《建设项目风险管理》课程教学参考资料：Dealing with the construction regulatory regime in the PRC——Practical Solutions for Foreign Investors and Contractors

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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)

after 1 July 2005 will be required to comply requirements as apply to local PRC with the full terms of Decree No. 113 design/engineering companies. However, 3.6 Circular No 159 also addressed other issues in compared with forming a Decree No 113 relation to the evaluation and determination of Decree No 114 entity are much more modest. the grade of construction enterprise qualification certificates. Under Circular 4.4 Another attractive feature of a Decree No. 114 No. 159, the track record of a foreign entity is that under a guidance opinionissued contractor outside of China may now be taken by the moC (Guidance Opinion"), it would to account in determining the grade of appear to be possible for a Decree No. 114 qualification awarded to the Decree No. 113 entity with an appropriate qualification to entity established by such foreign contractor. undertake Engineering procurement and These provisions used only to apply to Decree Construction( EPC") projects in China. The No. 113 entities set up by Hong Kong or Guidance Opinion encourages entities holding Macau contractors under CEPA, but now, by a design/engineering qualification to contract virtue of Circular No. 159, the right to use for projects as a general contractor, although overseas experience has been extended to al the construction works for such projects must foreign investors applying to establish Decree be subcontracted out to qualified construction No. 113 entities contractors. This means that foreign 4. ESTABLISHING A DECREE NO. 114 igh levels of registered capital needed for ENTITY setting up a Decree No. 113 entity, establish a Decree No. 114 entity to undertake EPC works 4.1 Decree No. 114 was issued at the same time in China Decree No. 113. Whilst Decree No. 113 regulates foreign contractors in the project 4.5 The main issue holding back formation of construction area, Decree No. 114 regulates Decree No. 114 entities remains the absence of foreign enterprises performing construction the Implementing Rules for Decree No. 114, project design and engineering activities. which means that foreign contractors(exce for Hong Kong investors qualified under 4.2 Like Decree No. 113. Decree No. 114 allows CEPA)cannot submit applications for the establishment of decree No. 114 WFOEs at design and engineering entities in the form of present. Based on our informal discussions with EJVs, CJVs and WFOEs. However, although the MOC, such Implementing Rules are likely the establishment of wfoes is technically to be issued in the first half of 2005, but the permitted under Decree No. 114, given that MOC is unwilling to specify a more precise the Implementing Rules for Decree No 114 date. The WTo commitment to allow WFOes are not in place, the authorities have not yet to be created in this area falls due five years after Chinas WTO accession at the end of establishment of decree No. 114 WFOEs 2006 However, please note that based on our informal enquiries with the MOC officials, 4.6 It is also important to note that Decree No application for the establishment of Decree No 114 imposes certain requirements relating to 114 WFOEs invested by Hong Kong expatriate personnel which are likely enterprises, in accordance with the CEPA, have present an issue for foreign enterprises looking eady been accepted. to establish such an entity. We would anticip that such personnel requirements may be 4.3 As with Decree No, 113 entities. Decree no. 114 requires that a Decree No. 114 entity Implementing Rules, broadly on the lines set must, after establishment, apply for a design or engineering qualification certificate. A Decree 9. The MOC Guidance Opinions on Promoting and Developing No. 114 entity must comply with the same oject Management Enterprises (ian Shi[2003] No 30

after 1 July 2005 will be required to comply with the full terms of Decree No. 113. 3.6 Circular No. 159 also addressed other issues in relation to the evaluation and determination of the grade of construction enterprise qualification certificates. Under Circular No. 159, the track record of a foreign contractor outside of China may now be taken into account in determining the grade of qualification awarded to the Decree No. 113 entity established by such foreign contractor. These provisions used only to apply to Decree No. 113 entities set up by Hong Kong or Macau contractors under CEPA, but now, by virtue of Circular No. 159, the right to use overseas experience has been extended to all foreign investors applying to establish Decree No. 113 entities. 4. ESTABLISHING A DECREE NO. 114 ENTITY 4.1 Decree No. 114 was issued at the same time as Decree No. 113. Whilst Decree No. 113 regulates foreign contractors in the project construction area, Decree No. 114 regulates foreign enterprises performing construction project design and engineering activities. 