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M&A in China Comes of Age

A variety of structures exists for foreign investors interested in mergers and acquisitions in China

Cole R. Capener

The recently announced mega-mergers of Daimler-Benz with Chrysler, Citicorp/Citibank with the Travelers Group Inc., and BankAmerica Corp. with NationsBank, have driven worldwide merger-and-acquisition (M&A) activity to new heights. These and other announced M&A transactions are certain to push this year far beyond 1997's record-breaking level of $1.6 trillion in aggregate value of such transactions. China has not been left out of this M&A frenzy, and it should come as no surprise that "M&A" has become a buzzword there as well. Indeed, the PRC has emerged as a key participant in, if recent arrival to, the international M&A field.

A popular target for foreign direct investment over the past decade and a half, China's investment environment is undergoing a gradual transformation. With the PRC investment climate maturing, both foreign and domestic investors' needs and strategic plans are changing. The rules governing business relationships have become both more settled and somewhat more sophisticated, and are coming to resemble their counterparts in other countries.

It is within this evolving investment environment that China's M&A activity has begun to grow. Last September's 15th Communist Party Congress, with its emphasis on State-sector reform, and the selection of Zhu Rongji as premier at the March 1998 National People's Congress, suggest a new openness and pragmatism, and a promise of even greater flexibility for foreign investment in China. The reality, unfortunately, is somewhat less clear cut; no panacea is likely to appear to transform China overnight into an easy country in which to do business. But certain systemic changes nonetheless promise greater M&A opportunities.

Back to basics

What exactly is M&A and does it really exist in China? While the term "M&A" refers generically to any combination of two or more business enterprises, a "merger" and an "acquisition" are two distinctly different legal transactions in many jurisdictions, including the United States--and China. An "acquisition" (shougou) can be defined as the purchase by one economic entity of all or part of the shares or assets of another economic entity. Both economic entities survive after the purchase. A "merger" (hebing or jianbing), on the other hand, is the legal combination of two discrete economic entities in which only one entity survives and assumes, by operation of law, all the assets and liabilities of both entities.

In developed economies like those of the United States and some European and Asian countries, M&A transactions can assume myriad forms. In the United States, for example, an acquisition could take the form of a purchase of a target company's assets with either cash or shares; a cash purchase of shares in the target; a purchase of shares in the target with the purchaser's shares; or some combination of these forms. Mergers, like acquisitions, can be effected with shares or cash. The transaction can leave the purchaser in place, in the case of a forward merger; leave the target in place, in the case of a reverse merger; or involve a subsidiary of the purchaser merging with the target, in the case of a triangular merger.

China in 1998 does not yet permit all of these M&A structures, but as its market sector matures, all of these forms inevitably will become more familiar to M&A participants in the PRC. Indeed, over the past several years, foreign investment in China has taken a number of M&A forms, including the acquisition, by a foreign-invested enterprise (FIE), of all of the assets of a going concern (usually a State-owned, township, or collective enterprise); the purchase of shares in a listed or unlisted PRC company; and the purchase from other foreign investors of existing interests in PRC entities.

M&A's recent history in China

The first foreign investment deals in China tended to be greenfield projects in which the parties funded a joint-venture company and built a new factory, usually furnished with imported machinery and equipment. Today, foreign investment is more likely to consist of a takeover of a PRC business by a newly established joint venture, in which the foreign partner has majority control, or by a wholly foreign-owned enterprise (WFOE).

Share purchases have also surfaced in the 1990s as another option for foreigners seeking to acquire an interest in a PRC company. Share-purchase transactions are not entirely new to China: foreign investors have long been permitted to acquire B shares in PRC-listed companies. In the last few years, however, an avenue has emerged for private equity deals in which foreigners can purchase shares through a private placement in an unlisted company, and for strategic investment by share acquisitions in listed companies.

The 15th Party Congress officially blessed the increased use of a Western-style, share-issuing corporate vehicle, known as a joint stock limited company (gufen youxian gongsi, also translated as company limited by shares) to hold State-owned assets (see p.18). Many non-share issuing State-owned enterprises (SOEs) are likely to convert into joint stock limited companies, providing foreign investors with opportunities to buy directly the shares of a going concern. Although it appears, from PRC and Hong Kong press reports, that Zhu Rongji may not share PRC President Jiang Zemin's enthusiasm for allowing State-owned assets greater autonomy through the use of this form, such deals are likely to prol iferate.

The last few years also have witnessed the emergence of a secondary market for investments in existing FIEs established by early investors in China. Some take the form of the purchase of an interest by one foreign party from another, or by the foreign party from the original Chinese party; or a sale from a foreign party back to either the Chinese party or a third party. Increasingly, the purchase and sale of such interests take place through transactions involving the transfer of shares held by a Hong Kong or other "offshore" holding company. The experienced M&A participant will find such transactions largely indistinguishable from cross-border acquisitions anywhere in the world.

