To accompany our review of the leading deals of 2010, we asked our readers to identify the key legal issues that will face business in the coming months. By Robin Weir
To complement our review of the transactions that defined 2010 (see Deals of the year, part two), we asked our readers what they think will keep them busy in the near future.
The results illustrate a tightening of control in some areas, but liberalization in others. The PRC Tort Law, which came into effect in July last year, is having an impact – not least in intellectual property circles, which are still also coming to terms with the revised PRC Patent Law (see Tort law has an impact on IP matters). The PRC Anti-monopoly Law and its recent subsidiary regulations on price fixing and other matters are changing the way business is done. Labour issues are causing worry.
More broadly, the environment for foreign investment is changing. In early February, the State Council published a circular instituting a national security review process for certain foreign investments. The new procedures, which are effective from 5 March, are sure to have an impact (see China introduces national security review of foreign investments on page 5). On a brighter note, the world of private equity and venture capital is alive with anticipation following the introduction of a pilot scheme in Shanghai which appears to allow foreign limited partners to make investments in PE funds in foreign currency.
Labour issues resurface
With the unrest that occurred in Shenzhen in the first half of 2010, labour matters have taken centre stage. “We can foresee that labour issues will dominate the scene in the next 12 months,” says Ulf Ohrling, head of the China practice at Swedish law firm Mannheimer Swartling.
Karin Xu, head of legal at pharmaceutical multinational Merck in China, also expects labour and human resources issues to loom large in the coming year. “HR and labour disputes are always an interesting topic,” she says.
Last year’s unrest at Foxconn and other manufacturers in Shenzhen prompted speculation that the era of cheap Chinese labour was over. Recent inflation figures seem to lend weight to that view. “Salary increases will play a big role, especially for workers in the lowest income brackets in times in which inflation seems to hit food prices hardest,” says Ohrling. “Issues associated with general working conditions will also be important.”
In August last year, the Shenzhen People’s Congress released a draft of the Shenzhen Special Economic Zone Rules on Collective Bargaining, inviting public comment. As drafted, the rules would impose new obligations on companies with respect to collective bargaining. One particularly worrisome provision, according to Lesli Ligorner, a partner in the employment department at Paul Hastings Janofsky & Walker in Shanghai, is that in the event of an impasse in the collective bargaining process, the parties may apply to the local labour relations coordination committee for mediation. She describes this as “binding” and worries that companies will have little control if an impasse with employees occurs.
Ligorner is also aware of increasing pressure on companies to involve lower-level employees in management decisions. “Many local governments have issued or are drafting local regulations about employees’ involvement in a company’s management,” she says. Specifically, she cites the Shanghai Employee Representative Congress Regulations, passed at the end of December and effective from 1 May. “A company in Shanghai will be required to establish its own employee representative congress [ERC],” says Ligorner. ERCs will have the power to make suggestions relating to the company’s operations, and to elect employee members of the board of directors and board of supervisors of the company.
Nationally, too, major and long-planned employment-related legislation has been passed. As reported in China Business Law Journal last month, the PRC Social Insurance Law will take effect on 1 July. And the PRC Application of Laws in Foreign-related Civil Relations Law, which will take effect on 1 April, clarifies certain issues relating to the choice and application of law. One thing it affects is labour contracts. “Labour contracts are governed by the law of the state in which the employee works,” says partner Ulrike Glück of CMS China in Shanghai. “Only if the employee’s work place cannot be determined will the law of the state of the employer’s headquarters be applicable. In the past, no such regulation existed.”
More broadly, the foreign investment landscape is also changing fast. The state security vetting mentioned above is only one among several sets of rules which have tightened the state’s grip on foreign companies.
The Registration and Regulation of Resident Representative Offices of Foreign Enterprises Administrative Regulations took effect on 1 March. According to Glück, such offices will need to adhere to “shorter time frames, new reporting obligations and stricter limitations on their business scope”. Glück sees the regulations, which include higher penalties for non-compliance and limits on the numbers of expatriates employed, as “a clear signal that the PRC government no longer tolerates operational activities carried out by representative offices”.
Omar Puertas, managing partner of the Shanghai office of Iberian law firm Cuatrecasas Gonçalves Pereira, says the new rules will “have a great impact in our day-to-day work advising our clients”. Ohrling at Mannheimer Swartling says that “many clients are considering restructuring their activities into a foreign-invested commercial enterprise instead”.
