lovells Client note Dealing with the Construction regulatory Regime in the pro Practical solutions for Foreign Investors and Contractors Alicante Amsterdam Beijing Berlin Brussels Chicago Dusseldorf Frankfurt Hamburg Ho Chi Minh City Hong Kong London Madrid Milan Moscow Munich New York Paris Prague Rome Shanghai Singapore Tokyo Warsaw Associated offices: Budapest Zagreb
Dealing with the Construction Regulatory Regime in the PRC: Practical Solutions for Foreign Investors and Contractors Client note Alicante Amsterdam Beijing Berlin Brussels Chicago Dusseldorf Frankfurt Hamburg Ho Chi Minh City Hong Kong London Madrid Milan Moscow Munich New York Paris Prague Rome Shanghai Singapore Tokyo Warsaw Associated offices: Budapest Zagreb abc
Contents FURTHER INFORMATION 1 Overview of the prc Construction market If you would like further information on Dealing varIous with the Construction Regulatory Regime in the 2 Setting up a Decree No. 113 entity PRC Please contact any of the following or your 4 Establishing a Decree No. 114 entity usual contact at the firm 5 Setting up a consulting WFOE to perform unregulated works CONTACTS 5 Delivering design services on a cross-border basis Beijing 6 Acquisition of local design, engineering and construction enterprises Robert lewis Tel:+861085181725 7 Conclusion Email:robertlewis@lovells.com Tel:+861085187167 Email:andrewmcginty@lovells.com Barbara li Tel:+861085181376 Emailbarbarali@lovells.com Shanghai Tel:+862162793155 London Tony Marshall Tel:+442072962000 Email:tonymarshall@lovells.com Rachel grove Tel:+442072962000 Emailrachelgrove@alovells.com Tim hill l:+85228405023 Email:timothyhill@lovells.com Terence Wong Tel:+85228405067 Email:terencewonglalovells.com Mark goodrich Tel:+81351578200 Email:markgoodrich@lovells.com This note is written as a general guide only. It should not be relied upon as a substitute
FURTHER INFORMATION If you would like further information on Dealing with the Construction Regulatory Regime in the PRC please contact any of the following or your usual contact at the firm. Beijing Robert Lewis Tel: +86 10 8518 1725 Email: robert.lewis@lovells.com Andrew McGinty Tel: +86 10 8518 7167 Email: andrew.mcginty@lovells.com Barbara Li Tel: +86 10 8518 1376 Email: barbara.li@lovells.com Shanghai Yanwen Le Tel: +86 21 6279 3155 Email: yanwen.le@lovells.com London Tony Marshall Tel: +44 20 7296 2000 Email: tony.marshall@lovells.com Rachel Grove Tel: +44 20 7296 2000 Email: rachel.grove@lovells.com Hong Kong Tim Hill Tel: +852 2840 5023 Email: timothy.hill@lovells.com Terence Wong Tel: +852 2840 5067 Email: terence.wong@lovells.com Tokyo Mark Goodrich Tel: +81 3 5157 8200 Email: mark.goodrich@lovells.com CONTACTS This note is written as a general guide only. It should not be relied upon as a substitute for legal advice. Contents Overview of the PRC Construction Market Overview of various options Setting up a Decree No. 113 entity Establishing a Decree No. 114 entity Setting up a consulting WFOE to perform unregulated works Delivering design services on a cross-border basis Acquisition of local design, engineering and construction enterprises Conclusion Page 1 2 2 4 5 5 6 7
Dealing with the Construction Regulatory regime in the Prc ractical Solutions for Foreign Investors and contractors 1. OVERVIEW OF THE PRC 1.4 Prior to Chinas accession to the WTo. under CONSTRUCTION MARKET MOC Decree No. 321, it was possible for 1.1 In the past two decades, China has witnessed foreign contractors without a presence in unprecedented growth in terms of the number China to apply for a Foreign Contractor Qualification Certificate(FCQC )on a and scale of construction, engineering and infrastructure projects. With China,'s accession project-by-project basis. In practice, obtaining a to the World Trade Organisation ( WTO")and FCQC was a quite straightforward process, and Beijing s successful bid to host the 2008 acquiring one FCQC, foreign contractors Olympic Games, there seems no doubt that the only needed to file for registration with local administrations of industry and commerce on PRC construction and engineering market will subsequent projects. Based on the FCQC, it maintain its momentum for growth during the was possible, as a practical matter, for foreign coming years. contractors to convert their RMB earnings 1.2 From the time the prc construction and from China projects into foreign currency and ngineering market first opened up to foreign remit such earnings abroad, subject to paying participation, foreign contractors have played the applicable prc taxes. an increasingly important role, particularly in 1.5 The legal environment has changed quite relation to foreign-invested pr technically demanding projects. By bringing radically since China's accession to the Wto. The moc and mofcom have issued a advanced technology and management skills foreign contractors have also made substantial number of new regulations to regulate market contributions towards raising the standards of try, the establishment of project contracting and management in China. enterprises in the construction area, and on construction qualification issues. On the one 1.3 Consistent with the practice in most other hand, these new regulations simplify the jurisdictions, the PRC construction and approval process, but on the other hand, the