On September 28, 2009, the PRC General Administration of Press and Publication ("GAPP"), National Copyright Administration, and National Office of Combating Pornography and Illegal Publications jointly published the Notice Regarding the Consistent Implementation of the "Stipulations on 'Three Provisions'" of the State Council and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Pre-examination and Approval of Internet Games and the Examination and Approval of Imported Internet Games (Xin Chu Lian  No. 13, "Notice 13"). Notice 13 restates the general principle espoused in recently promulgated regulations that foreign investment is not permitted in Internet game operating businesses in China. In addition, Notice 13 expressly prohibits foreign investors from using contractual or other control arrangements to gain control over domestic Internet game operators.
This is the first time that Chinese authorities have expressly prohibited the contractual and other control arrangements that have been used to facilitate foreign investment in certain industries in China. To date, it has been common for foreign investors to employ a series of operating, technical service, and share pledge or call option agreements to address domestic ownership requirements and other restrictions on foreign investment in these industries. Investment structures in the Internet sector have typically used such arrangements between a wholly foreign-owned domestic subsidiary and a domestic license-holding operating entity to help ensure control of the latter so that the operating entity's revenues can be consolidated for financial accounting purposes based on "variable interest entity" status with those of the foreign-owned subsidiary (the "VIE Model").
Prior to the publication of Notice 13, PRC regulators had tacitly permitted use of the VIE Model in a number of industries where foreign investment is restricted, such as advertising, tourism, and businesses requiring valueadded telecommunications licenses (including Internet-related businesses, and in particular, online gaming). No Chinese laws or regulations expressly prohibited use of the VIE Model, and it has been possible to obtain reasonably qualified legal opinions from PRC law firms confirming the legality of VIE arrangements in connection with offshore listings of companies operating domestic businesses in such restricted industries. As a result, a significant number of Chinese companies have utilized the VIE Model to structure offshore pre-IPO financings and later become listed on U.S. and Hong Kong stock exchanges. The enactment of Notice 13 on its face calls into question the feasibility of the VIE Model in the Internet gaming industry and potentially other industries in China where foreign investment is restricted. We highlight below key aspects and certain regulatory background relating to Notice 13, and consider its effect on foreign investment in China going forward.
1. Notice 13 Highlights
- Article I of Notice 13 defines " Internet games" as "all Internet game products provided to the public for mutual online use or for downloading through the Internet (including cable and mobile Internet)." The definition includes "without limitation" MMORPG games, Web games, casual games, downloaded standalone games, games with interconnecting functions (multiplayer games), web-based war game platforms, and mobile phone Internet games. "Imported" Internet games are defined as those licensed by overseas copyright owners.
- Article II states that GAPP is "solely" responsible for pre-examination and approval of Internet games as authorized by the central government and State Council, and that the provision of Internet games either online or on a downloaded basis constitutes Internet game publishing, which is subject to pre-examination and approval by GAPP. Under Article II telecom operators are further prohibited from providing Internet access for Internet games that have not been pre-approved and examined by GAPP, and GAPP is authorized to issue an order suspending operations with non-pre-approved games, as well as to conduct investigations and impose legal sanctions. In extreme cases, GAPP is authorized to revoke the relevant licenses and registrations of non-compliant Internet game operators. Interestingly, other government departments are prohibited from re-examining games that have received GAPP preexamination and approval. It is generally understood that Article II seeks, among other things, to prevent Internet game operators from relying on Internet publishing licenses held by third parties, a practice that was widespread during a period of time when GAPP was not granting such Internet publishing licenses. It is also understood that GAPP has recently resumed issuing such licenses, and therefore GAPP intends to enforce the requirement that Internet game operating companies obtain Internet publishing licenses directly from GAPP.
- Article III confirms that GAPP holds authority for examination and approval of imported Internet games, and that central-level GAPP approval is required before imported games can be offered to the public by Chinese game operators. Under Article III, GAPP holds similar sanctions powers with respect to imported games as those noted above.
- Article IV of Notice 13 expressly prohibits foreign investors from participating in Internet game operating businesses via wholly owned, equity joint venture or cooperative joint venture investments in China, and from controlling and participating in such businesses directly or indirectly through contractual or technical support arrangements. Article IV further prohibits the use of user registration, account administration or point-cards to enable access to Internet games or war game platforms which are de facto controlled or owned by foreign investors, as a means of permitting foreign investors from controlling or participating in online gaming operations and services.
