By Linda Lau and Victoria Yan
As part of efforts to promote trade, in August 2013 the State Council of the People’s Republic of China officially approved the establishment of the Shanghai Pilot Free Trade Zone per the “Shanghai Pilot Free Trade Zone Comprehensive Program”. The program was officially established on September 29, 2013. The Guangdong, Tianjin, and Fujian Pilot Free Trade Zones were later established On April 21, 2015.
Free trade zones are just one of the many pilot measures implemented by China for reforming government functions, financial systems, trade services, foreign investments, and tax policies. These free trade zones also work to promote the development of Chinese trade. In the wake of the establishment of free trade zones and the passage of these new policies, domestic and foreign law firms hope to ride the success of these new developments, expanding the scope of their businesses and services, along with consistently satisfying the legal and business demands of clients both in Chinese and foreign markets.
On January 27, 2014, The Ministry of Justice of the People’s Republic of China officially approved the “Work Plan for the Pilot Program of Exploring the Manner and Mechanisms for Close Business Cooperation Between Chinese and Foreign Law Firms in the Shanghai Pilot Free Trade Zone.” The plan was formulated by the Shanghai Municipal Bureau of Justice (“Shanghai Bureau of Justice”) and paved the way for Chinese and foreign law firms to utilize free trade zone policies to expand their markets and facilitate more meaningful collaboration with one another. On November 18, 2014, the Shanghai Municipal People’s Government issued the “Implementation Measures for Mutual Assignment of Lawyers to Serve as Legal Consultants by Chinese and Foreign Law Firms in the Shanghai Pilot Free Trade Zone” and the “Implementation Measures for Economic Association Between Chinese and Foreign Law Firms in the Shanghai Pilot Free Trade Zone” (“Implementation Measures”). These plans were both developed by the Shanghai Bureau of Justice and both of these policies established guidelines for each of the following: necessary conditions for the exchange of lawyers between Chinese and foreign law firms, necessary conditions for establishing joint offices, providing legal services, liabilities and responsibilities of firms, and supervision mechanisms.
- I. The Status and Trends of Joint Services Between Chinese and Foreign Law Firms
The above plans are among the first 23 liberalization measures in expanding and opening up service industries and they represent a major milestone in the liberalization of legal services in China.
On April 15, 2015, the international law firm Baker & McKenzie and the Beijing-based FenXun Partners announced their plans to establish and operate a joint office in the Shanghai Pilot Free Trade Zone, the first joint office of its kind approved by the Shanghai Bureau of Justice. This was a move of historical significance for both firms as they built a platform from which they could better manage Chinese and international legal services for their clients. Recently, Standard Chartered Bank (China) opened an account for the newly formed, Baker & McKenzie FenXun in the Shanghai Pilot free trade zone. It was the first such account opened for a Chinese-foreign joint office since the Implementation Measures were issued. Since the opening of this account, Baker & McKenzie FenXun has been able to maintain their financial independence while also centralizing the collection of legal service fees—greatly simplifying the payment process for each firm, as well as, contributing to the development of their joint business.
In August 2015, the Pudong New District Market Supervision Administration in Shanghai issued the “Notice on Permitting Shanghai Llinks Law Offices, et al., to Use Their Workplace as a Centralized Registration Location.” This notice permitted seven law firms – Shanghai Hongqiao Zhenghan Law Firm, Shanghai Llinks Law Offices, Beijing DHH Law Firm, Shanghai Yuanshi Law Firm, Shanghai Pu Dong Law Office, Beijing Zhong Yin Law Firm, and Beijing JunZeJun Law Offices – to conduct centralized registration of other business by using their workplaces as a registration address for the enterprises in the free trade zone, with no limit to the number of businesses they can register. This policy greatly facilitated the registration of foreign enterprises in the free trade zone. Foreign enterprises are also able to use the free trade zone’s preferential policies to continue furthering investments in China or to conduct investments overseas.
At present, 130 foreign law firms (excluding those in Hong Kong and Macau) have established representative offices in Shanghai. Generally, these foreign law firms are well established and they have high requirements for maintaining professional conduct. As of June 7, 2016, 1,438 law firms have registered with the Shanghai Bar Association, and nearly 70 percent of these were not compliant with the requirements for the mutual exchange of lawyers or for the establishment joint offices. Currently, there is extremely high demand in China for international legal services, not only for those domestic enterprises that are branching out and need an understanding of foreign investment environments, but also foreign enterprises entering the Chinese market, requiring an understanding of Chinese legal regulations.
According to a report by Phoenix Satellite Television Company, Chinese enterprises are currently strengthening their active mergers and acquisitions globally. In the first three months of 2016, the volume of overseas mergers and acquisitions carried out by Chinese enterprises came close to reaching the record amount for the entire year of 2015. Meanwhile, Chinese investors’ enthusiasm for migrating to the U.S. is as high as ever, and although the EB-5 application process is facing a retrogression, there is no stopping the surging demand for green cards by Chinese investors.
- II. Necessary Conditions for the Exchange of Lawyers and for the Operation of Joint Offices
The exchange of lawyers is often done according to an agreement between a Chinese and a foreign law firm where one assigns lawyers to the other party to provide services to the receiving firm’s clients. By utilizing each lawyer’s practice area and expertise, the offices work together to develop collaborative approaches and strengthen industry cooperation.
The operation of joint offices require agreements between Chinese and foreign law firms to work closely to provide legal services related to both Chinese and foreign law.