engineering market is heavily regulated. For promulgation of Decree Nos. 113 and 114(in example, foreign investment in this area is particular)has meant that foreign contractors subject to dual approval by both the industry carrying out regulated activities in China have regulator, the PRC Ministry of Construction had to substantially restructure their business (MOC and by the general foreign investment activities in China to remain compliant and, as a regulator, the PRC Ministry of Commerce CMOFCOM"). According to PRC laws and 1. The Provisional Regulations on Administration of egulations, an entity is required to have an Qualification Certificates of Foreign Contractors Contract appropriate qualification to perform certain for Projects in China(issued by the MOC in 1994, repealed by Decree No 113). regulated construction-related activities. The of Foreign-Invested Construction grade of qualification obtained will determine nterprises(issued by the MOFCOM and the MOC on 27 the maximum size of project that can be ptember 2002, and effective from 1 December 2002) 3. Regulation on Administration of Foreign-Invested undertaken by such entity. Construction Engineering and Design Enterprises(issued by ptember 2002, an effective from 1 December 2002)
1. OVERVIEW OF THE PRC CONSTRUCTION MARKET 1.1 In the past two decades, China has witnessed unprecedented growth in terms of the number and scale of construction, engineering and infrastructure projects. With China's accession to the World Trade Organisation ("WTO") and Beijing's successful bid to host the 2008 Olympic Games, there seems no doubt that the PRC construction and engineering market will maintain its momentum for growth during the coming years. 1.2 From the time the PRC construction and engineering market first opened up to foreign participation, foreign contractors have played an increasingly important role, particularly in relation to foreign-invested projects and technically demanding projects. By bringing advanced technology and management skills, foreign contractors have also made substantial contributions towards raising the standards of project contracting and management in China. 1.3 Consistent with the practice in most other jurisdictions, the PRC construction and engineering market is heavily regulated. For example, foreign investment in this area is subject to dual approval by both the industry regulator, the PRC Ministry of Construction ("MOC") and by the general foreign investment regulator, the PRC Ministry of Commerce ("MOFCOM"). According to PRC laws and regulations, an entity is required to have an appropriate qualification to perform certain regulated construction-related activities. The grade of qualification obtained will determine the maximum size of project that can be undertaken by such entity. 1.4 Prior to China's accession to the WTO, under MOC Decree No.321 , it was possible for foreign contractors without a presence in China to apply for a Foreign Contractor Qualification Certificate ("FCQC") on a project-by-project basis. In practice, obtaining a FCQC was a quite straightforward process, and after acquiring one FCQC, foreign contractors only needed to file for registration with local administrations of industry and commerce on subsequent projects. Based on the FCQC, it was possible, as a practical matter, for foreign contractors to convert their RMB earnings from China projects into foreign currency and remit such earnings abroad, subject to paying the applicable PRC taxes. 1.5 The legal environment has changed quite radically since China's accession to the WTO. The MOC and MOFCOM have issued a number of new regulations to regulate market entry, the establishment of foreign-invested enterprises in the construction area, and on construction qualification issues. On the one hand, these new regulations simplify the approval process, but on the other hand, the promulgation of Decree Nos. 1132 and 1143 (in particular) has meant that foreign contractors carrying out regulated activities in China have had to substantially restructure their business activities in China to remain compliant and, as a Dealing with the Construction Regulatory Regime in the PRC: Practical Solutions for Foreign Investors and Contractors - 1 - 1. The Provisional Regulations on Administration of Qualification Certificates of Foreign Contractors Contracting for Projects in China (issued by the MOC in 1994, repealed by Decree No. 113). 2. Regulation on Administration of Foreign-Invested Construction Enterprises (issued by the MOFCOM and the MOC on 27 September 2002, and effective from 1 December 2002). 3. Regulation on Administration of Foreign-Invested Construction Engineering and Design Enterprises (issued by the MOFCOM and the MOC on 27 September 2002, and effective from 1 December 2002)