4.2 Like Decree No. 113, Decree No. 114 allows for immediate establishment of foreign-invested design and engineering entities in the form of EJVs, CJVs and WFOEs. However, although the establishment of WFOEs is technically permitted under Decree No. 114, given that the Implementing Rules for Decree No. 114 are not in place, the authorities have not yet accepted and processed any applications for the establishment of Decree No. 114 WFOEs. However, please note that based on our informal enquiries with the MOC officials, application for the establishment of Decree No. 114 WFOEs invested by Hong Kong enterprises, in accordance with the CEPA, have already been accepted. 4.3 As with Decree No. 113 entities, Decree No. 114 requires that a Decree No. 114 entity must, after establishment, apply for a design or engineering qualification certificate. A Decree No. 114 entity must comply with the same requirements as apply to local PRC design/engineering companies. However, compared with forming a Decree No. 113 entity, the registered capital requirements for a Decree No. 114 entity are much more modest. 4.4 Another attractive feature of a Decree No. 114 entity is that under a guidance opinion9 issued by the MOC ("Guidance Opinion"), it would appear to be possible for a Decree No. 114 entity with an appropriate qualification to undertake Engineering, Procurement and Construction ("EPC") projects in China. The Guidance Opinion encourages entities holding a design/engineering qualification to contract for projects as a general contractor, although the construction works for such projects must be subcontracted out to qualified construction contractors. This means that foreign contractors can, without undertaking to inject the high levels of registered capital needed for setting up a Decree No. 113 entity, establish a Decree No. 114 entity to undertake EPC works in China. 4.5 The main issue holding back formation of Decree No. 114 entities remains the absence of the Implementing Rules for Decree No. 114, which means that foreign contractors (except for Hong Kong investors qualified under CEPA) cannot submit applications for the establishment of Decree No. 114 WFOEs at present. Based on our informal discussions with the MOC, such Implementing Rules are likely to be issued in the first half of 2005, but the MOC is unwilling to specify a more precise date. The WTO commitment to allow WFOEs to be created in this area falls due five years after China's WTO accession, at the end of 2006. 4.6 It is also important to note that Decree No. 114 imposes certain requirements relating to expatriate personnel which are likely to present an issue for foreign enterprises looking to establish such an entity. We would anticipate that such personnel requirements may be relaxed in the forthcoming Decree No. 114 Implementing Rules, broadly on the lines set - 4 - 9. The MOC Guidance Opinions on Promoting and Developing Construction Project Main Contracting and Construction Project Management Enterprises (Jian Shi [2003] No. 30)

out under Circular No. 159 in relation to 5.5 According to Decree No 200, PM services Decree No. 113 entities, although this will only means specialised management an become clear in the fullness of time provided by a PM entity which is entrusted by the project owner to provide PM services fo 5. SETTING UP A CONSULTING WFOE TO all, or just certain specific stages of, a PERFORM UNREGULATED WORKS construction project. One possible reading of such definition is that the PM services 1 Given the heavy regulatory compliance, capital performed by a PM entity entrusted by the and personnel burdens imposed by Decree main contracto to perform the PM services fo Nos 113 and 114 on potential foreign investors the benefit of the main contractor do not fall (as discussed above), some foreign contractors within the application scope of this Decree have been considering whether they could limit However, this depends on how the MOC their activities in China to unregulated interprets the provisions. If it takes a"hard construction-related works. If this is feasible line", it is possible that even this avenue will be from the business perspective, foreigN contractors could either deliver such unregulated works on a cross-border basis, or 5.6 Decree No 200 expressly provides that an by setting up a consulting WFOE to do so. The entity must hold one other construction-related difficulty is ensuring that the qualification in relation to survey, design, does not"spill over" into any regulated construction, construction works supervision, construction-related works tendering agency etc. to perform PM services in China. On the face of such 5.2 Detailed analysis in relation to delivering cross- still possible for a party to provide"technical border services will be provided in Section 6 services"without being required to obtain a In this Section, we briefly discuss the qualification, but given the wide scope of the establishment of a consulting WFOE to definition of pm under decree no 200. mos perform unregulated works services are likely to fall within the scope of 5.3 Setting up a consulting WFOE is a relatively