Foreign-Invested Partnership Rules Issued: Partnership Form Will Ease Foreign Investment In Industries

Article by Lawrence Sussman , Qiang Li Walker Wallace , and Yi Zhang

The door for foreign individuals and entities to invest directly in partnership enterprises in China officially opened with the issuance of the Administrative Measures for Foreign Enterprises and Individuals to Establish Partnership Enterprises in China (the "Measures") by the State Council on December 2, 2009.

Previously, only domestic individuals and entities registered in China may be partners of partnership enterprises in China.  After the Measures take effect on March 1, 2010, foreign investors will be able to set up foreign-invested partnerships ("FIP") in China either by themselves or by partnering with domestic individuals or entities.  FIPs will be governed by the Partnership Enterprise Law, issued as a general rule over partnership enterprises in 2007, and will be limited by the Foreign Investment Industry Catalogue.

In an unprecedented development, the Ministry of Commerce and its local counterparts ("MOFCOM") seem to have stepped down from the gatekeeping role for FIPs.  Historically, prior approval from MOFCOM, as the watchdog for any form of foreign investment, is a prerequisite for foreign-invested enterprises to obtain a business license issued by the State Administration of Industry and Commerce or its local branches (the "Registration Authority").  Under the Measures, however, FIPs may go directly to the Registration Authority for establishment, any subsequent change, and termination.  Instead of approving, MOFCOM will only be notified by the Registration Authority after the registration is completed.  Note, however, that market watchers maintain a significant amount of healthy skepticism as to whether MOFCOM would indeed allow FIPs to operate without their involvement.      

A pipeline of detailed rules on FIPs must follow to supplement these sixteen-article-long Measures from various practical standpoints including registration, tax, foreign exchange, bank accounts, accounting, customs, etc.  It remains to be seen how the Measures will be interpreted and applied by various levels of government departments, which may affect whether and when the FIPs may be able to gain popularity against other existing forms of foreign investment, such as equity joint ventures, cooperative joint ventures and wholly-foreign owned enterprises.  

Special implications for private equity funds

The Measures are of great interest to a wide range of Chinese industries that involve foreign investment.  Of particular interest is the venture capital and private equity fund industries, where partnership enterprises are the preferred legal form.  Currently, foreign participation in Chinese private equity funds is predominantly structured by way of indirect investments in Chinese partnership enterprises and direct investments in other Chinese vehicles (including foreign-invested venture capital enterprises).  The Measures open up the possibility of having direct foreign investment (the so-called "foreign LPs") in Chinese private equity funds in the form of partnership enterprises.  Although a step in the right direction, the Measures however do not fully allow such foreign LP investment.  Instead, the Measures have taken a classic tentative approach:  the Measures do not carve out FIPs from the investment sector but at the same time suggest that other regulations could more properly govern this space.  In addition, a set of Q&As issued by the Legal Affairs Office of the State Council explaining the Measures make specific mention of the private equity industry and indicate that a flexible approach should be taken.  Interested investors should continue to follow the future rulemaking by various regulatory authorities on this topic.  

O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.

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