p atter, foreign contr 2. OVERVIEW OF VARIOUS OPTIONS market entry requirements than ever before. 2.1 As discussed above. under the current prC 1.6 In addition to decree nos, 113 and 114. the legal regime, foreign contractors may be able to MoC has issued other regulations or rules with adopt one or more of the following options a view to further regulating the PrC a means to gain access and exposure to the construction and engineering services market China market: Such regulations and rules include, among (a) setting up a Decree No 113 entity thers, the Implementing Rules for Decre No. 113, Circular No. 159, Decree No. 200 (b) setting up a Decree No 114 entity and Decree No. 78. These new regulations and les have all been issued within a relatively (c) establishing a foreign-invested consultancy enterprise to perform unregulated short period of time, and foreign contractors onstruction-related works will need time in order to work out how such regulations and rules will be implemented and (d) collaborating with a Chinese design administered in practice, whilst regulatory institute to provide cross-border design bodies in China will still be"finding their feet services in this regard. Given the element of uncertainty (e) acquiring an interest in a domestic design, that has been created by the new rules and ngineering or constructio by regulations, we have set out below an overview merger or acquisition, thereby of the various practical solutions transforming it into a foreign-invested foreign contractors, focusing on what foreign enterprise. contractors can currently do in China and how they can do it in order to maintain their 2.2 In the following paragraphs, we will provide an presence in the China engineering and analysis in relation to each of the above construction market whilst. at the same time options in turn. their o legal and 3. SETTING UP A DECREE NO. 113 ENTITY 1.7 This overview is intended to provide only an 3.1 Decree No 113 expressly repeals Decree outline and brief discussion in relation to certain No 32. Therefore, after 1 April 2004, in aspects of regulatory issues affecting foreign principle, foreign contractors may no longer use contractors wishing to engage in the carrying their Decree No 32 FCQCs to contract for out of construction and other construction- construction projects in China(see, however, the elated activities in China. The information exception created by Circular No. 159 below) contained in this client note is general in nature Foreign contractors must now set up a local and should not be relied on as exhaustive. nor entity to apply for a construction qualification in should it be treated as legal advice or regarded order to carry out construction activities in as a substitute for detailed advice in individual China. No further qualification certificates will cases based ecific facts be issued to foreign contractors who have not 3.2 The type of local entities established by foreign The Implementing Rules for the ontractors may take the form of a Sino Qualifications in relation to the Regulations on Administration of Foreign-invested Construction Enterprises(issued by the foreign equity joint ventures( EJVs"), Sino- MOC and effective from 8 April 2003). foreign co-operative joint ventures(CJVs")or 5. Circular on Several Issues regarding the Administration of wholly foreign-owned enterprises(" WFOES") Qualifications for Foreign-invested Construction Enterprises Gian Shi [2004] No 159) Compared with the old regime, Decree 6. Circular on the Issue of Construction and Engineering Project No. 113 has streamlined the examination and Management Tentative Measures ( ian Shi [2004] No 200) 7. Provisional Regulations on the Administration of Foreign approval process in relation to the establishment of foreign-invested construction Construction Projects in the PRC (MOC Decree No 78")
practical matter, foreign contractors face stiffer market entry requirements than ever before. 1.6 In addition to Decree Nos. 113 and 114, the MOC has issued other regulations or rules with a view to further regulating the PRC construction and engineering services markets. Such regulations and rules include, among others, the Implementing Rules for Decree No. 1134 , Circular No. 1595 , Decree No. 2006 and Decree No. 787 . These new regulations and rules have all been issued within a relatively short period of time, and foreign contractors will need time in order to work out how such regulations and rules will be implemented and administered in practice, whilst regulatory bodies in China will still be "finding their feet" in this regard. Given the element of uncertainty that has been created by the new rules and regulations, we have set out below an overview of the various practical solutions available to foreign contractors, focusing on what foreign contractors can currently do in China and how they can do it in order to maintain their presence in the China engineering and construction market whilst, at the same time, minimising their exposure to legal and regulatory risks. 1.7 This overview is intended to provide only an outline and brief discussion in relation to certain aspects of regulatory issues affecting foreign contractors wishing to engage in the carrying out of construction and other constructionrelated activities in China. The information contained in this client note is general in nature and should not be relied on as exhaustive, nor should it be treated as legal advice or regarded as a substitute for detailed advice in individual cases based on specific facts. 