A U.S. Investor’s Guide To China

Tuesday, November 27, 2012 - 12:35

The Editor interviews Suat Eng Seah, Partner, Weil Gotshal’s Shanghai office.

Editor: Tell us about your practice.

Suat Eng: My practice is focused primarily on mergers and acquisitions, corporate restructurings and general corporate matters in the greater China region and other parts of Asia.

Editor: What key considerations should a U.S. business be aware of when making an investment in China?

Suat Eng: At a strategic level, a U.S. business should consider whether it should make the investment on its own by setting up a wholly owned subsidiary or by setting up a joint venture (by acquiring an interest in an existing Chinese company or by establishing a new entity). For certain companies, setting up a wholly owned subsidiary would be the right approach if they are already familiar with the Chinese market. If they believe that it would be helpful to have a Chinese shareholder in their business, they should consider setting up a joint venture. In some instances, a strategic alliance or distribution agreement may achieve the same purpose.

Obviously, the benefits of having a Chinese partner would have to be balanced against the fact that the U.S. company would have less control over a joint venture due to Chinese corporate governance requirements. In certain cases the law does not permit the foreign investor to establish a wholly owned subsidiary, such as in the automobile industry.

Although China is opening up to a greater extent than in the past, there are still many laws and restrictions. U.S. investors should be aware of the requirements that relate to investments in a particular industry and whether there are preferential policies in effect in the area in which their business will be located.

To do this, investors should first check the current edition of the Catalog for Guidance of Foreign Investment, which sets out whether foreign investment in a particular industry is prohibited, restricted or encouraged and whether there are any foreign shareholding limits or other requirements. Apart from that, there may also be other industry-specific regulations or local policies that are applicable. China’s western and central regions (which are less developed) have their own catalog aimed at encouraging foreign investment there.

Editor: What is the Chinese regulatory process for gaining permission to invest in a Chinese company?

Suat Eng: The government approvals required depend on the type of industry, the amount of the investment, the nature of the Chinese company (for instance, whether it is a state-owned company or publicly traded) and the specific policies and practices of the authorities in the locality in which the investment is to be made.

Generally, the approval of the Ministry of Commerce (which is the basic approval authority for every foreign investment) or its local counterpart and registration with the local Administration for Industry and Commerce are almost always required. In addition to certain special industry-specific approvals, the approval of the National Development and Reform Commission may be required for certain projects, and if state-owned interests are involved, the approval of the State Assets Supervision and Administration Commission may also be required.  If the transaction constitutes a business concentration and the parties meet certain revenue thresholds, the approval or clearance of the transaction by the Anti-Monopoly Bureau of the Ministry of Commerce would also be needed.

There is now a wealth of information on the Internet, and in many cases it is easy to find out generally what needs to be done whenever an investment is being made, but the problem is that many of the laws are still vague and open to interpretation, and the application of the laws may differ in different localities in China, so inquiries should also be made with the relevant authorities for their specific requirements.

Editor: How can IP be protected?

Suat Eng: Although the Chinese government at the central level has been placing more emphasis on IP protection and has introduced criminal liability for more egregious IP infringements, there is uneven implementation of these policies. This is particularly true in less developed areas where local protectionism may lead to serious IP infringement issues. Ultimately, the IP protection strategy to be adopted depends on the nature of the transaction, the type of IP involved and the objectives of the company.

In the case of a technology license, the agreement should clearly set forth the scope of the license and include safeguards such as restrictions on reverse engineering, sublicensing and access to information. It should require the licensee to implement IP protection policies and give the licensor the right to audit the licensee for compliance with the terms of the license. It should also include a confidentiality undertaking on the part of the licensee.

In addition to having a well-drafted document, the licensor should also take practical steps to reduce the risk of infringement of its IP rights. For instance, if the technology is sensitive, it should ensure that access to the technology is restricted to a limited number of trusted individuals and, if possible, segments of the manufacturing process should be separated so that no one other than the IP owner itself would have a complete knowledge of the IP and how it works.

It should be noted that under the Technology Import and Export Administrative Regulations, improvements to technology belong to the party making the improvements. Therefore, if the licensee is likely to be making improvements to the technology, the licensor should make sure it gets a cross license for the improvements, subject to any restrictions that might be applicable to the exportation of such technology from China.