PM. Decree No 200 now leaves the market in straightforward process and such entities are the rather bizarre situation whereby a much quicker to set up as compared to a tendering agency for construction projects or a Decree No. 113 or Decree No. 114 entity. design institute holding a qualification in China ng, for are automatically qualified to provide PM example, are now down to five working days whether or not they have any relevant for the initial approval reply. The establishment experience, whilst a world-famous international of a consulting WFOE only requires the project management or engineering contractor approval of the competent MOFCOM without a Decree No. 113 or Decree No. 114 authority and the registered capital entity in China is not permitted to provide requirements are far lower than those of a gulated PM services in China Decree No. 113 or even of a Decree No 114 WFOE. 6. DELIVERING DESIGN SERVICES ON A CROSS-BORDER BASIS 5.4 Prior to the issuance of moc decree No 200 a consulting WFOE could provide project 6. 1 The repeal of Decree No 32 means that no management services and technical consulting further construction-related qualification services. However after Decree No 200 takes certificates will be issued to foreign effect, on 1 December 2004, a consulting contractors. However, this does not necessarily WFOE can only perform technical services mean that foreign enterprises must set up a hich do not fall within the scope of regulated local entity to undertake construction-related project management(PM") services under works in China. For certain specia MOC Decree No 200 is possible for foreign enterprises to deliver ertain services on a cross-border basis by co-

out under Circular No. 159 in relation to Decree No. 113 entities, although this will only become clear in the fullness of time. 5. SETTING UP A CONSULTING WFOE TO PERFORM UNREGULATED WORKS 5.1 Given the heavy regulatory compliance, capital and personnel burdens imposed by Decree Nos.113 and 114 on potential foreign investors (as discussed above), some foreign contractors have been considering whether they could limit their activities in China to unregulated construction-related works. If this is feasible from the business perspective, foreign contractors could either deliver such unregulated works on a cross-border basis, or by setting up a consulting WFOE to do so. The difficulty is ensuring that the scope of work does not "spill over" into any regulated construction-related works. 5.2 Detailed analysis in relation to delivering crossborder services will be provided in Section 6. In this Section, we briefly discuss the establishment of a consulting WFOE to perform unregulated works. 5.3 Setting up a consulting WFOE is a relatively straightforward process and such entities are much quicker to set up as compared to a Decree No. 113 or Decree No. 114 entity. Local approvals in many parts of Beijing, for example, are now down to five working days for the initial approval reply. The establishment of a consulting WFOE only requires the approval of the competent MOFCOM authority and the registered capital requirements are far lower than those of a Decree No. 113 or even of a Decree No. 114 WFOE. 5.4 Prior to the issuance of MOC Decree No. 200, a consulting WFOE could provide project management services and technical consulting services. However, after Decree No. 200 takes effect, on 1 December 2004, a consulting WFOE can only perform technical services which do not fall within the scope of regulated project management ("PM") services under MOC Decree No. 200. 5.5 According to Decree No. 200, PM services means specialised management and services provided by a PM entity which is entrusted by the project owner to provide PM services for all, or just certain specific stages of, a construction project. One possible reading of such definition is that the PM services performed by a PM entity entrusted by the main contractor to perform the PM services for the benefit of the main contractor do not fall within the application scope of this Decree. However, this depends on how the MOC interprets the provisions. If it takes a "hard line", it is possible that even this avenue will be cut off. 5.6 Decree No. 200 expressly provides that an entity must hold one other construction-related qualification in relation to survey, design, construction, construction works supervision, tendering agency etc. to perform PM services in China. On the face of such provisions, it is still possible for a party to provide "technical services" without being required to obtain a qualification, but given the wide scope of the definition of PM under Decree No. 200, most services are likely to fall within the scope of PM. Decree No. 200 now leaves the market in the rather bizarre situation whereby a tendering agency for construction projects or a design institute holding a qualification in China are automatically qualified to provide PM, whether or not they have any relevant experience, whilst a world-famous international project management or engineering contractor without a Decree No. 113 or Decree No. 114 entity in China is not permitted to provide regulated PM services in China. 6. DELIVERING DESIGN SERVICES ON A CROSS-BORDER BASIS 6.1 The repeal of Decree No. 32 means that no further construction-related qualification certificates will be issued to foreign contractors. However, this does not necessarily mean that foreign enterprises must set up a local entity to undertake construction-related works in China. For certain specialised areas, it is possible for foreign enterprises to deliver certain services on a cross-border basis by co- - 5 -