2. OVERVIEW OF VARIOUS OPTIONS 2.1 As discussed above, under the current PRC legal regime, foreign contractors may be able to adopt one or more of the following options as a means to gain access and exposure to the China market: (a) setting up a Decree No.113 entity (b) setting up a Decree No.114 entity (c) establishing a foreign-invested consultancy enterprise to perform unregulated construction-related works (d) collaborating with a Chinese design institute to provide cross-border design services (e) acquiring an interest in a domestic design, engineering or construction company by merger or acquisition, thereby transforming it into a foreign-invested enterprise. 2.2 In the following paragraphs, we will provide an analysis in relation to each of the above options in turn. 3. SETTING UP A DECREE NO. 113 ENTITY 3.1 Decree No. 113 expressly repeals Decree No. 32. Therefore, after 1 April 2004, in principle, foreign contractors may no longer use their Decree No. 32 FCQCs to contract for construction projects in China (see, however, the exception created by Circular No. 159 below). Foreign contractors must now set up a local entity to apply for a construction qualification in order to carry out construction activities in China. No further qualification certificates will be issued to foreign contractors who have not established a local entity in China. 3.2 The type of local entities established by foreign contractors may take the form of a Sinoforeign equity joint ventures ("EJVs"), Sinoforeign co-operative joint ventures ("CJVs") or wholly foreign-owned enterprises ("WFOEs"). Compared with the old regime, Decree No. 113 has streamlined the examination and approval process in relation to the establishment of foreign-invested construction - 2 - 4. The Implementing Rules for the Administration of Qualifications in relation to the Regulations on Administration of Foreign-invested Construction Enterprises (issued by the MOC and effective from 8 April 2003). 5. Circular on Several Issues regarding the Administration of Qualifications for Foreign-invested Construction Enterprises (Jian Shi [2004] No. 159). 6. Circular on the Issue of Construction and Engineering Project Management Tentative Measures (Jian Shi [2004] No. 200). 7. Provisional Regulations on the Administration of Foreign Enterprises Engaging in Design Activities in relation to Construction Projects in the PRC ("MOC Decree No. 78")
enterprises. Decree No. 113 outlines a two-step industry in China, which is mainly made up of application process. If the proposed Decree large-scale State-owned companies, many with No. 113 entity only applies for a Grade-B or very high levels of staffing. Furthermore, the lower qualification, the MOC and MOFCOM high capitalisation requirements(USS36 authorities at the provincial level ar million for a special grade main contractor authorised to approve the application licence, the highest grade)and rigid track Applications for the establishment of a Grade-A record requirements make it difficult for small or higher Decree No. 113 entity require ind medium-sized foreign main contractors or approval by the MOC and MOFCOM authorities at the central level qualifications. As a result, many have been 3.3 Decree No. 113 specifies that a Decree deprived of the opportunity to compete for No 113 WFOE is limited to undertaking the large projects in China, which may not be in China's long-term interests. Even for the bigger following four types of projects, namely, oreign-financed projects, projects financed by players, US$36 million is a large investment to justify, particularly when the Decree No. 113 international financial institutions, sino-foreign joint venture projects or projects which are entity should be receiving stage payments on technically demanding and which domestic each project. Using performance bonds to contractors do not have the skills to perfor replace part of the registered capital requirement would be one way of resolving by themselves. However, there are no restrictions on the type of projects a Decree this issue without diminishing the protection available to project owners and other interested No. 113 Sino-foreign joint venture(Decree No. 113 JVs")may undertake, and for those parties. We understand that this possible applicants which have an entity which has solution is under discussion with moc at the obtained certification as a Hong Kong Service ime of writin Supplier(HKSS")under the Closer Economic 3.5 In order to mitigate the impact of Decree Partnership arrangement between Hong Kong No 113, on 21 September 2004 the MOC SAR and the Chinese mainland (or the issued Circular No. 159, which grants a limited corresponding provisions of the treaty with extension to the Decree No 32 scheme to Macao SAr (collectively referred to below as those foreign contractors which previously held CEPA")), they will not be subject to such a Decree No. 32 FCQC and have applied to restrictions establish a Decree No. 113 entity, and which have obtained a formal approval certificate for 3.4 Decree No. 113 provides that a Decree such Decree No. 113 entity. It is important to No. 113 entity must, after its establishment, apply for a construction qualification, and for note that a Decree No. 1 13 entity satisfying the requirements under Circular No 159 would this purpose it will be subject to the same rements in terms of registered capit: allow the foreign contractor which has set up track record, personnel and equipment as are such Decree No. 113 entity on the basis of an required of local PRC construction companies application for a lower grade