The full Chinese text and an unofficial English translation of Notice 13 is attached for reference as an appendix to this update.
2. Regulatory Background
It is generally understood that Notice 13 represents GAPP's response to the enactment of the Regulations on the Main Functions, Internal Organization and Staffing of the PRC General Administration of Press and Publication issued by the State Council on July 11, 2008 ("Regulation"), the corresponding interpretation thereof issued by the State Commission Office for Public Sector Reform on September 7, 2009 ("Interpretation"), and public comments thereon by Ministry of Culture ("MOC") officials last month.
The Regulation and Interpretation were expected to dispel uncertainties as to which Chinese agency had jurisdiction for approving the establishment of Internet game operators. Before the enactment of the Regulation and Interpretation, MOC and GAPP had both claimed jurisdiction over Internet gaming operations and separately required applicants to file applications with their respective departments to operate online gaming enterprises.1 These overlapping application procedures had been in existence for a number of years and were seen as redundant and burdensome by some applicant companies. The Regulation and Interpretation streamlined the process by authorizing the MOC to regulate the online gaming industry overall, while granting GAPP the authority to grant licenses for the Internet publication of online games.
Notice 13, which GAPP appears to have promulgated without involvement from MOC, continues the debate regarding jurisdiction over the Internet gaming industry by suggesting that GAPP not only has the authority to grant licenses for the Internet publication of online games, but also jurisdiction to regulate aspects of online game operations, including prohibiting the use of the VIE Model.
3. Implications of Notice 13
While Notice 13 appears on its face to prohibit the VIE Model frequently used for investment in the Internet gaming industry, its implementation in practice raises a number of questions:
- First, while GAPP has the authority to grant licenses for the Internet publication of online games pursuant to the Regulation and Interpretation, it appears that the Regulation and Interpretation do not give GAPP authority to regulate the operational aspects of online gaming enterprises, since MOC retains overall administrative authority thereunder. To that extent, Notice 13 may conflict with the Regulation and Interpretation. As a result, it is unclear whether GAPP holds the administrative jurisdiction to enforce the prohibition of the VIE Model that it contemplates.
- Second, Notice 13's restriction of the use of the VIE Model is unprecedented, and it bears noting that other Chinese government agencies whose participation and assistance would be critical for effective enforcement of its prohibitions, such as the Ministry of Commerce, the National Development and Reform Commission, and the Ministry of Industry and Information Technology, did not join GAPP in issuing the Notice. The views of these bodies will be important in clarifying the scope of implementation and enforcement of Notice 13.
- Third, it appears that the promulgation of Notice 13 was, to a significant extent, a reaction to recent actions by certain foreign gaming companies in cooperation with domestic industry players. The restrictions on foreign investors (外商) are broadly written and on their face do not distinguish between strategic industry players and financial investors. As a result, it is unclear whether Notice 13 is intended to target primarily foreign game companies, or also the private equity and venture capital investors who continue to invest actively in the Internet game sector in China. In either case, however, investment or licensing arrangements that give rise to de facto control or participation in Internet game operation services by the foreign party are likely to present issues under Notice 13.
If applied literally and uniformly, Notice 13 would render the VIE structure used by gaming portals and many other Chinese companies that are listed overseas invalid and illegal. However, the Notice has not yet been endorsed by other PRC government authorities, most importantly MOFCOM, whose support will be necessary for meaningful implementation and enforcement. Consequently, it would be premature to write off the VIE Model at this stage. Notice 13 is one in what is likely to be a continuing series of regulatory pronouncements in this area, and further regulations/notices are needed to clarify the issues it presents. We will continue to monitor the situation on behalf of our friends and clients.
1 MOC claimed its approval jurisdiction under the Provisional Measures on Administration of Internet Culture issued by MOC, which became effective in July 2003. GAPP claimed its approval jurisdiction under the Provisional Measures on Administration of Internet Publications issued jointly by GAPP and the Ministry of Industry and Information Technology; this came into effect in August 2002.