operating with local PRC companies by purchasing the equity interests in, or assets perform the services, and without setting up a of, the target domestic enterprise. Such local entity acquisitions of domestic enterprises would 6.2 According to MOC Decree No 78, foreign however, be subject to approval by (at the very enterprises are permitted to collaborate with least) the competent MOFCOM authority. qualified Chinese design institutes o to provide However, it seems unlikely that as a practical preliminary design and detailed design services matter acquisitions will be allowed to run ahead of"fresh establishment"approvals, so it is China, but such design services performed debatable whether a WFOE Decree No. 114 by foreign enterprises may not exceed the entity could be created by acquisition at the time scope of work permitted under the of writing. Furthermore, CEPA I provides ation ce Chinese design institute expressly that, for example, HKSSs may ac 1000 of a Chinese construction contractor 6.3 In order to make use of this structure concession would be meaningless(except enterprises must comply with the requi possibly in terms of giving HKSSs a headstart) if set out in Decree No. 78. For example, it was possible for all foreign investors to do enterprises must enter into a co-operation likewise. Therefore, one of the most important agreement with the Chinese design institute, due diligence type enquiries that needs to be and all design documents prepared and issued made before going ahead with an acquisition of by the foreign enterprise must be verified and a PRC target in the construction sector is to chopped by the Chinese design institute in confirm with the relevant regulatory authorities order for them to be valid. Decree No. 78. in hat the acquisition is feasible from a policy effect, simply legitimises what has historically been the practice, where the designs on 7.3 The effect of such an acquisition would be to foreign-invested projects in particular have been drawn up overseas and then, to a greater convert a domestic capital PRC enterprise into a foreign-invested enterprise such as an EJV, CV or WFOE (an"FIE"). In addition, if the co-operating Chinese design institute. target domestic enterprise is a State-owned enterprise or encompasses State-owned assets, 7. ACQUISITION OF LOCAL DESIGN, the acquisition is subject to mandatory State ENGINEERING AND CONSTRUCTION owned assets valuation(which will determine ENTERPRISES the minimum purchase price)and the transfer 7.1 Another option worth considering is the must comply with the relevant ratification acquisition of an existing PRC design, and/or record filing procedures(as the case engineering or construction enterprise. The may be)with the competent State Assets advantage of acquiring an existing PRC Supervision and Administration Commission or company is that the PRC company will usually Ministry of Finance organ, as well as the new have already obtained a construction-related procedures for the listing of State-owned assets ion permit, and it may have alr transactions on Property Rights Exchanges. established itself in the relevant market in 7.4 Another important point to note is that as the terms of market position, technical ane acquisition will have the effect of converting the personnel resources eto domestic enterprise into an FIE, and given that 7.2 Pursuant to the applicable Prc laws and the target company conducts business in the construction and engineering industry, the target it is, in theory at least, permitted for a foreig company, after being acquired, would not be nterprise to acquire domestic enterprises either seen as an"ordinary"FIE, but as a foreign invested construction or design/engineering 0. In general, China has chosen to organise design services into enterprise under Decree No. 113 or Decree No design institutes"rather that having architectural partnerships 114. Thus, in addition to complying with all the or companies as elsewhere