qualification to C regulation including, notably, MOC Decree No 87. FCQC, which is not subject to a grading However, this apparent"level-playing field system. In short, under its Decree No 32 FCQC, it would not be subject to any grade- treatment has not been generally welcomed by based restrictions on the size and nature of the foreign contractors, who do not believe that projects to be undertaken. However, foreign the way forward is to make all foreign contractors structure their Decree No. 113 ontractors may only take advantage of this entities to reflect the structure of the domestic route(which could be seen as a limited scope "backdoor"further extension of Decree No. 32) until 1 July 2005, it is also subject to the 8. Regulations on Administration of qualification Certificates of approval of the construction authorities on a Construction Enterprises(issued by the MOC on 18 April 2001 and effective on 1 July 2001, Decree No. 87) project-by-project basis. Projects commenced
enterprises. Decree No. 113 outlines a two-step application process. If the proposed Decree No. 113 entity only applies for a Grade-B or lower qualification, the MOC and MOFCOM authorities at the provincial level are authorised to approve the application. Applications for the establishment of a Grade-A or higher Decree No. 113 entity require approval by the MOC and MOFCOM authorities at the central level. 3.3 Decree No. 113 specifies that a Decree No. 113 WFOE is limited to undertaking the following four types of projects, namely, foreign-financed projects, projects financed by international financial institutions, sino-foreign joint venture projects or projects which are technically demanding and which domestic contractors do not have the skills to perform by themselves. However, there are no restrictions on the type of projects a Decree No. 113 Sino-foreign joint venture ("Decree No. 113 JVs") may undertake, and for those applicants which have an entity which has obtained certification as a Hong Kong Service Supplier ("HKSS") under the Closer Economic Partnership Arrangement between Hong Kong SAR and the Chinese mainland (or the corresponding provisions of the treaty with Macao SAR (collectively referred to below as "CEPA")), they will not be subject to such restrictions. 3.4 Decree No. 113 provides that a Decree No. 113 entity must, after its establishment, apply for a construction qualification, and for this purpose it will be subject to the same requirements in terms of registered capital, track record, personnel and equipment as are required of local PRC construction companies in accordance with relevant PRC regulations, including, notably, MOC Decree No. 878 . However, this apparent "level-playing field" treatment has not been generally welcomed by foreign contractors, who do not believe that the way forward is to make all foreign contractors structure their Decree No. 113 entities to reflect the structure of the domestic industry in China, which is mainly made up of large-scale State-owned companies, many with very high levels of staffing. Furthermore, the high capitalisation requirements (US$36 million for a special grade main contractor licence, the highest grade) and rigid track record requirements make it difficult for small and medium-sized foreign main contractors or specialist contractors to acquire higher-grade qualifications. As a result, many have been deprived of the opportunity to compete for large projects in China, which may not be in China's long-term interests. Even for the bigger players, US$36 million is a large investment to justify, particularly when the Decree No. 113 entity should be receiving stage payments on each project. Using performance bonds to replace part of the registered capital requirement would be one way of resolving this issue without diminishing the protection available to project owners and other interested parties. We understand that this possible solution is under discussion with MOC at the time of writing. 3.5 In order to mitigate the impact of Decree No. 113, on 21 September 2004 the MOC issued Circular No. 159, which grants a limited extension to the Decree No. 32 scheme to those foreign contractors which previously held a Decree No. 32 FCQC and have applied to establish a Decree No. 113 entity, and which have obtained a formal approval certificate for such Decree No. 113 entity. It is important to note that a Decree No. 113 entity satisfying the requirements under Circular No. 159 would allow the foreign contractor which has set up such Decree No. 113 entity on the basis of an application for a lower grade qualification to proceed under its previous Decree No. 32 FCQC, which is not subject to a grading system. In short, under its Decree No. 32 FCQC, it would not be subject to any gradebased restrictions on the size and nature of the projects to be undertaken. However, foreign contractors may only take advantage of this route (which could be seen as a limited scope "backdoor" further extension of Decree No. 32) until 1 July 2005, it is also subject to the approval of the construction authorities on a project-by-project basis. Projects commenced - 3 - 8. Regulations on Administration of Qualification Certificates of Construction Enterprises (issued by the MOC on 18 April 2001 and effective on 1 July 2001, Decree No. 87)