The changes to foreign investment rules are not confined to representative offices. Last April, the State Council published the Duly Carrying Out the Work Associated With the Use of Foreign Investment Several Opinions (see China Business Law Journal volume 1 issue 5, page 14). According to Jim Qiu, a partner at Yao Liang Law Offices in Shanghai, these opinions have opened new areas to foreign investment. “As well as encouraging multinational companies to establish regional headquarters, research and development centres and procurement centres, they also encourage the establishment of new types of functional operations such as financial management centres, clearing centres, cost accounting centres,” he says. The Opinions also encourage A-listed companies to attract foreign strategic investment; and support the public issue of shares and corporate debt (such as medium-term notes) within China by foreign investment enterprises.
And there are other, specific signs of liberalization. Dan Connelly, of counsel in the Shanghai office of Norwegian law firm Wikborg Rein, specializes in energy and natural resources. He says that the requirement for refund guarantees (commonly used in vessel and jack-up rig construction contracts) to be registered with the State Administration of Foreign Exchange (SAFE) before becoming effective, was dropped last summer. Because it typically took six to eight weeks to obtain SAFE approval, Connelly says that “this requirement served as an impediment to ship and rig owners when considering contracting with a Chinese shipyard”. Since the change, a refund guarantee becomes effective immediately upon issuance. Connelly views the move as part of the “general trend by the Chinese authorities to encourage business by simplifying the regulatory requirements that are necessary to do business in China” now that the Olympics and the Shanghai Expo are receding into memory. He predicts that over the next year and beyond, “we will see a slow but steady liberalization of the laws and requirements with which companies must comply to do business”.
Yet changes can cut both ways. According to Kevin Xu at Martin Hu & Partners, “the era of ‘national treatment’ is approaching”, symbolized by the equalization of tax rates on domestic and foreign enterprises. “Neither preferential treatment for foreign enterprises nor unfair market access are compatible with the principle of national treatment and are being discarded, for example in the eligibility qualifications for government procurement, and internet sales by foreign investment enterprises,” says Xu.
Monopoly law is fleshed out
Another quickly developing area of law is the anti-monopoly regime. According to Cheng Shoutai, managing partner at Tahota Law Firm in Chengdu, the sets of anti-monopoly regulations that have been issued are among those which will have the greatest impact on business. These include provisions on monopoly pricing, monopolistic agreements, abuse of a dominant market position, and the abuse of administrative power to eliminate or limit competition.
According to Rebecca Silli, the head of Gide Loyrette Nouel’s Hong Kong office, the regulations on monopolistic conduct of business operators “have prompted and continue to prompt FIEs to review their marketing and pricing strategies”. Silli says the regulations are “likely to have a significant impact on all business operators in the PRC”.
Bailey Xu, a partner at Haworth & Lexon in Shanghai, shares this view. “The implementation of the Anti-monopoly Law, especially after the National Development and Reform Commission and the State Administration of Industry & Commerce (SAIC) have issued detailed implementing regulations, will have great influence on companies that sell products in China.”
Private equity and venture capital
As hinted above, last year began with promise in the world of China private equity and venture capital. The Registration and Regulation of Partnership Enterprises with Foreign Investment Administrative Measures, which came into effect on 1 March 2010, provided a structure allowing foreign investment without the approval of the Ministry of Commerce. However, many had hoped that the Measures – which had been long anticipated – would allow foreign venture capital investors to replicate their offshore structures within China. The Measures fell short.
Now, private equity circles are abuzz once more. In late December 2010, the Shanghai municipal government announced a pilot project allowing foreign investors to use foreign currency for investment in private equity funds that they managed. Under the measures, foreign-funded equity investment management enterprises (FFEIMEs) and foreign-funded equity investment enterprises (FFEIEs) can apply to become “pilot enterprises” under the scheme – which has become known as the qualified foreign limited partner, or QFLP, scheme.
It is believed that pilot enterprises can obtain an RMB quota, up to which limit they can convert their foreign currency into RMB and use it to invest in China. According to media reports, the aggregate quota for pilot enterprises is US$3 billion. However, no such a quota is included in the implementing measures governing the pilot scheme (see QFLP scheme breaks the ice in Shanghai on page 21). According to Geraldine Johns-Putra, a senior foreign legal consultant at Australian law firm Minter Ellison in Hong Kong, a similar pilot project is expected to be launched in Beijing.
“The Shanghai regulations on FFEIMEs and FFEIEs may encourage overseas investment management institutions to invest in the Chinese market,” says Xu of Haworth & Lexon.
