Domestic A-share listing by for-profit educational institutions

The Standing Committee of the National People’s Congress (NPC) amended the Education Law on 27 December 2015, revising the provision reading “no organization or individual may establish a school or other educational institution with the aim of making a profit” to “a school or other educational institution that is founded with, or the founding of which is participated in with, fiscal funds or donated assets may not be established as a for-profit organization”.

On 7 November 2016, the NPC Standing Committee revised the Law on Promoting Private Education. The revised law specifies that existing private schools may opt to register as for-profit private schools, registering anew and continuing to operate. The revised law will enter into effect on 1 September 2017.

IMPLICATIONS OF THE REVISION

The revision of the Law on Promoting Private Education has positive significance for the domestic listing of A shares by private schools. From permitting the existence of private schools as for-profit legal persons, it can be seen that the revised law has swept away the greatest obstacle to the listing of A shares by private schools.

The law specifies that founders of for-profit private schools can profit from their running of schools, with the surplus derived from running a school to be handled in accordance with such laws and administrative regulations as the Company Law. The tuition rates for for-profit private schools are to be subject to market regulation, with the schools deciding the same at their own discretion. Once a private school can earn revenue through pricing set at its own discretion, and treat the surplus from running the school as a profit source for the enterprise, the two major obstacles to such an entity lawfully securing operational profits and an ongoing operational capacity are fundamentally resolved, permitting private schools to rightly and properly list A shares in China.

The revised law specifies that a private school is required to establish a board of governors, board of directors or other manner of decision-making body and establish the corresponding supervisory mechanism. The founder of a private school participates in the running and management of the school with the authority of, and by the procedures specified in, the school’s charter. The above-mentioned provisions also provide the rule basis for the establishment by for-profit private schools of such corporate governance mechanisms as boards of directors, supervisory boards, shareholders’ general meetings, etc., that satisfy the standards for the governance of listed companies.

Relevant provisions of the Implementing Regulations for the Law on Promoting Private Education have an effect on the domestic listing of A shares by private schools. Although the law has been revised, the implementing regulations have yet to be amended. The current, effective implementing regulations specify that the founder of a private school may not raise funds from students, or the heads of their households, to establish a private school, or publicly raise funds from the public to establish a private school. The implementing regulations directly block the road to for-profit educational institutions raising funds by domestically listing A shares through an IPO. If a private educational enterprise were to publicly offer shares to raise funds, it would directly violate the restrictive provisions of the above-mentioned implementing regulations.

Since the law has been revised and the state is encouraging the private sector to establish schools, the authors are confident that relevant provisions of the implementing regulations will be revised in the not too distant future, so as to satisfy the demand for for-profit private educational institutions to directly raise funds domestically to expand the educational industry.

VIE RISKS

The legal risks existing in the VIE (variable interest entity) structures of private educational institutions listed overseas. Given the obstacles to private educational enterprises listing domestically in the past, the majority opted to list abroad via a VIE structure, but it cannot be denied that listing abroad via a VIE also poses significant legal risks.

In the closely watched Yaxing v Ambow Education case, known as the “first VIE structure case”, although the Supreme People’s Court (SPC) did not directly deny the validity of the VIE agreement, in its judgment it pointed out that, “the act of a foreign investor participating in the establishment of, or actually controlling the founder of, a private school providing compulsory education through an acquisition of equity could potentially jeopardize educational security and the public interest, and falls within the purview of the competent educational authority. With respect to the potential existence of an act of entry by a foreign investor into the compulsory education sector in a disguised manner, and its involvement in school management through its control of the school founder, the same should be regulated and should be punished by the administrative law enforcement as a violation of the law. In this respect, this court has issued a judicial recommendation to the PRC Ministry of Education, recommending that, in the course of administrative approval and administrative oversight, it regulate the same in accordance with the law so as to safeguard the public interest and educational security.”

The SPC’s recommendation with respect to “safeguarding the public interest and educational security” is bound to bring a lot of uncertainty and legal risk for domestic private educational enterprises listing abroad via VIE structures.

BETTER OPTION

The revision of the Law on Promoting Private Education has removed systemic obstacles to the domestic listing of A shares by private educational enterprises. With the past method of listing overseas using the VIE model increasingly subject to stringent review and oversight by the government, the return of private educational enterprises to list A shares domestically should be a better option. Once the implementing regulations are revised in the light of the principles set out in the revised law, the day that private educational enterprises can domestically list A shares to seek financing for development will not be far off.

Jeffrey Yang is a senior partner and Feng Chengliang is a partner at AllBright Law Offices