English Translation of Notice 13
Notice Regarding the Consistent Implementation of the Stipulations on "Three Provisions" of the State Council and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Preexamination and Approval of Internet Games and the Examination and Approval of Imported Internet Games
Xin Chu Lian  No.13
September 28, 2009
To: The Administration of Press and Publication (Copyright Bureau) and the Office of "Combating Pornography and Illegal Publications" of all provinces, autonomous regions, municipalities directly under the Central Government, the Administration of Press and Publication (Copyright Bureau) and the Office of "Combating Pornography and Illegal Publications" of Xinjiang Production and Construction Corps, the Administration of Press and Publication (Copyright Bureau) of the Propaganda Department under the General Political Department of the People's Liberation Army
On July 11, 2008, the General Office of the State Council issued the Notice Regarding Issuance of the Provisions on the Main Functions, Internal Bodies and Staffing of the General Administration of Press and Publication (National Copyright Administration) (Guo Ban Fa  No.90, hereinafter referred to as the Stipulations on "Three Provisions"). On September 7, 2009, the State Commission Office for Public Sector Reform issued the Notice Regarding the Printing and Issuance of the Interpretation of the State Commission Office for Public Sector Reform on Certain Provisions of the Stipulations on "Three Provisions", issued by the Ministry of Culture, the State Administration of Radio, Film and Television and General Administration of Press and Publication, Regarding the Integrated Law Enforcement for Animation and Comics, Online Games and Cultural Market (Zhong Yang Bian Ban Fa  No.35) (hereinafter referred to as the Interpretation of "Three Provisions"), which is of vital importance for solving the long-term problems of self-created examination and approval, duplication of examination and checking in the administration of Internet games by the General Administration of Press and Publication ("GAPP"), for the performance of examination, approval and administration duties for Internet games, for strict control of contents of Internet games, guiding the development of Internet games, standardizing the administration of Internet games.
To consistently implement the decisions of the Central Government and the State Council in a serious manner, according to the Procedures for the Administration of Internet Information Service and the Regulations on the Administration of Publication of the State Council, the Procedures Regarding the Strengthening of Importation Administration for Cultural Products (Zhong Xuan Fa  No.15) of the Central Propaganda Department and five other ministries and commissions, Several Opinions Regarding Canvassing Foreign Investment into the Cultural Sector (Wen Ban Fa  No.19) of the Ministry of Culture, the State Administration of Radio, Film and Television, GAPP, National Development and Reform Commission, the Ministry of Commerce, and the Stipulations on "Three Provisions" of the State Council and the Interpretation of "Three Provisions" of the State Commission Office for Public Sector Reform, the Notice on further strengthening of the administration of pre-examination and approval of Internet games and the examination and approval of imported Internet games is hereby given as follows:
1. Internet games referred to herein shall mean all Internet game products provided to the public for mutual online use or for downloading through Internet (including cable Internet and mobile communications networks, etc.), which mainly include but not limited to: MMORPG, WebGame, leisure games, Stand-alone games downloading, games with interconnecting functions, interconnected war game platforms, mobile phone Internet games.
Imported Internet games shall mean the Internet game products licensed by overseas copyright owners.
2. Provision to the public with online mutual use or downloading of contents of Internet games through the Internet and such other operation services are Internet game publishing acts which shall be pre-examined and approved in strict compliance with the rules and regulations of the State. GAPP is the governmental department solely responsible for the pre-examination and approval of Internet games as authorized by the Central Government and the State Council.
Without the pre-examination and approval of GAPP and obtaining of the Internet publishing license with scope of operation covering Internet games, any organization or individual shall be prohibited from engaging in online game operation services. Otherwise, the departments for the administration of press and publication will ban the same in accordance with the law and at the same time, inform the department for the administration of telecommunications to cancel the corresponding value-added telecommunication operation service license of such organization or individual and inform the administrative department for industry and commerce to change or cancel the registration in accordance with the law.
All Internet games not pre-examined and approved by GAPP shall not be uploaded and the telecommunication operators shall not provide Internet access services for such Internet games. The Internet games which have been pre-examined and approved by GAPP may be used on the Internet, and any department shall not re-examine such games which shall be administered by cultural, telecommunication and such other departments in strict accordance with the contents of pre-examination and approval by GAPP.
