Complex patchwork of corruption risks

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China is very attractive to international capital, and numerous industrial parks and development zones have even become hot spots for foreign investment. But investment in industrial parks involves many potential risks as well. One of the risks is the investment policy risk, which is often overlooked by investors during the initial stage of an investment in industrial parks. Whether potential policy risks contained in the special industrial park investment patterns in China will be translated into actual damage depends on how well investors are aware of policy risks and what methods they are going to take to prevent and control them. The major task of an industrial park is to attract foreign investment in setting up factories in the park. During this process, the business attraction department or the management committee of the park often offers preferential tax or support policies to foreign investors.

Although these policies are attractive, they contain some risks.

What are the risks?

Changes in the laws or regulations of a government at a higher level. The preferential policies of an industrial park are often designed by the people’s government in a county or municipality where the park is located, and sometimes even by the administrative committee of the park. These “preferential policies” are mostly refined on the basis of the relevant documents of the central government or the government at a higher level, and mostly made as internal documents, rather than laws, regulations or rules. Therefore, in case of any conflict between newly enacted laws, regulations or rules and the policies of an industrial park, or in case the department of a government at a higher level introduces new policies to attract investment, it will be difficult to assure such policies will have legal force.

Policies in violation of the law. In order to attract foreign investors, industrial parks will sometimes make some preferential commitments by bypassing restrictions under laws or regulations. For example, some parks will promise investors that they can acquire land at an extremely low price by excluding others from bidding for the land, or that the actually transacted land price will be lower than the quoted price, and that part of the price difference will be returned to the investors. These commitments are actually in violation of Chinese laws governing land grant process and proceeds from such land grants, and should be null and void in law. These special commitments are implemented ultimately with the help of the management committees of industrial parks. This is very subjective.

Policies vary from person to person, and are not applicable uniformly. Industrial parks tend to offer more preferential and attractive policies for large-scale and reputable investment projects, which will help enhance the park’s image. For example, they will make huge offers or concessions to attract large investors in terms of the actual price of land grant, percentage and number of years for tax refunds, supporting facilities and assistance in the employment of workers. However, the ultimate criteria for these policies are often set following several rounds of negotiations, and these policies should not be directly used as publicly available investment attraction policies, since they are highly uncertain.

Limitations of administrative jurisdiction. The preferential policies of an industrial park are made by a local government or the administrative committee of the park. They have an influence and a binding force, to a certain degree, on the relevant administrative authorities directly under the local government. However, the enforcement of these policies will be heavily undermined with respect to those administrative functional authorities not directly under the jurisdiction of the local government.

Foreign investors in industrial parks need to scrutinise policy conditions.
Foreign investors in industrial parks need to scrutinise policy conditions.

We have dealt with a case in which a local government in a place made a commitment to an offshore fund that a cross-border renminbi equity fund would be set up in that place, and that foreign exchange settlement would be very convenient. However, after the offshore fund arrived, it was told by the local administration of foreign exchange that it had to carry out foreign exchange settlement in strict compliance with relevant procedures. The fund encountered a lot of restrictions in the actual foreign exchange settlement, and ended up in failure.

How to cope with crisis

When the above policy risks translate into an actual crisis, the approach taken by an investor will have a direct impact on whether the risk will deteriorate further. The risk control mechanisms of some foreign companies are likely to produce an opposite effect. For example, although costs could be saved and procedures regulated if the legal affairs concerning an investment in the establishment of a company in an industrial park are to be handled exclusively by the overseas headquarters or the China headquarters located in Beijing or Shanghai, in fact this will weaken the capacity of the local company to deal with the crisis in a timely manner. The instructions given by the investors (or the headquarters) that exercise control in a different location may also be incompatible with local culture or legislation, or an erroneous judgment may be made due to misunderstanding of the local special policy environment.

 Ian Zheng
Ian Zheng

Some investors will directly apply an overseas corporate regime to Chinese local enterprises, or will resort to their “counterparts” or “fellows” in China instead of seeking local professional legal support when they encounter a problem. This is likely to trigger unnecessary legal risks as well. We recommend that foreign investors making an investment in industrial parks engage local professional foreign-related business lawyers to analyse and determine the compliance of relevant policies and help them complete the deal structure and investment negotiations.

Preferential policies should be expressly specified under investment agreements, and visits should be paid to relevant administrative departments to understand whether these policies are operational and feasible. For some large projects, a request should be made to a local people’s government, where necessary, asking it to issue approval documents on key, special preferential policies to ensure such policies remain in force.

Ian Zheng is a partner at Zhong Hao Law Firm in Chongqing. He can be contacted on +86 23 6371 6888 or by email at ian@zhhlaw.com