In recent months, the prospects for China’s economy have become the subject of global attention and debate. Inflation is being keenly felt. In February, interest rates rose again.
Glück at CMS points out that the sale and production of cars in China have been declining since April last year, and that it has been predicted by strategy consultants Roland Berger that China’s car market will contract by 15% in 2011. “China’s manufacturers must adjust their strategy with better strategies for the international market,” she says.
Matthew Murphy at MMLC points out that a new automotive industry development policy, being drafted by the National Development and Reform Commission, is likely to be published during 2011. They say there is “heated debate” over whether to relax the current rule that the Chinese party to an automotive joint venture must hold at least 50% of its equity.
Across many industries and sectors, liberalization is being accompanied by tighter regulation. Silli of Gide Loyrette Nouel predicts that a new national law on safeguarding national secrets, “which makes negotiations with state-owned enterprises more difficult when dealing with sensitive technical or commercial information”, will have a significant impact in the coming year.
Glück points to the Supervising and Dealing With Contractual Violations Measures, issued by the SAIC, which became effective on 13 November 2010 (see China Business Law Journal volume 1 issue 10, page 12). These Measures introduced tighter regulation of business activities connected to civil and commercial contracts. She says the Measures “modify and clarify the civil law regime by setting up new criteria for the validity of contract content and conclusion”. Although the Measures are issued by the SAIC and, as such, do not constitute a formal revision or modification of the PRC Contract Law, “they should be taken into account when concluding contracts subject to PRC law”.
Xu Meng, a partner at V&T Law Firm, predicts that the capital markets will also experience a tightening of control. “The raising of surplus funds during the IPO process has been a continuous problem for ChiNext. From the issuer’s point of view, although surplus funds are strictly controlled, having more cash is always better than not having enough. From CSRC’s point of view, too many companies have raised too much surplus funding, which suggests that there is a structural problem. I predict that this will be one of the aspects of issuing new shares that will be reformed in future.”
Tort Law has an impact on IP matters
The PRC Tort Law took effect on 1 July last year. It brought together provisions that had been scattered among various laws, regulations and court opinions, and introduced some concepts that were new to Chinese law, such as that of punitive damages (see China Business Law Journal volume 1 issue 7, page 37).
According to Takahashi Nakayama, general manager of Toshiba (China), the introduction of the law prompted Toshiba to issue internal newsletters explaining it and its implications. For Yi Jianmin, an attorney at automotive components maker Delphi in Shanghai, the law led to a real change in practice. “In consideration of joint and several liabilities between the polluter and its agent under chapter 8 of the PRC Tort Law, we just revised our waste disposal and transportation contracts with our vendors to provide clear-cut liabilities,” says Yi.
Kevin Xu, a partner at Martin Hu & Partners, confirms that “although many details are still to be fleshed out and refined, the Tort Law will certainly have a significant impact in many specific areas of law”.
One such area, according to intellectual property lawyers, is IP. According to Ella Cheong of Ella Cheong Patent Design & Trademark Agents, the Tort Law “makes it clear that service providers will bear joint liability as to the extended loss” if they fail to take actions such as deleting an infringing website upon notice by the IP owners. This gives IP owners a convenient way to take down infringing websites if they cannot locate the infringers.
Intellectual property law has changed in other respects, too. According to Aaron Wininger, a partner at Perkins Coie in Beijing, the main legal development in IP in the past year has been the amendment of the PRC Patent Law, and its implementing regulations which came into effect on 1 February 2010.
Under the new patent regime, companies must pay their employees compensation for inventions. The implementing regulations specify a default amount if no other amount is specified by the employer or agreed. “Besides the complexity in calculating what this royalty is, the default rule could lead to huge damages awards against employers,” says Wininger. He points to a sum of 20 billion yen (US$240 million) which was awarded to an employee in Japan – which has similar laws – for inventing the blue light-emitting diode. “Employers need to make sure they specify what the reward amounts are (preferably a flat fee) and that the employees sign an agreement confirming this,” he states.
But Xu Jiali, executive partner at Longan Law Firm, expresses optimism, pointing to a current crackdown on IP infringement by the Ministry of Commerce. The crackdown has followed the Cracking Down on Intellectual Property Infringements, Production and Sales of Counterfeit and Shoddy Commodities in the Field of Commercial and Trade Circulation Implementation Plan issued by the Ministry of Commerce. Xu describes the coming 12 months as “more promising” for IP in China.