Chinese and International Law firms looking to either exchange lawyers or establish a joint office must meet the following requirements:
l Chinese law firms must meet all of the following six conditions: (1) the firm must have been established for at least three full years; (2) they must have adopted a partnership business model; (3) they must employ at least 20 full-time lawyers; (4) the firm must have relatively strong legal capabilities and must meet the governmental standards of internal management; (5) the firm must not have been subject to any administrative penalties in the last three years; and (6) the firm must be either based entirely in either Shanghai or in another province, autonomous region, or municipality with a Shanghai branch.
l Foreign law firms must meet the following two conditions: (1) they must have established a representative office in Shanghai for three full years or have a representative office in another city for three full years as well as one in Shanghai for any amount of time; and (2) the representative offices must not have been subject to any administrative penalties within the last three years.
l In addition to the above conditions, Chinese-foreign joint office must have at least one party establish a representative office in the free trade zone, i.e., a foreign law firm should establish a representative office in the free trade zone or a Chinese law firm (or a branch) should do the same. A Chinese or foreign law firm can only establish lawyer-exchanges and/or joint offices with another law firm, and cannot establish these relations with multiple firms. A Chinese law firm’s branch office or a foreign law firm’s representative office cannot be a party for a lawyer exchange or joint office, only the main offices of each party may participate.
Additionally, Chinese lawyers dispatched to a foreign law firm’s representative office in Shanghai to serve as an advisor on Chinese law must meet the following three conditions: (1) they must have at least five years of experience practicing law in China; (2) they must have relatively strong capabilities in handling Chinese domestic law and laws pertaining to foreign affairs; and (3) they must not have received any administrative penalties in the last three years.
Lastly, the person in charge of a Chinese law firm or branch and/or the person in charge of a foreign law firm, or its representative office in China, may not be exchanged to the opposite party.
Chinese and foreign law firms should put “lawyer exchange” and “joint office” agreements in writing. Only the Chinese and foreign law firms can be parties to the agreement, and the term of the agreement must be for at least two years. After the term expires, both parties may begin talks to renew the agreement in accordance with relevant government regulations. Lawyer exchange agreements must contain at least seven required items and joint operations agreements should contain at least 13 required items.
- III. EB-5 Industries Can Profit From Joint Operations Between Chinese and Foreign Law Firms
As many people are aware, investors who want to obtain a green card though the EB-5 program must invest funds into a U.S. based project. Meaning, there must be an existing project to invest in. Free trade zone policies provide great advantages for the establishment of EB-5 projects. This kind of cooperation between Chinese and American law firms can provide dual legal safeguards for the establishment and operation of EB-5 compliant projects. For example, Beijing DHH Law Firm (Shanghai) utilizes free trade zone policies to carry out research on foreign investment and funds utilization, which has resulted in the creation of two legal services: “legal expertise on low-cost foreign investment through the free trade zone policy” and “legal expertise on bidirectional pool of funds in the free trade zone”.
First, “legal expertise on low-cost foreign investment in the free trade zone” provides specialized services at a lower cost and higher efficiency for those enterprises with foreign investment goals. Firms accomplish this through utilizing special economic policies for cross-border investment in the free trade zone combined with partnerships with qualified banks in cross-border investments. This legal service is suitable only for enterprises incorporated in the Shanghai Free Trade Zone. According to current regulations, there are limitations on the amount of money that can be placed in overseas investments. Specifically, the amount invested in natural resource development must be under $300 million and non-natural resource development must be under $100 million. At the same time, during the foreign investment process, such enterprises can use the free trade zone as a platform to obtain low-cost financing abroad for investment projects.
Those companies who wish to establish an EB-5 investment project in the U.S. can utilize free trade zone policies to register a company in the free trade zone. They can then use the same company name to establish a company or a platform company in the U.S. or any other country. The company in the free trade zone would hold a controlling share of the subsidiary company, and thus minimize its tax burden by employing overseas tax benefits and utilizing tax agreements between China and foreign countries.
Secondly, “legal expertise on bidirectional pool of funds in the free trade zone” provides specialized service for those enterprises with multiple subsidiaries to utilize the “Notice of the Shanghai Head Office of the People’s Bank of China on Supporting the Expansion of the Cross-border Use of RMB in China (Shanghai) Pilot Free Trade Zone” to cooperate with qualified banks and allow for the easy cross-border transfer of currency. Specifically, multinational companies will register a subsidiary in the free trade zone and use it to establish a bidirectional account but all transfers must be done though this account. The funds must be generated from production and operation activities or other industrial investment activities, but not from any financing activities. For multinational corporations, the benefit of this service is having accessible internal financing between a corporation’s member enterprises, both domestic and abroad, with no limits on the amount, or purpose, of the funds.
Before the launch of these policies, China’s large-scale corporations funded mergers and acquisitions primarily through loans. If a large corporation wanted to profit from these acquisitions they could rely only on the dividends of their subsidiaries to receive returns on their investment. Once these policies were enacted however, the efficiency of corporations’ internal fund settlements improved significantly.
For those multinational corporations looking to establish an EB-5 project, bidirectional cross-border accounts in the free trade zones will accelerate the process. These funds, along with establishing a company in the United States., are critical to the Chinese-American investment chain. This allows the RMB to flow freely within the enterprise and easily convert between RMB and USD internally, thus avoiding the limitations associated with strict foreign currency policy.