In the event no pre-examination and approval by GAPP has been obtained for Internet games operation or contents of Internet games have changed without examination and approval of GAPP, GAPP shall inform the relevant local department for the administration of press and publication to issue an order for suspension of such operation services, and conduct investigation and impose sanction in accordance with the law.
3. GAPP shall be responsible for the examination and approval of imported Internet games. Authorizations from the copyright owners shall be obtained in advance in accordance with the law for all imported Internet games operated in China, and the formalities for certification of copyrights shall be completed. Upon obtaining of the Approval Reply for Registration of Copyright Contract issued by the department for the administration of copyrights, the operating entity shall make an application to the bureau of press and publication at the provincial level where such entity is located, and the same will be filed with GAPP for examination and approval upon examination by and with the consent of the bureau of press and publication at the provincial level.
In the event imported Internet games operation services in China have not been examined and approved by GAPP, or overseas Internet games operations are marketed in China without examination and approval of GAPP, GAPP shall inform the relevant local department for the administration of press and publication to ban the same and suspend the relevant operation, and inform the department for the administration of telecommunications to cancel the relevant Internet access service and close down the related websites.
Engaging in the operation of imported Internet games without legal authorization by overseas copyright owners shall be deemed as news infringement and piracy, and the National Copyright Administration shall, in conjunction with the administrative departments for telecommunications, industry and commerce and such other departments, establish a case for investigation and sanction according to the Copyright Law of the PRC, and the Regulations on the Protection of the Right of Communication through Information Networks of the State Council and such other laws and regulations.
Suspected criminal cases shall be transferred to the authority of public security for investigating into criminal liabilities in accordance with the law.
4. Investments by foreign investors in Internet game operation services in China by means of wholly-foreign owned, equity joint venture, or cooperative joint venture enterprises shall be prohibited. Foreign investors shall not be de facto controllers of, or engage in the Internet game operation services of domestic enterprises through the establishment of other equity joint venture enterprises, execution of relevant agreements or provision of technology support and such other indirect means, and shall not control or participate in Internet game operation services in disguise by direct introduction of user registration, account administration, pointcard consumption into interconnected game networks, war game platforms with foreign investors as the de facto controller or owner of such platform or by such other means. In the event of a violation of these provisions, GAPP shall, in conjunction with the relevant departments of the State, investigate and handle the same in accordance with the law. In serious cases, the relevant license and registrations shall be cancelled.
5. When an operating entity for Internet games subject to pre-examination or examination and approval for importation by GAPP is changed, the operating entity shall be required to re-initiate the same procedures for pre-examination and approval or for examination and approval for importation. From the date the operating entity changes until the date the new approvals are obtained, all operational services for the relevant Internet games shall be suspended. Otherwise, operations during such time shall be deemed as illegal web publishing.
6. Where new versions, information shall be supplemented or new contents shall be updated for Internet games with the pre-examination or examination and approval for importation by GAPP, the operation entity shall undertake the same procedures for the pre-examination or examination and approval for importation. In case of unauthorized operation of new versions, new information or updating of new contents without the pre-examination and approval or examination and approval for importation of GAPP, GAPP shall cancel the original documents of pre-examination and approval or examination and approval for importation and inform the relevant local department for the administration of press and publication to issue an order in accordance with the law to suspend operation services, and investigate into the case and impose punishment as a case of illegal web publishing. Where unauthorized operation of new versions, new information or updating of new contents and the supplemented or updated contents are in violation of laws and regulations, severe punishment shall be imposed, and the department for the administration of telecommunications shall be informed to cancel the relevant Internet access service and close down the related websites.
Upon the receipt of this Notice, the working departments of news and press, patents, "Combating Pornography and Illegal Publications" of all localities shall immediately forward this Notice to all relevant local administrative departments and enterprises, and centralize the efforts to jointly organize an overall clearance of the examination, approval and operation services of Internet games in this October. Violations of laws and regulations shall be investigated into and handled in a serious manner in accordance with the law.
General Administration of Press and Publication
National Copyright Administration
National Office of "Combating Pornography and Illegal Publications"
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
© Morrison & Foerster LLP. All rights reserved