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Patrick J. Kelly

Patrick J. Kelly International

pkelly@fredlaw.com
612.492.7040
Printable Version

Doing Business in China: Following The Trend - Forming a Wholly Foreign-Owned Enterprise

By: PATRICK J. KELLY

April 2002

Now that the People's Republic of China (China) has joined the World Trade Organization (China's application was approved November 11, 2001), it is poised to enjoy a substantial increase in foreign investment. With growing prosperity and an estimated population of at least 1,273,111,290, China is a market that is impossible to ignore.

The popularity of China as a market is further evidenced by Minnesota's focus on trade with China. Governor Ventura will conduct a trade mission to China in June of this year. In Minnesota, as elsewhere, businesses are investing and doing business in China.

When foreign businesses invest in China, historically they have done so through joint venture arrangements, which do not allow the foreign investor 100% control and ownership of the enterprise. This article discusses another approach-the Wholly Foreign Owned Enterprise, which does allow for 100% foreign ownership.

Background on Foreign Investment in China

China first announced its "open door" policy for foreign investors in 1979, adopting legislation to allow equity joint ventures that permit foreign investors to own Chinese enterprises. The government issued regulations for the equity joint venture in 1983. Until 1986, however, foreign investors could not own 100% of the Chinese enterprise.

From its inception, the most popular investment vehicle by far for investment in China was the equity joint venture. These take the form of a limited liability company, with a separate legal existence that affords liability protection for the company's investors. Chinese and foreign investors share profits and losses in proportion to their respective ownership interests. The foreign investor must supply at least 25% of the capital, and may have majority ownership. Potential disadvantages associated with the joint venture include the uncertainties caused by having a Chinese partner, sharing management, and having to meet certain debt-to-equity ratios.

Wholly Foreign Owned Enterprises

For some foreign investors, the prospect of having to partner with a Chinese investor presents too great a hurdle to investing in a China enterprise. Others hesitate to share technology or business strategies. Still others simply lack the necessary contacts.

The Wholly Owned Enterprise Law of the People's Republic of China was adopted at the Fourth Session of the Sixth National People's Congress, effective April 12, 1986. Rules regulating the wholly foreign owned enterprises (hereafter WFOE, pronounced as woof-ee) were not implemented until December 12, 1990. These rules require businesses to satisfy certain requirements before being allowed to operate a 100% foreign owned enterprise in China. These original regulations required that the WFOE:

  1. Be a manufacturing business

  2. Be in a business area conducive to the development of China's national economy

  3. Be capable of gaining remarkable economic results

  4. Meet at least one of the following conditions:

    1. Use advanced technology and equipment, engage in the development of new products, conserve energy and raw materials, and cause the upgrading of products and the replacement of formerly imported products; or

    2. Export more than 50% of annual output value of all products.

On April 12, 2001, in order to eliminate legal barriers that would impede China's joining the WTO, China announced significant changes to the WFOE regulations, including the repeal of the restrictions described in number 4 above. As a result, the WFOE has become even more popular. Additional changes allowing the establishment of WFOEs for sales or trading companies located in special economic zones, such as certain trade zones around Shanghai, have further enhanced the WFOE's standing among foreign investors.

Process for Establishing a WFOE

Currently, in order to obtain approval for a WFOE, the foreign investor must:

  1. File an application for approval of a name for the limited liability company to be formed

  2. Provide a letter from its bank certifying the good credit standing of the investor

  3. File a feasibility report with the local county government where the enterprise will be located stating the purpose or aim of the enterprise, scope or scale of the business, and estimated need for power and water (this requirement has been eliminated in Shanghai, but may still be required in other locations)

  4. File an application with the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and be granted a license from MOFTEC to operate. The application requests information on the investor and must include a business plan. If the WFOE is going to concentrate on sales and trading rather than manufacturing, the applicant must locate the enterprise within a designated special economic zone and obtain a lease for space within such a zone prior to making an application for the establishment of the WFOE

  5. File an application with local authorities with basic information concerning the investor and providing basic corporate documents of the investor.

If the applications mentioned above are approved, and the name proposed for the WFOE is available, the investor files the Articles of Association for the WFOE limited liability company.

Characteristics of the WFOE Limited Liability Company

The WFOE limited liability company is a separate legal person and offers limited liability protection to the investor. Requirements include:

  1. Only one member/owner

  2. Three directors, none of whom need be Chinese citizens or residents

  3. A general manager/president, who is not required to be a Chinese citizen or resident

  4. A minimum capitalization of approximately $200,000 U.S. (this requirement may vary depending upon local regulations).

The process of applying for approval of a WFOE can be complicated. Preparing the application, leasing space in one of the free trade zones and laying other groundwork can take several months. Once the application and the Articles of Association of the WFOE are filed with the appropriate Chinese authorities, the authorities must respond to the application with an approval, denial or request for additional information within 30 days (this time period can vary from province to province).

If you have additional questions regarding establishing a WFOE, or regarding doing business in China generally, please contact us.