MEMORANDUM ON ESTABLISHMENT OF CHINESE SUBSIDIARY
INTRODUCTION
This memorandum is prepared for xx to provide a general overview of the establishment of a subsidiary in China. It is our understanding that xx. wishes to establish a presence in China which would allow the firm to better identify and service Chinese companies who are looking to invest in the United States. The establishment of a Chinese subsidiary would further demonstrate to US companies with international operations or a desire for such expansions, the broad international reach of xx.
This memo addresses general procedures and requirements in regards to setting up an office in China with a minimal capital investment. Based on legal research we conducted and consultations with relevant government authorities, this memo provides:
(1) General information regarding the establishment of a representative office (“Rep Office”) in the People’s Republic of China (“PRC”) and related concerns/legal issues;
(2) Special requirements and/or stipulations of relevant laws and regulations relating to the establishment of a Rep Office for a foreign financial institution and for a foreign securities institution;
(3) General information regarding establishing a foreign consultant WFOE and related concerns/legal issues; and
(4) Our recommendations.
1. General Information Regarding the Establishment of a Rep Office in the PRC and related concerns
1.1 General Information
(a) A Rep Office is the basic form of foreign business presence in China. Establishing a Rep Office provides foreign companies a presence and a permanent base in the PRC, from which it may conduct local sales and purchasing activities. In many instances, it is desirable and even necessary for foreign companies to establish a Rep Office to engage in the following activities:
· Setting up an office with official representatives and signatories;
· Establish a local presence and contact information;
· Open bank accounts;
· Import office equipment and supplies;
· Import personal effects of foreign resident company representatives; and
· Hire Chinese employees.
The most attractive aspect of a Rep Office is that under the current PRC law, it requires no minimal capital registration, thus allowing the opportunity for foreign investors to consider the establishment of a presence in China with a minimal amount of capital investment.
(b) The main restriction of a Rep Office is the prohibition to engage in “direct business operations” and violations of this may result in fines and the closure of the Rep Office. Whilst there is no clear definition of the scope covered under the term “direct business operations”, it is well established that the Rep Office may not directly enter into contracts or directly invest in the PRC, with a view of making profits in its local capacity.
1.2 Regulatory Framework
(a) The principal regulations governing the establishment and operation of Rep Offices in the PRC are the:
(a) Interim Regulations of the State Council of the People's Republic of China Concerning the Control of Resident Representative Offices of Foreign Enterprises, effective as of 30 October, 1980 (the "Interim Regulations");
(b) Procedures of the State Administration for Industry and Commerce ("SAIC") of the People's Republic of China for the Registration and Administration of Resident Representative Offices of Foreign Enterprises, enacted by the State Council and effective as of 15 March, 1983 (the "Registration Procedures"); and
(c) Detailed Rules of the Ministry of Foreign Trade and Economic Cooperation for the Implementation of the Provisional Regulations Governing the Examination, Approval and Administration of Resident Representative Offices of Foreign Enterprises, effective as of 13 February, 1995 ("Detailed Rules").
Local regulations at the provincial levels are also applicable.
Please note that specific information relating to the establishment of a Rep Office in a particular region of China is not included in this memo. We would like to elaborate on such concerns further, pursuant to your strategy and/or determination. We would also highlight that specific details may vary from locality to locality in China and may only be confirmed separately.
(b) In regards to the nature and functions of a Rep Office, a Rep Office is not considered to be a separate legal person under PRC law. This has been affirmed recently by the new PRC Company Law, effective as of January 1, 2006. A Rep Office is considered to be a liaison office with a limited scope of authorized activities and its parent enterprise will maintain legal responsibility for the activities of its Rep Office.
By law, the activities a Rep Office may engage in is restricted and activities that exceed the basic business scope will require specific approvals during the application process. An established Rep Office may only engage in activities that are within its registered business scope. Rep Offices for specific business sectors, e.g. finance or securities, will need to meet additional regulatory thresholds. (This is detailed below under Section 2.)
As mentioned above, PRC law provides that Rep Offices are prohibited from engaging in direct business activities. The following types of activities within the business scope of the Rep Office are permissible:
(1) conducting business liaison for the parent enterprise;
(2) introduction of products;
(3) market research;
(4) technological exchanges in China; and
(5) Conducting its own administrative matters.
In practice and in our experience, a Rep Office can also coordinate visits/exchanges of personnel, and conduct negotiations on behalf of its affiliate companies/parent enterprise in the PRC. However, as it does not enjoy the status of a legal person, a Rep Office does not have the legal standing to enter into contracts with other entities in its own capacity and may only enter on behalf of its parent enterprise.
The intention of limiting Rep Offices to "non-direct business activities" is to ensure that Rep Offices act only on behalf of the foreign-based parent enterprise they represent and not on their own behalf as separate business entities. Thus contracts signed by the Rep Office (other than those relating to its own administration, such as the office lease) should be signed in the name of its parent enterprise or one of its affiliates, and not in the name of the Rep Office itself. Consequently, such contracts should indicate the parent enterprise or its affiliate’s address outside of China. Any sale and subsequent billing and collection of money for technical, consulting, inspection, or other services should similarly be carried out by the parent enterprise or one of its affiliates, and not the Rep Office. Based on the regulations, Rep Offices should not perform the functions of a "service centre".
If a Rep Office is found to be "directly engaging in business activities", the Registration Procedures provide for penalties including fines of up to RMB 20,000 and the suspension of business activities. In practice, actual fines and sanctions are somewhat discretionary and determined on a case-by-case basis. It is possible that the Rep Office may be allowed to remedy the situation without sanction or that appropriate penalties will be determined on the basis of the amount invested in such activities and/or income generated through such business activities.
1.3 Application requirements and process overview for establishing a Rep Office
(a) A foreign enterprise seeking to establish a Rep Office in the PRC must satisfy the
following basic requirements:
(1) the parent enterprise must be legally registered in its home country;
(2) it must enjoy a sound commercial reputation;
(3) it must provide valid and reliable documents as required by the relevant laws
and regulations; and
(4) it must complete the application procedures as required by the relevant laws and
regulations.
These are flexible principles which can be managed easily with diligent preparation of
the documentation required for the application.
(b) Generally speaking, before the issuance of the China Administrative Licensing Law in 2003, the application for the establishment of a Rep Office had to undergo a two-step application process: (i) approval, and (ii) registration.
(i) The approval process included the preparation and filing of application materials for approval, and upon approval;
(ii) The registration process included required procedures with the relevant Chinese registration authorities.
Without the approval of and registration with the relevant authority, a Rep Office could not be established. After 2003, the two-step application process was consolidated and simplified into a one-step registration process making the process less burdensome.
To establish a Rep Office now, the parent enterprise will only be required to register the Rep Office with the SAIC and other PRC government agencies as necessary.
(c) Until a foreign party has successfully registered its Rep Office, the following is prohibited:
(1) putting up any signs or nameplates in front of any offices, including hotel rooms or private residences which may serve as offices;
(2) holding out to the public (whether through brochures or other forms of advertisement) that it has an "office" in the PRC;
(3) using a seal identifying its "office" in the PRC; and
(4) opening a bank account.
If the SAIC determines that any foreign party has engaged in such activities prior to the legal establishment of the Rep Office, that foreign party may be ordered to pay a fine and/or terminate its business activities in the PRC. Although such fines and sanctions may be levied on a discretionary basis, it is advisable that prior to registration, the office does not enter into any employment agreements with local employees or other office-related contracts in its own name.
(d) As discussed above, in most cases, foreign investors will only be required to register with the SAIC and other relevant government agencies for the establishment of a Rep Office. There are however instances which require foreign investors to undergo the traditional approval and registration process. This is usually applicable for specific business sectors such as finance or securities, where the application needs to obtain additional regulatory approvals. In summary, the foreign parent enterprise should apply to the following governmental agencies in accordance to its business:
(1) a financial institution shall apply to the China Banking Regulatory Committee;
(2) a maritime shipping agency shall apply to the Ministry of Communications of the PRC;
(3) an air transport enterprise shall apply to The General Administration of Civil Aviation of the PRC;
(4) a law office shall apply to the Ministry of Justice of the PRC;
(5) an accounting firm shall apply to the Ministry of Finance of the PRC;
(6) an insurance company shall apply to the China Insurance Regulatory Committee;
(7) a securities company, including a securities advisory entity, shall apply to the China Securities Regulatory Committee; and
(8) any other enterprises shall, according to the nature of their business, apply to the competent commissions, ministries or bureaus of the Central Government of China.
1.4 Detailed application process for establishing a Rep Office
(a) Registration Certificates
The foreign investor needs to undertake registration procedures with the relevant Chinese registration authority to obtain a registration certificate for the Rep Office (the "Registration Certificate"), and certificates for the Representatives ("Identification Certificates"). Within thirty (30) days of the date of issuance of the Approval Certificate, the foreign investor must register at the local branch of the SAIC to obtain a Registration Certificate. The Approval Certificate will automatically become invalid if registration is not completed within the thirty (30) day period.
