry, an existing clientele and manufacturing facilities into the partnership.

On the other hand, it is much more time consuming to establish a JV than to set up a WFOE. Also, the foreign partner must give up part of future profits according to the share ratio of the participants, and there is almost always a significant know-how transfer to the Chinese partner. After all, JVs, from our experience, usually work well only when both partners benefit from each other in the cooperation. As soon as the Chinese partner can produce the products of the JV themselves or the foreign partner has understood the market sufficiently, JVs often disintegrate.

In addition, JVs with potential competitors are highly risky. Therefore a JV contract should always include a liquidation plan in the event of termination of the JV. Furthermore, the foreign partner should not, as far as possible, disclose its core technology, but only provide components for assembly in the JV. The know-how of the foreign partner should be clearly defined; components that will be provided by the foreign partner must be listed and priced.

The JV agreement should also include clauses that protect the foreign partner from being pushed out by the Chinese side through some common tactics. These protective measures include provisions according to which in the event of a boycott by the Chinese side the Board of Directors remains able to act, and which give the foreign partner the right to sell its shares for a reasonable price to the Chinese partner under certain conditions or to take over the shares of the Chinese partner. Finally, technology should in general be provided not as an investment contribution but as a license, as in such cases no official assessment on the value of the technology is required and the license agreement can be terminated in case of conflict.

Our consulting services concerning the establishment of JVs include:

• Negotiation of the joint venture contract
• Determination of strategic investment structure, for example, through setting up in an off-shore jurisdiction a special purpose vehicle as the shareholder of the JV
• Determination of share-holding structure of the JV as well as the long-term customer-supplier relationships between the JV and its investors
• Due Diligence concerning the assets to be contributed by the Chinese investor if not only cash
• Review of the eligibility of the selected office and production facilities
• Acquisition of land use rights for construction of a production plant
• Preparation of all necessary application documents
• Guidance on/Following through the whole establishment procedure

5 The possibility for foreign companies to set up a partnership in China has only existed since 2010. Foreign companies or investors can set up a partnership together with other foreign or Chinese legal or natural persons; or participate in an already existing partnership. Partnership enterprises are comparable to German partnerships (such as OHG and KG).

For the establishment of a partnership there is basically no MOFCOM approval required. Registering the company with local AMR is sufficient for it to start business. A special license is only required if restricted business areas are involved, or if the licensing requirements for partnerships requires it or if a prior approval is explicitly specified.

The advantage of a partnership is the simple establishment process. However, this advantage was significantly offset by the reform of the Chinese company law in the autumn of 2016. In addition, the legal status of such an entity is still unclear and therefore carries risks. Furthermore, the authorities of some locations have never implemented the rules on partnerships, so that the establishment of a partnership is sometimes in fact impossible.

Our consulting services concerning the establishment of partnerships include: