Risk assessment of land grant fee reduction and exemption clauses

By Zhang Jingping, Concord & Partners
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Foreign investors involved in mergers and acquisitions (M&A) in China may find a land grant fee reduction and exemption clause existing in the investment agreement between a target company and the local government. This article analyses the behavioural nature and legal risks of such clauses.

Reduction and exemption

When a target company was embarked upon, the local government often agreed to set a land grant fee reduction and exemption clause in the investment agreement with the target company, for the sake of attracting business, urban redevelopment, restructuring of state-owned enterprises (SOEs) or other matters. Such a reduction and exemption clause was usually expressed in two ways:

章敬平 Zhang Jingping 共和律师事务所 合伙人 Partner Concord & Partners
章敬平
Zhang Jingping
共和律师事务所
合伙人
Partner
Concord & Partners

In the first case, wording in such a clause was explicit and accurate with words like “reduction and exemption”, or their synonyms. In the second case, such a clause expressed its land grant fee reduction and exemption intention in an implicit way. For instance, in the investment agreement the target company and the local government first reached an agreement on the peak price for the land use right acquisition by the target company, and then the parties made an arrangement that if the target company’s cost for acquiring the land use right actually exceeded the agreed peak price, the local government would make a compensation to the target company in cash equal to the balance between the actual cost and the agreed peak price.

The land grant fee refers to the sum paid by the target company for obtaining the state-owned land use right through the bidding, auction and listing process or by agreement, and it was often referred to as “state-owned land use right grant income” or “land grant income” in government documents. The management of land grant fees is the responsibility of the financial department under the local government, and its collection is the duty of land and resources management departments. Since 2007, the management of land grant fees has been brought into local fund budget control; all the relevant incomes have been reverted into the local treasury, and all the relevant expenses have been arranged in the local fund budget control in the name of land grant fees, so as to thoroughly separate expenditure from income.

As a consequence, the first case, which means the land grant fee will be reduced and remitted directly, has been rare in practice in recent years, while the second case has become popular, in which the land grant fee is refunded to the target company in the form of subsidies from the local financial department, after it has been collected in full and reverted into the local treasury following the management of separating expenditure from income, and the requirements of bidding, auction and listing processes or the relevant assignment agreement.

Legal risks

In the first case above, such reduction and exemption clauses had a behavioural nature which violated the Notice of the General Office of the State Council on the Regulating the Management of Incomes from and Expenses for the Assignment of the Right to Use State-owned Land. According to the notice, no region, department or entity may reduce or exempt any land grant incomes, implement a “zero land price”, or even “negative land price” in the name of investment promotion, urban redevelopment or restructuring of SOEs.

Similarly, the implicit expression of reduction and exemption intention in such a clause arrangement has contravened the prohibitive provisions that no region, department or entity may reduce or exempt any land grant incomes in a disguised form by way of exchanging projects with land, returning fees after collecting them or granting subsidies.

Nationwide campaign

In 2007, the Ministry of Supervision, the Ministry of Land and Resources, the Ministry of Finance, the Ministry of Construction and the National Audit Office jointly issued a notice launching a nationwide campaign to deal with the granting of state-owned land use rights, with the collection, administration and use of land grant fees being a main focus. The three main points of the review are: 1) whether land grant fees are collected in full in accordance with the grant contracts; 2) whether land grant fees are reduced or exempted without authorisation; and 3) whether land grant fees are refunded to the land-using entities under various guises.

In conclusion, such land grant fee reduction and exemption clause arrangements are likely to be considered the case of “reduction and exemption of land grant fee” or “reduction and exemption of land grant fee in disguised forms” in the legal investigation or examination by the department of finance, auditing agency and/or the supervisory organ.

Tips for foreign investors

When such reduction and exemption of land grant incomes, whether arranged in various names or in disguised forms, are investigated, the target company shall be responsible for making a supplementary payment in respect of the actual reduction and exemption amount of land grant fee, and may also be responsible for the statutory fine or the agreed fine in the relevant assignment agreement for delaying payment.

During the pre-acquisition due diligence phase, foreign investors are advised to have lawyers investigate the investment agreement between the target company or its existing shareholders and the local government, and also arrange accountants to audit the financing affairs of the target company, in order to ascertain the existence of such land grant fee reduction and exemption clause arrangement, and the form of such reduction and exemption, if such a clause arrangement exists.

Investigations by lawyers and accountants may find two different situations. One is that the target company has obtained some or all balance agreed in its investment agreement with the local government, and the other is that the target company has only obtained the contractual rights, rather than such benefits.

In the first situation, foreign investors may require those existing shareholders to write a covenant that in case the land grant fee reduction and exemption amount enjoyed by the target company is retroactively paid, or the target company is required to make a supplement payment for such amount, the existing shareholders shall make an equal amount of compensation to the target company.

In the other situation, foreign investors may require the target company to reduce the estimated value of the corresponding contractual rights.

Zhang Jingping is a partner at Concord & Partners

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zhangjingping@concord-lawyers.com

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