The application must be made through a local Chinese sponsor, which is usually a foreign service unit accredited by MOFCOM to submit documents on behalf of the applicant for a fee (the "Sponsor"). In order for the Sponsor to file the application materials and documents with the registration authority, the foreign investor needs to issue a power of attorney addressed to the registration authority certifying the Sponsor's authority to file the application on its behalf. The Sponsor submits the various documents to the relevant Chinese registration authority and carries out the application procedures on behalf of the foreign enterprise. The Sponsor does not play a significant role in the actual operation of the Rep Office. Examples of such sponsors include the Foreign Enterprise Services Corporation ("FESCO") in Beijing and the Shanghai Foreign Investment Service Centre in Shanghai, both of which serve as foreign service units and, can submit applications and handle application formalities for the foreign investor. Other sponsors may also be authorized to provide such services.
(b) Required Documents
The following documents must be submitted to the local branch of the SAIC as part of
the registration procedures to obtain the Registration Certificate:
(1) the completed standard registration forms prescribed by the local authorities;
(2) the Approval Certificate;
(3) a complete set of the application documents (previously required to be submitted for
obtaining the Approval Certificate); and
(4) a resume, Identification Certificate and two photographs for each representative.
(c) Registration Procedures
The Rep Office is deemed to be officially established on the date of registration. The registration of the Rep Office is generally a procedural process once approval is obtained. Under Chinese law, if the documents submitted by a foreign enterprise or an economic entity for registration conforms to the stipulation of the relevant regulations, the registration authority shall give its permission to register and issue a certificate of registration and certificates for the representatives (working card) after the registration fee is properly paid.
(d) Time Required
In our experience, in Beijing and Shanghai, the application process does not usually take more than one (1) month from the date of submission of all required documents for the application (times in other cities may vary). However, the collection of all the relevant documents and preparation of the full submission may take anywhere from a few weeks to a few months, depending on the particular circumstances of the applicant.
The information given above is an overview and summary of the registration process for the establishment of a Rep Office. Detailed information or further elaboration on the registration process may be provided pursuant to further inquiries from you.
2. Special requirements and/or stipulations of relevant laws and regulations relating to the establishment of a Rep Office for a foreign financial institution and for a foreign securities institution
As previously mentioned, a Rep Office for a specific business, e.g. finance or securities, needs to meet an additional regulatory threshold. Since the finance and securities sectors in China are still highly regulated, foreign entrants into such sectors will be subject to more burdensome regulatory approvals and stringent funding/track-record requirements.
The business scope of Rep Offices for foreign financial institutions or foreign securities institutions is generally the same as it is for other Rep Offices. These include engaging in non-profit activities such as the provision of information about the institutions, promotion of customer awareness of the institutions and liaison with potential Chinese clients and relevant Chinese government authorities, as a base for market research and an initial information processing center on the Chinese market.
However, notwithstanding the similar nature of the business scope, it should be noted that the requirement to obtain relevant approvals to set up the Rep Office would be based on the business nature of its parent enterprise, regardless of the business scope of the Rep Office.
2.1 A Rep Office for a foreign financial institution
(a) For parent enterprises categorized as a “foreign financial institution”, application for setting up a Chinese Rep Office will be governed by the Administrative Measures on Chinese Representative Offices for Foreign Financial Institution (“Administrative Measures”), issued by the Peoples Bank of China (“PBOC”) on June 13 2002. In 2003 the China Banking Regulatory Committee (“CBRC”) assumed the regulatory functions of the PBOC, including the approval and supervision of banks, financial asset management companies(“AMC”), trust investment companies and other financial institutions. After the reform, the PBOC now mainly focuses on monetary policies. According to the Administrative Measures, foreign financial institutions include financial entities registered and established in foreign countries and are recognized by the financial supervising bureau in its domestic country/region. Such description provides a vague definition of “foreign financial institutions” because there is no clear answer as to whether an insurance company, securities company, securities advisory company or fund management company will fall within the scope of "foreign financial institutions”. To date, CBRC has not made any written clarification. Based on our telephone consultations with two officials in CBRC and its Shanghai branch respectively, they affirm that foreign financial institutions covered under the Administrative Measures exclude institutions that are under the supervision and regulation of CSRC and CIRC as China has not adopted a unified or universal supervision regime and adheres to the principle of “separation of supervising powers over financial sector”.