operating with local PRC companies to perform the services, and without setting up a local entity. 6.2 According to MOC Decree No. 78, foreign enterprises are permitted to collaborate with qualified Chinese design institutes10 to provide preliminary design and detailed design services in China, but such design services performed by foreign enterprises may not exceed the scope of work permitted under the qualification certificate held by the relevant Chinese design institute. 6.3 In order to make use of this structure, foreign enterprises must comply with the requirements set out in Decree No. 78. For example, foreign enterprises must enter into a co-operation agreement with the Chinese design institute, and all design documents prepared and issued by the foreign enterprise must be verified and chopped by the Chinese design institute in order for them to be valid. Decree No. 78, in effect, simply legitimises what has historically been the practice, where the designs on foreign-invested projects in particular have been drawn up overseas and then, to a greater or lesser extent, "rubber stamped" by the co-operating Chinese design institute. 7. ACQUISITION OF LOCAL DESIGN, ENGINEERING AND CONSTRUCTION ENTERPRISES 7.1 Another option worth considering is the acquisition of an existing PRC design, engineering or construction enterprise. The advantage of acquiring an existing PRC company is that the PRC company will usually have already obtained a construction-related qualification permit, and it may have already established itself in the relevant market in terms of market position, technical and personnel resources etc. 7.2 Pursuant to the applicable PRC laws and regulations relating to mergers and acquisitions, it is, in theory at least, permitted for a foreign enterprise to acquire domestic enterprises either by purchasing the equity interests in, or assets of, the target domestic enterprise. Such acquisitions of domestic enterprises would, however, be subject to approval by (at the very least) the competent MOFCOM authority. However, it seems unlikely that as a practical matter acquisitions will be allowed to run ahead of "fresh establishment" approvals, so it is debatable whether a WFOE Decree No. 114 entity could be created by acquisition at the time of writing. Furthermore, CEPA I provides expressly that, for example, HKSSs may acquire 100% of a Chinese construction contractor: this concession would be meaningless (except possibly in terms of giving HKSSs a headstart) if it was possible for all foreign investors to do likewise. Therefore, one of the most important due diligence type enquiries that needs to be made before going ahead with an acquisition of a PRC target in the construction sector is to confirm with the relevant regulatory authorities that the acquisition is feasible from a policy angle. 7.3 The effect of such an acquisition would be to convert a domestic capital PRC enterprise into a foreign-invested enterprise such as an EJV, CJV or WFOE (an "FIE"). In addition, if the target domestic enterprise is a State-owned enterprise or encompasses State-owned assets, the acquisition is subject to mandatory Stateowned assets valuation (which will determine the minimum purchase price) and the transfer must comply with the relevant ratification and/or record filing procedures (as the case may be) with the competent State Assets Supervision and Administration Commission or Ministry of Finance organ, as well as the new procedures for the listing of State-owned assets transactions on Property Rights Exchanges. 7.4 Another important point to note is that as the acquisition will have the effect of converting the domestic enterprise into an FIE, and given that the target company conducts business in the construction and engineering industry, the target company, after being acquired, would not be seen as an "ordinary" FIE, but as a foreigninvested construction or design/engineering enterprise under Decree No. 113 or Decree No. 114. Thus, in addition to complying with all the - 6 - 10. In general, China has chosen to organise design services into "design institutes" rather that having architectural partnerships or companies as elsewhere

elevant requirements as discussed above under 8.2 Given the highly regulated nature of the the relevant mergers and acquisition rules, an onstruction industry in China, as discussed in acquisition of a domestic PRC construction, this note, foreign contractors looking to access design or company by a foreign or step up their presence in the Chinese market nterprise would also be subject to the approval up the legal and qualification requirements under Decree risks and benefits of each available structure Nos 113 or 114, as appropriate. This means that and to determine which option is the most all the requirements or limitations in relation to suitable for its business operations in China Decree No. 113 or Decree No. 114 entities a The analysis is not"one size fits all"and discussed above should apply similarly to all depends to a large extent on the specific FIEs created by means of acquisitions circumstances and objectives of the foreign contractor. Our China team, based in Beijing, 8. CONCLUSION Shanghai and Hong Kong, has extensive practical experience of advising international 8.1 In summary, the recent spate of PRC lients on regulatory and other legal issues with construction-related laws and regulations may respect to the construction market in China be seen as representing further progression and the region, as well as in relation to setting towards completing the legal and reg up the corresponding investment vehicles. We framework for the opening up of the PRC also work