Using equity transactions to transfer control of state-owned land

Under article 39 of the Urban Real Estate Administration Law, transfer of state-owned land use rights is conditional on the payment of all land grant premiums, the obtaining of land use rights certificates, and a certain degree of progress in terms of development of the land. The aim of this provision is to limit land speculation seeking excessive profits. In light of these conditions, many enterprises opt to buy a target company that controls the land use rights, so indirectly changing the actual control of those rights via equity transfer.

Such transactions are nominally equity transfers, but in fact the underlying effect is to enable the buyer of the equity to secure control of the land use rights. But what do the current regulations and laws, as well as judicial precedents, tell us about the feasibility and legal consequences of such arrangements?

Laws and regulations

Subject to compliance with the Civil Code and the Land Administration Law, a direct transfer of state-owned land use rights is required to satisfy the relevant requirements under article 39 of the Urban Real Estate Administration Law and article 19 of the Interim Regulations Concerning the Assignment and Transfer of the Right to the Use of State-owned Land in Urban Areas.

However, in the case of transferring state-owned land use rights via equity transfer, no consideration need be given to the above restrictions, as one is required only to comply with article 71 of the Company Law, as well as any requirements for, or restrictions on, equity transfer under the company’s articles of association. Furthermore, if a stock transaction of a listed company is involved, the Securities Law must also be observed.

In addition to relevant civil laws and regulations, the Criminal Law, for the purposes of reining in violations of land administration regulations involving the illegal transfer or flipping of land use rights for profit, establishes the “crime of illegally transferring or flipping land use rights” in article 228. Depending on the severity, violation may lead to a prison sentence of three to seven years, a sentence of less than three years or limited incarceration.

Case research

After looking through the above legal provisions, we may tentatively assume that a transfer of state-owned land use rights and a transfer of equity are separately governed in law, answering to different sets of laws and regulations. Even if the objective of an equity transfer is to acquire the core assets (i.e., land use rights) of the target company, the title to the state-owned land use rights remains unchanged, therefore the nature of the equity transfer should not change as a result and such transaction arrangements should not be invalidated by application of the Urban Real Estate Administration Law.

To further shed light on the opinions on this issue in relevant judicial decisions, the authors first performed an extensive case search on Wolter Kluwers (https://law.wkinfo.com.cn/) using the keywords “article 39 of the Urban Real Estate Administration Law”, “equity transfer dispute”, “land use rights” and “contract validity”. The results show that between 2012 and 2019 the Supreme People’s Court looked at a number of equity transfer contracts under which a transfer of control of state-owned land use rights was accomplished and had been positive towards the validity of such transaction arrangements.

In a 2016 equity transfer dispute involving Yingkou Hengqi Property Development and Yingkou Minghong Property Development, the court found that under the equity transfer contract in question, land acquisition took place in the name of equity transfer, which constituted investment in a target company as part of a commercial transaction, as well as an agreement on rights, obligations and the manner of performance within an equity transaction.

This did not change the target company itself, nor the subject entitled to use the disputed land, hence the case should not be reviewed based on laws and regulations on land management. Given that no mandatory provisions in the existing laws strictly prohibit the transfer of land use rights by transferring the equity of a real estate project company, the equity transfer should be deemed valid.

Recommendations

Judging from the research of legal provisions and judicial decisions, the SPC does recognise the transfer of control of state-owned land use rights via equity transfer, and considers the relevant equity transfer contracts valid. This is principally based on the notion that equity transfer and land use rights transfer fall under two entirely separate legal systems.

Equity transfer changes the shareholders of the target company without passing on the land use rights; hence the relevant provisions of the Urban Real Estate Administration Law should not apply, and such transfers likewise do not constitute “concealing illegal objectives under lawful disguises”. Transferring control of construction land use rights by way of equity transfer is commonly applied in real estate development, and as the equity transfer contract does not violate any mandatory provisions under relevant laws or administrative regulations, it is deemed valid.

However, although the SPC considers an equity transfer contract that in essence transfers the control of state-owned land use rights to be valid, under certain circumstances, it is not impossible for transaction entities using this model to be exposed to criminal legal risks.

For example, in the case of Yu 09 Xing Zhong No. 290 (2018), the equity transferor lacked sufficient funds or capacity to develop the land, the land premium had not been fully paid at the time of transfer, the state-owned land use certificate had not been obtained, construction of the project had not substantively commenced and had deviated from its designated purpose, equity was transferred within a relatively short period of time after securing the land use rights, and the transaction was confirmed to be for illegitimate profit-making, all of which led the court to find the transferor guilty of the crime of illegal transfer or flipping of land use rights.

Based on the above-mentioned, the authors recommend that enterprises considering the transfer control of state-owned land use rights via equity transfer should avoid the sort of circumstances set out above before making such a transaction arrangement, so as to ward off criminal legal risks.

Yao Xiaomin is a founding partner and Wang Chengtao is an associate at Lantai Partners