(b) It is understood that xx. is a Chicago-based investment firm that provides investment banking and asset management services. In light of this, it would be unlikely that xx. would be deemed as a “bank” or other institutions falling within the definition of “foreign financial institutions” under the Administrative Measures. We also doubt that the relationship between xxx. and its existing domestic clients would constitute a bank-creditor relationship in the US. Therefore, it is likely that xxx. may not fall into the applicable scope of the above-mentioned Administrative Measures and may not be subject to the approval requirements required under Administrative Measures. In practice, based on our consultations with CBRC and CSRC officials, if xx. submitted its application to the CBRC Shanghai branch for approval, it is likely that the CSRC will stand out and proclaim its jurisdiction over this matter and/or CBRC will pass the application to CSRC eventually.
2.2 A Rep Office for a foreign securities institution
(a) According to the Regulations on Chinese Representative Offices for Foreign Securities Institution (the “Regulations”), issued by CSRC on April 22, 1999. The Regulations apply to foreign parent enterprises which are investment banks, merchant banks, securities firms and fund management companies incorporated and registered outside of China which engage in securities business. The Regulations also apply to securities consultation enterprises (enterprises that engage in securities advisory business but are not eligible for underwriting and brokerage services) incorporated and registered outside of China.
If xx. proposes to establish a Rep Office in China, it is most likely to fall under the bounds of the Regulations. This has been further confirmed by a senior official from CSRC during our anonymous telephone consultations.
(b) To be eligible to establish a Rep Office, the foreign parent enterprise must satisfy the following preconditions as provided in the Regulations:
(1) The applicant’s home country or region has in place a legal framework for the regulation and supervision of finance businesses;
(2) The applicant is a qualified financial institution approved by the competent regulatory body in its home country or region;
(3) The applicant enjoys a good business reputation and operates in full compliance with the law; and
(4) The applicant has been profitable in the immediate preceding three years.
A foreign securities institution applying to establish a Rep Office needs to submit the following documents to CSRC(such applications shall be forwarded to the local branch of CSRC where the Rep Office will be located):
(1) an application letter to the Chairman of CSRC signed by the chairman of the board of directors or the general manager of the parent company;
(2) the business license (copies) or the supporting documents sanctioning the legal incorporation issued by relevant authorities in parent company’s country or region;
(3) the constitutional documents of the parent company, e.g. the articles of association;
(4) the annual report of the three preceding fiscal years;
(5) list of the members of the board of directors for the Rep Office;
(6) the ratification documents or other relevant documents issued by the regulatory authorities in the parent company’s home country or region signifying the approval of the company to establish a Chinese Rep Office; and
(7) other documents as deemed necessary by CSRC (e.g. letters of appointment of the chief representative of the Rep Office, etc.)
(c) CSRC in Beijing handles all examinations and approval matters and its local counterpart does not require the applicant to go through an initial examination and approval procedure set out under the Regulations pursuant to the China Administrative Licensing Law.
According to SAIC’s recent regulations, after obtaining the above-mentioned approval, the registration for the Rep Office for a foreign securities institution, or a foreign financial institution, must be registered with the National SAIC and not its local counterpart at provincial level.
(d) Please note that the Regulations are issued by CSRC and the State Council of the People's Republic of China Concerning the Control of Resident Representative Offices of Foreign Enterprises are issued by the State Council. The inter-relationship and legal hierarchy among different levels of Chinese statues and regulations tend to be complicated and ambiguous in practice. It is not clear whether the interim regulations of the State Council will apply to the application for establishing a Rep Office for foreign securities institutions. The Regulations are also silent as to whether they will prevail in cases of inconsistencies with other laws and regulations.
Therefore, the uncertainty over the jurisdictions where there are overlapping regulations in regards to the establishment of a Rep Office for foreign securities institution cannot be easily clarified.
3. General information regarding establishing a foreign consultant WFOE and related concerns/legal issues
(a) Wholly Foreign-Owned Enterprises (“WFOE”) are limited liability enterprises in which all equity is owned by one or more foreign investors. The main advantage of a WFOE is that foreign investors can retain sole control over the management and financial affairs of the company.
(b) Generally speaking, setting up a WFOE in China may be subject to greater government scrutiny than that for joint ventures, the most common vehicle for greenfield investments.
China financial supervision authority are very rare in practice.
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