Control risks before submission of FIE equity contract for approval

China currently implements an approval system for foreign investment, with the establishment, division, merger and changes in the major particulars of a foreign-invested enterprise (FIE) all subject to the approval of the approval authority and the relevant registration with the administration for industry and commerce.

Article 3 of the Several Provisions on Changes in the Equity of Investors of Foreign-Invested Enterprises specifies that “changes in the equity of investors of foreign-invested enterprises shall comply with the relevant laws and regulations of China and, pursuant hereto, be subject to the approval of the approval authority and registration of the change by the registration authority”.

From this, it can be seen that changes in the equity of FIEs fall within the scope of matters subject to approval, and equity transfer contracts that have not been approved by the approval authority do not enter into effect.

However, in practice, the counter-parties to many contracts are negligent in performing their approval obligations, or refuse to co-operate in such procedure, after the execution of an equity acquisition contract. If it is to their advantage, they will carry out the approval procedure, but if not, they do not.

They may even go as far as not performing the contract on the grounds that the equity transfer contract is invalid because it was not approved. Accordingly, control of the legal risks before an FIE equity acquisition contract is submitted for approval is of particular importance.