In the case of a distribution agreement, it is important to ensure that the U.S. company’s trademarks have been registered in China and there are adequate trademark protection provisions, such as control over the packaging and the use of names, marks, symbols and labels on the products that are being distributed. The distributor should be prohibited from making any patent or copyright filings that contain or are based on the U.S. company’s IP. Ideally, there should be a requirement that the distributor notifies the U.S. company of any infringement of its IP and not take enforcement action on its own, without the U.S. company’s participation.

Editor: What measures have Chinese compliance regimes put into practice in order to protect China’s IP?

Suat Eng: In order to regulate the outflow of Chinese technology from China, the authorities have put in place technology export control laws. Depending on the nature of the technology, these laws may prohibit its export or require approval to be obtained or filings to be made.

Editor: Why should U.S. companies be especially diligent regarding FCPA infractions and violations of Chinese antibribery laws?

Suat Eng: Historically, China has been seen to be a “high-risk” environment for doing business.  Potential FCPA-related issues have arisen in China because of its traditional gift-giving culture, significant government involvement in various commercial enterprises, reliance on personal relationships in doing business and the general lack of transparency in accounting practices and approval processes.

U.S. companies engaging in business activities in China need to strictly comply with the FCPA and have an effective compliance system in place. Also, China has one of the strictest antibribery laws in the world, but not many people are aware of this. U.S. companies should not assume that Chinese antibribery laws will not be enforced against them or their employees simply because they are dealing with very influential parties.

Editor: Tell us about China’s antimonopoly law.

Suat Eng: China’s antimonopoly law came into effect in 2008. It has a fairly aggressive merger-review process.  U.S. companies should be aware of the antimonopoly law in making an acquisition regardless of whether the transaction occurs in or outside of China.

If a filing is required, the parties cannot close the transaction until clearance is obtained from the Antimonopoly Bureau of the Ministry of Commerce. Failure to make a filing, if required, can result in that Bureau ordering a transaction to be halted or reversed and the payment of a fine. U.S. companies are well-advised to consider whether any Chinese merger clearance is required as part of any transaction and if so, allow for sufficient time for the merger clearance to be completed before closing.

Recently, it has been taking longer for transactions to be cleared, partly because of the increasing volume of filings the Bureau has received and the thoroughness of its review process.

Editor: Why is it important for U.S. companies to include arbitration provisions in contracts with Chinese counterparties?

Suat Eng: Choosing arbitration rather than litigation as a method for resolving disputes provides U.S. companies with the opportunity to ensure that disputes are resolved in a relatively neutral forum. Also, arbitration proceedings, unlike court proceedings, are confidential. If the arbitration is to be held outside of mainland China or Hong Kong, U.S companies should make sure that the seat of arbitration is in a country that has ratified the New York Convention so that the arbitral award can be enforced in China. It is important to ensure that the agreement to arbitrate is valid under Chinese law, which requires that the agreement be in writing, the parties’ intention to settle disputes by arbitration be clear and unequivocal and that the choice of arbitration institution be specified.

There has been an ongoing debate about whether a foreign party should insist on a neutral arbitration forum outside China. Most Chinese parties prefer to arbitrate in China. Our position currently is that it is important to have an impartial setting for the arbitration, particularly, where the Chinese party exerts a high degree of local influence. We recommend arbitrating the dispute in a neutral jurisdiction where possible.

Editor: What are some basic differences in documentation between Chinese and U.S. M&A deals?

Suat Eng: The style of documentation for M&A deals in China tends to depend on the lawyers who do the drafting and on the size and complexity of the deal.  Usually, the documents are less voluminous than those for U.S.-style M&A deals. This is partly because there are many legal concepts embodied in U.S.-style documents that are not applicable in China, and partly due to a Chinese party’s or the approval authorities’ preference for less complex documents. Also, depending on which Chinese regulations or laws apply to a particular transaction, the parties may be required to include certain provisions in the acquisition or joint venture agreements, and such agreements may have to be governed by Chinese law.

In recent years, the documents used in Chinese M&A transactions have become more sophisticated and comprehensive. But, compared to the U.S., they still tend to be relatively simple.

Please email the interviewee at suateng.seah@weil.com with questions about this interview.