The July edition of China Economic Review profiled the Opinion on Guiding the Work of Examining and Approving Foreign Investment Enterprises issued recently by the Ministry of Foreign Trade and Economic Co-operation (Moftec). The article mentioned that Moftec is targeting not just foreigners' new investment projects but the expansion of their existing projects as well.
Moftec draws a distinction between different types of capital increase:
where its purpose is not to expand the scale of production
where its purpose is to expand the scale of production and the industry concerned is subject to various restrictions
where its purpose is to expand the scale of production and the industry is unrestricted.
Not surprisingly, the opinion reminds local approval authorities to observe approval limits. In particular, where the purpose of the capital increase is to expand the scale of production and the project concerned involves any items under the overall state balancing pro-gramme and/or they fall into 'category B' restricted projects, the enterprise needs to get approval from the State Planning Commission or the State Economic and Trade Commission.
The opinion goes on to list a number of factors that form the basis of approval for a capital increase. The list begins in-nocuously enough. Earlier contributions of registered capital should have been made in the time stipulated in the joint venture contract, the source of funds for the capital increase should have been ascertained and the enterprise should be in 'good health' ?essentially an enter-prise that has begun commercial production should be a profitable one.
However, it soon becomes clear that Moftec's real concern is changes in the relative percentages in the registered capital of a joint venture ?specifically, where the foreign party will be contributing more to the increase than is war-ranted by its existing holding. This, of course, raises the perpetually thorny is-sue of the protection of Chinese state as-sets. If foreign parties increase their share in a joint venture, implicitly they have acquired a greater proportional interest in Chinese assets.
To make things worse, the value or amount of those assets should have al-ready increased during the life of the venture. So if, during the term of the enterprise's operations, the increase of capital involves an adjustment in the equity interests held by the shareholders under a shareholders' agreement, or the Chinese party transfers any part or all of its share in the increased capital to the foreign party, or the Chinese party makes its contribution in the form of state-owned (or collective) property, the fact that an increase in the assets originally contributed is also being transferred has to be taken into account. The transfer must take place at a value accepted by – the owner of the assets and must be reflected in the proportions of the equity interests held by the capital holders afterwards.
The sector in which the joint venture operates may be one in which 'state-owned property must account for a con-trolling or dominant proportion' ?a polite way of saying that the Chinese must retain control of certain industries. Examples are telecommunications and auto manufacture. In those sectors, any adjustment in the equity interests held by each registered capital holder as a result of a capital increase must not cause the foreign investor or a non-Chinese state-owned enterprise to take the con-trolling or dominant position.
Interestingly, the opinion adds that where an enterprise's products are mainly sold in domestic markets, in principle the Chinese party should maintain its percentage holding in the registered capital at over 50 per cent.
What happens if control is ceded to a foreign party due to a capital increase? The contract must contain terms for protection of the interests of the Chinese party as a minority shareholder. These would include the right to make strate.