Stricter Supervision of Foreign Representative Offices in China

By Ralph Koppitz* and Stephen Wu**, Taylor Wessing Shanghai Office

On January 4, 2010, the State Administration of Industry and Commerce and the Ministry of Public Security of the People’s Republic of China jointly issued the Circular on Further Strengthening the Administration of the Registration of Foreign Enterprise Resident Representative Offices in China (“Circular”). This Circular was seemingly prompted by an increasing observance of illegal activities by representative offices of foreign enterprises. The Circular will have a significant impact and lead to a stricter supervision of foreign representative offices in China.

The indirect aim of the new Circular is the encouragement of setting up limited foreign invested liability companies instead of registering representative offices in China. The Circular does not apply to unregistered “liaison offices” of companies registered in China, which sometimes are also misleadingly referred to as “representative offices” (and where more flexible rules apply).


Strict Form Requirements during Registration

As in the past, when applying for the establishment or a name change of a representative office, the applicant needs to submit certain documents including foreign enterprise’s registration document (an excerpt from the commercial register, a business license or the like) evidencing the foreign enterprise’s legal operation.

The Circular requires that the foreign enterprise must already be in existence for at least two years. This requirement does not exist for the setting-up of a subsidiary company in China. This makes the establishment of a representative office less attractive for start-ups, where simultaneously a presence on the China market is needed. In case the two-year record of the foreign head office does not exist, the only alternative for an immediate set up would be the establishment of a limited liability company as subsidiary in China. The establishment of a foreign invested enterprise leads to more cumbersome approval processes and especially to the need of an investment by injecting registered capital.

In relation to the required documents the foreign enterprise’s registration document as well as a bank letter of creditworthiness both need to be notarized by a public notary at the location of the foreign enterprise and thereafter legalized by the competent Chinese embassy or consulate.

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Whether any documents submitted prior to the issuance of the Circular not meeting the above-mentioned requirements might have an impact on the valid registration of the representative office is not addressed in the Circular. It is unlikely that any requests for the curing of potential past defects will be raised by the registration authorities. However, the Administration for Industry and Commerce as the registration authority might in future request notarized and legalized documents (if not yet submitted in such form) at the time when the representative office applies for any change registration or renewal of the representative office’s validity term.


Registration Term

The Circular emphasizes the current rule set out in the 1983 Administrative Measures on the Registration of Representative Offices that the validity term or any renewals shall always be only for a period of one year. In the event that a registration certificate was issued for longer than one year in the past, such certificate shall be replaced by a certificate bearing a one-year term when the representative office applies for change registration or renewal.


Number of Representatives

A completely new rule stipulated in the Circular is that the number of the representatives of the representative office shall “generally” not exceed four persons including the chief representative. Foreign staff of the representative office can only be registered as representatives. If the current number of representatives exceeds four persons “in principle” only de-registration of the representative(s) is permitted and no further representative(s) may be added.

This stipulation leads to various concerns. Firstly, the words “generally” and “in principle” seem to indicate that exceptions to the four-representative rule may be possible. However, the Circular is completely silent on the question in which cases such exemption could be granted (e.g. only in special individual cases or generally in certain industries). Especially more cautious registration officials may now be very reluctant to register any set-up with more than four representatives, even if valid reasons could be provided by the applicant. It would also not be uncommon for China to not further clarify such exceptions regarding the above rule. This would result in a high degree of governmental discretion and corresponding legal uncertainty whether or not a higher number can exceptionally still be registered. Even if a number larger than four is exceptionally permitted, any later change of the consenting government official may still lead to a changed position of the authority at a later point in time. There will be no guarantee that any earlier precedents will be followed in the future.

The second and much more imminent practical question is the rule’s effect on existing representative offices with more than four representatives. It appears that it will not be required to actively apply for de-registration of the surplus representatives, and there is neither any stipulation forcing the registration authority to request de-registration of the surplus representatives, e.g. when the representative office applies for the next change or renewal registration. However, since a replacement of representatives may in such case not be possible, affected foreign companies will need to very quickly consider an alternative set-up to host such staff, e.g. a limited liability company (Sino-foreign joint venture, or wholly foreign owned enterprise, where permitted).


Inspections

According to the Circular, the local Administration for Industry and Commerce shall conduct on-site verification and examination on the registered items of newly established representative offices within three months upon the issue of the registration certificate. Representative offices should be well prepared for such inspection, which may – especially if conducted jointly with the public security bureau - also lead to a review of the passports of foreigners found in the premises as well as their residence and employment permits.

Any illegal acts like provision of false documents, expiration of validity term, unlawful (unregistered) change of the office site, etc. shall be controlled.

A further key aspect is the supervision of the business activities. Representative offices are only permitted to carry out liaison work for their head office. Active business activities are not permitted. In particular no business income may be generated by a representative office. If a representative office receives payments for business activities in any forms, administrative punishments may be imposed. The legal consequences of such illegal activities and business income include the revocation of the registration, confiscation of illegal proceeds, and fines up to RMB 500,000 (approx. EUR 50,000) depending on the severity, or even criminal liability. The amount of the administrative fines stipulated in the Circular for illegal business activities of representative offices is in serious cases much higher than the maximum of RMB 20,000 as stipulated in the old 1983 regulations.


Cooperation with the Public Security Bureau

The Circular requires closer cooperation between local Administrations for Industry and Commerce and the Public Security Bureaus. The Administration for Industry and Commerce shall regularly report the registration information and any illegal activities of representative offices to the exit-entry administration departments of the Public Security Bureaus. Representatives of incompliant offices should expect to be refused entry or exit to or from China or, in serious cases, even detention by the police.

* Ralph Koppitz (Partner, Taylor Wessing Shanghai)
Ralph advises German and international manufacturing and service companies on all legal aspects related to their business transactions in China. This includes the areas of foreign direct investment, M&A (share and asset deal acquisitions, mergers of foreign invested enterprises, equity transfers), restructuring and liquidation, technology transfer, and labor law. Ralph has specific experience in the manufacturing (including medical devices, pharmaceutical, chemical), and service sectors (including logistics, trading and certification services). Increasingly important becomes the advice concerning China-outbound M&A and direct Chinese investments in Germany.

** Stephen Wu (Associate, Taylor Wessing Shanghai)
specializes in foreign direct investment, general corporate law, and China-related M&A. He advises foreign companies on all aspects of Chinese laws in relation to their strategy and business in China and projects in various areas in particular in the general manufacturing. Stephen has special experience in the medical device sector.

The contents of this newsletter are a general information on the respective subject matter only and cannot be treated as a complete description or a substitute of specific advice.