closely and actively with various on market to foreig and investment and bringing the PrC construction safeguard foreign contractors' interests in the market into line with international practice. Chinese market, whilst maintaining a regular However, not all the recent developments have dialogue with the industry regulators. We also been welcomed in the foreign contractor work closely with our team in London. Should business community: a contrary view is that the you wish to obtain any further information or policy behind many of these new regulations is of the issues raised by this note an attempt to"shut out"foreign contractors please feel free to contact any of our team from this market, particularly if such foreign members listed on the preface page. contractors have not set up a local entity in China, and to"shoe-horn"more efficient and leaner"foreign contractors into an ill-adapted regulatory framework which replicates the structure of the Chinese domestic construction April 2005 industry. One concern is that the effect of the personnel requirements under Decree No. 113 for example, is that foreign investors establishing Decree No. 113 entities will end up with an uncompetitive or unsustainable cost structure in China, as compared to their State- owned competitors. The implementation of Decree No. 200 further restricts the scope of activities w hich can be performed by offshore entities w ithout setting up a local entity and obtaining an appropriate qualification, so could also be seen as a further step down the road of limiting foreign involvement in the short particularly as PM was an area in which foreign contractors were known to be active ◎ Lovells2005 ll rig

relevant requirements as discussed above under the relevant mergers and acquisition rules, an acquisition of a domestic PRC construction, design or engineering company by a foreign enterprise would also be subject to the approval and qualification requirements under Decree Nos.113 or 114, as appropriate. This means that all the requirements or limitations in relation to Decree No. 113 or Decree No. 114 entities as discussed above should apply similarly to all FIEs created by means of acquisitions. 8. CONCLUSION 8.1 In summary, the recent spate of PRC construction-related laws and regulations may be seen as representing further progression towards completing the legal and regulatory framework for the opening up of the PRC engineering and construction market to foreign investment and bringing the PRC construction market into line with international practice. However, not all the recent developments have been welcomed in the foreign contractor business community: a contrary view is that the policy behind many of these new regulations is an attempt to "shut out" foreign contractors from this market, particularly if such foreign contractors have not set up a local entity in China, and to "shoe-horn" more efficient and "leaner" foreign contractors into an ill-adapted regulatory framework which replicates the structure of the Chinese domestic construction industry. One concern is that the effect of the personnel requirements under Decree No. 113, for example, is that foreign investors establishing Decree No. 113 entities will end up with an uncompetitive or unsustainable cost structure in China, as compared to their Stateowned competitors. The implementation of Decree No. 200 further restricts the scope of activities which can be performed by offshore entities without setting up a local entity and obtaining an appropriate qualification, so could also be seen as a further step down the road of limiting foreign involvement in the short term, particularly as PM was an area in which many foreign contractors were known to be active. 8.2 Given the highly regulated nature of the construction industry in China, as discussed in this note, foreign contractors looking to access or step up their presence in the Chinese market need to weigh up the legal and commercial risks and benefits of each available structure, and to determine which option is the most suitable for its business operations in China. The analysis is not "one size fits all" and depends to a large extent on the specific circumstances and objectives of the foreign contractor. Our China team, based in Beijing, Shanghai and Hong Kong, has extensive practical experience of advising international clients on regulatory and other legal issues with respect to the construction market in China and the region, as well as in relation to setting up the corresponding investment vehicles. We also work closely and actively with various industry associations and groups seeking to safeguard foreign contractors' interests in the Chinese market, whilst maintaining a regular dialogue with the industry regulators. We also work closely with our team in London. Should you wish to obtain any further information or to discuss any of the issues raised by this note, please feel free to contact any of our team members listed on the preface page. April 2005 © Lovells 2005. All rights reserved. - 7 -

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