Compliance in dismantling of a red-chip structure

The erection of a red-chip structure generally involves the founding shareholder of a domestic company first establishing an offshore special purpose vehicle (SPV) in the British Virgin Islands or Cayman Islands, using the SPV to establish a wholly owned subsidiary in Hong Kong, then having the Hong Kong subsidiary establish a wholly foreign owned enterprise (WFOE) in mainland China, which executes various agreements with the domestic company for the control of domestic equity, and finally having the SPV, as the financing platform, sell preferred shares or convertible loans to a fund to carry out private financing and realise the overseas listing of the SPV.

Where a company abandons its overseas listing plan to list domestically instead, it is known as an “unlisted red chip return”. The clearest and most straightforward model of red-chip return is the complete dismantling of the red-chip structure. When carrying this out, it is necessary not only to pay attention to the method of buying back the equity of the other offshore investors in the entity that was to be listed offshore, but also to the issue of compliance in the buyback procedure, and of the buyback funds.

Procedural compliance

The basic method of dismantling a red-chip structure is to carry out the operations in reverse. If the actual controller is a domestic enterprise or natural person, it or he/she should proceed in a manner that is the reverse to that when the red-chip structure was erected, and repatriate the relevant equity to China. The usual dismantling procedure will see the domestic company establish a wholly owned subsidiary offshore – generally Hong Kong – to acquire all of the equity of the other offshore investors in the offshore company, thereby severing control of the offshore structure. Once the offshore red-chip structure has been eliminated, the offshore company correspondingly begins the deregistration work, and the deregistration of the WFOE established in China, as well as the negotiated control model, also need to be carried out and a series of termination agreements executed.