Doing Business with China

1. Doing Business with China TAGLAW - Berlin 2008 AGM Mark Ho & Blaine Turnacliff

2. Presentation Points • Introduction • Legal investment vehicles • Outbound investment • Real estate business in China

3. China: Big Numbers

4. Coming to Grips with the Numbers and therefore Potentials • 1.3 billion people • 0.7 billion peasants • 0.2 billion migrant workers • 200m aspiring middle class • 100m middle class as now • 14m engineers • 140k lawyers

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

6. China’s Comparative Disadvantages: the reality about this economic gorilla • 25% of the world’s population, 6% of global economic activity (28% for US) • At current growth rates, by 2050 China will be the world’s largest economy, but the average Chinese will be poorer than the average American was in 2005 • Excess labour • Innovation gap • Governance deficit • Commercial immaturity (SOEs)

7. Foreign Investment Operating Structures in China • Representative Office • Equity Joint Venture • Cooperative Joint Venture • Wholly Foreign Owned Enterprise (WFOE) • Foreign Invested Commercial Enterprise (FICE) • Holding Companies

8. Representative Office • Quick (procedure to register is not complicated) and inexpensive way to establish a legal presence in China. Can carry out market research, render advice, collection of information, coordinate company activities in China and hire staff • No direct business activities permitted – cannot enter into sales contract, issue invoices, arrange for importing goods • no registered capital requirements • Do require a leased office before registration

9. Equity Joint Venture • In the 80s and early 90s, was the most commonly used foreign investment structure • First foreign investment structure allowed in China • Benefit to the Chinese economy - foreign party generally provides technology, management expertise & cash • Dividends / profits based on equity shareholding of each party

10. Cooperative Joint Venture • Similar to Equity Joint Venture in structure but with more flexibilities because • Sharing of profits may be governed mostly by JV contract • Foreign partner can obtain return of investment in priority to Chinese partner; or early recovery of investment

11. Wholly Foreign Owned Enterprise (“WFOE”) • 100% owned by foreign investors • More and more industries are open to WFOEs (although still some restricted industries) • Complete control of operation – no local partner • It is becoming first choice of foreign companies • Approval and registration procedure similar to Joint Ventures • Minimum registered capital –4000 USD but should be proportional to scope of business plans

12. Foreign Invested Commercial Enterprise (FICE) • Allowed to engage in retail, distribution, agency and franchising • First time in modern history foreign companies could undertake trading • Become very popular • Franchisors need to own / operate two units for one year in order to begin franchise business • Lower minimum registered capital (4,000 USD legally but most companies invest much more)

13. Exit Strategy • Need to have a plan in place that will allow you to pull out or sell your investment with minimum of difficulties and costs • Ten year minimum operational period to enjoy tax incentives • Wind up procedures are very onerous and time consuming • Offshore vehicle (SPV) enhances flexibility and presents options for both partners • liability, sale of company, tax considerations

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

15. The Chinese are Coming! • China’s appetite for commodities, natural resources, distribution networks for their products, desire to move up the value added chain • Over 1.5 trillion USD in foreign currency reserves • Fall of USD / appreciation of RMB • Government policy of “going global” • outbound M & A investment • 4.3 billion USD in 2004 • 16 billion USD in 2006 • 24.6 billion outbound M & A in 2007

16. Outbound M & A Transactions • Notable Deals: • 2.3 billion USD stake in Nigeria’s offshore oilfield by CNOOC • 5.6 billion USD of Standard Bank (SA) by ICBC • 4.3 billion USD of Canada’s Nations Energy’s Kazakhstan oil rights Plus: • Recent purchase of 50 Airbus A320s for 3.3 billion • Expected 280 billion USD for 2,900 planes over next 20 years

17. Governmental Approval • Generally 3 or 4 step process • State Development and Reform Commission (SDRC) • Ministry of Commerce (MOFCOM) • State Administration of Foreign Exchange (SAFE) • If State Owned Enterprise, also State Assets Supervision and Administration Commission

18. Bank Financing Issues • Chinese domestic companies cannot borrow from offshore so must obtain funding in China • Can be easy if borrower is large co, but difficult if smaller • Foreign competitors often label the Chinese financing as government subsidies • In future, will likely see the rules on overseas borrowing loosen

19. Legal Services in China • Legal Services are relatively new in China • 1989 was first year private law firms allowed • mainly very young, inexperienced lawyers, mostly 20 or 30s • Few have experience dealing with western companies

20. Real Estate Business in China

21. Real Estate Business in China Chinese real estate sector is increasingly attracting foreign investment (300% property appreciation in the past 10 years or so); plus Foreign business requires acquisition of real estate properties for operations

22. One Big Project

23. Property Ownership in China • No private land ownership, Only: (i) State or (ii) Collective Ownership • Collective – rural areas or countryside • State – urban areas or cities • Concept that land ownership is separate from land use rights; types of use rights: • Allocated land use rights • Granted land use rights

24. Allocated Land Granted Land (introduced post-1988) Term Indefinite term Set term – usually 40 to 70 years Use Granted for designated purpose – usually agricultural or military or infrastructure use Granted for a range of designated uses Consideration normal or nil consideration paid to the State Land grant premium to be paid to the local Land and Property Bureau Transferability Not transferable (and therefore technically cannot be mortgaged) Transferable subject to restrictions Different Types of Land Use Rights

25. Ownership of Buildings • May be privately owned • May be mortgaged, sold or leased • May be for an indefinite term • Subject to a term of land use rights • Subject to registration and certification • Subject to zoning regulations

26. Property Protection and Risks • Recording, Registration and Certificates • property ownership is recorded at different levels of government and there may be discrepancies in records for old buildings (municipal vs. district) • Most cities have open records to the public • Shanghai is at municipal level • Foreign ownership permitted but restricted

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

28. Implications of New Laws • Can no longer use offshore company to directly purchase RE in China • So must pay China taxes on sale or transfer • If want to invest in Chinese RE, must set up a RE Development Company • Total Investment minimum – 10 million USD • 5 million USD to be invested upfront

29. Establishing a Foreign Invested RE Development Company • Essentially two methods: • Project Development Company • bid and purchase land use rights • Acquire / merge with an existing Chinese Property Development Company

30. Project Development Company • Must participant in a public auction to obtain land • Generally pay bond to be eligible to participate • If win the bid, sign a Land Grant Contract with local government (Land Bureau) • Land Use Certificate is granted for a term depending on types of development purposes (40-70 years) • Set up WFOE / JV

31. Merge/Acquire Property Development Company • Due diligence and deal documentation • Financial and legal • Execution of M&A documentation • Application to Ministry of Commerce for approval • If approved, share transfer will be registered with local government • A Business license is issued

32. Use of non-RE FIE to Invest • Foreign Entities established in China can purchase RE only for “self use” • Self use means business or housing for staff/employees • Purchase of “excessive” residential units become grey area • Purchase of 100 units likely “excessive”

33. Lease of Chinese Real Estate • Office Lease: typical 2 year term • Facilities Lease: 20 year maximum • Retail Lease: 20 year maximum • Housing Lease: typical 1 year subject to renewal • Leasing Pitfalls: zoning, granted land; existing mortgage, etc.

35. Q & A Mark Ho mark.ho@jzfz.cn Blaine Turnacliff blaine.turnacliff@jzfz.cn Address: 10/F, Longfeng Tower No. 1566 Yan’an W. Road Shanghai 200052, ChinaTel: (86 21) 5258-2666 Fax: (86 21) 5258-7968Website:www.jzfz.cn THANK YOU!