Like acquisitions, mergers among domestic PRC companies have become commonplace. Such mergers attempt both to rescue failing SOEs by combining them with healthy enterprises, and to create Korean chaebol-like conglomerates, which Chinese policymakers believe will enable them to compete more effectively against foreign competitors both at home and abroad. Mergers directly involving foreign companies are still not possible in China, but as foreign investors seek to restructure their existing PRC holdings, there have been a growing number of mergers of FIEs. The flurry of mega-mergers outside of China, moreover, dictates some consolidation of the merger parties' entities within China.

Building the legal and regulatory framework

The array of laws and Chinese regulations governing M&A transactions is expanding rapidly. The applicable laws for a given deal will depend on how the deal is structured. In general, acquisitions common in the Chinese M&A market today take one of two forms. In the "direct acquisition" structure, a foreign investor either purchases assets through a company registered in China, or directly purchases shares (or an interest in the registered capital) in a listed or unlisted company registered in China. In an "indirect acquisition" structure, a foreign purchaser acquires the shares in a non-PRC offshore holding company, the assets of which include an interest in a company or companies registered in China. The various M&A scenarios possible in China include the following:

• Asset purchase PRC law generally does not permit the acquisition of a domestic company's assets by a foreign entity unless the foreign acquirer has established (or concurrently establishes) a registered presence in China, in the form of either an equity or cooperative joint venture, a WFOE or, more recently, a joint stock limited company. In addition to the respective pieces of legislation that apply to joint ventures and WFOEs, these entities are theoretically subject to the relevant provisions of the Company Law, which also govern the establishment and o peration of joint stock limited companies. The Company Law stipulates, however, that where the provisions of legislation governing each type of FIE are different from those of the Company Law, the laws and regulations specifically relating to the FIE will prevail. Generally, asset acquisitions of Chinese targets must be made through a PRC-registered FIE in which the foreign investor owns at least a 25 percent interest. But in late 1997, the Shanghai municipal government issued the Several Opinions on Promoting Opening to the Outside World and Extending the Use of Foreign Investment, which permit foreign investors to acquire assets of a domestic enterprise through an investment vehicle in which they hold less than 25 percent. Though this policy applies only in Shanghai, it may eventually be extended throughout the country. All direct acquisition transactions are subject to PRC government approval, either local or central. The establishment of the acquisition vehicle and the acquisition project must be approved by foreign-investment and planning authorities, respectively. Whether an acquisition of the assets of (or merger with) a Chinese target is permissible will depend in large part on State policies for industrial development and the direction of foreign investment. PRC regulations classify all foreign investment projects into four categories: encouraged, permitted, restricted, and prohibited. The Guiding Catalogue for Foreign Investment in Industry (the Cata logue), first issued in 1995 and recently amended and effective January 1, lists the various industries in which foreign investment is encouraged, restricted, or prohibited (see The CBR, March-April 1998, p.4).
• Purchase of registered capital in an FIE Compelled by financial or strategic imperatives, foreign investors with previously established FIEs in China are increasingly pursuing exit strategies. In most cases, the sole option is to sell the registered capital in the entity, either to one of the other equity holders in the joint venture (if the investment is through a joint venture) or to a third party. The Several Regulations of the Ministry of Foreign Trade and Economic Cooperation [MOFTEC] and the State Administration for Industry and Commerce [SAIC] Concerning Changes in Equity Interest of Investors in Foreign Investment Enterprises (the Equity Change Regulations), adopted in May 1997, represent the PRC government's attempt to address this type of M&A transaction.
      In fact, much of the content of the Equity Change Regulations is not new, but offers more specific guidance on the approval process and requirements, as well as additional restrictions. For example, the Equity Change Regulations stipulate that MOFTEC must approve the equity sale from the Chinese party to a foreign party in a joint venture if, as a consequence of the foreign party's purchase, the joint venture would be converted into a WFOE in an industry in which the establishment of a WFOE is restricted. The Equity Change Regulations clearly prohibit the aggregate equity share held by foreign investors to fall below 25 percent of registered capital through such an acquisition, unless all of the foreign party's interest is to be acquired by the Chinese party.
      Of particular importance to foreign investors acquiring an interest in an FIE through an offshore merger is a provision that if the other parties (such as the Chinese party for whom this right is obviously intended) object, the FIE may have to be liquidated. The Equity Change Regulations do not apply to joint stock limited companies. n Share purchase transaction With MOFTEC's 1995 Provisional Regulations on Several Issues Concerning the Establishment of Joint Stock Limited Companies with Foreign Investment (the Provisional Regulations), Chinese law now explicitly allows foreign investors to acquire shares in a PRC company (other than as a passive B shareholder). In a share purchase transaction, the target company may be a listed or an unlisted joint stock limited company. A foreign investor may either acquire the shares from existing shareholders, typically a holding company set up to hold State-owned shares or another C hinese legal person holding legal person shares, or acquire newly issued shares directly from the joint stock limited company.
      According to official PRC statistics, China has almost 8 million industrial enterprises, of which 9,000-13,000 had been organized as, or converted into, share-issuing joint stock limited companies by the end of 1996. Of these, only 745 have issued A shares on one of the two major PRC stock exchanges, 101 have issued B shares, and 42 are currently listed on an overseas exchange (including Hong Kong). Even though the 15th Party Congress may have implicitly encouraged the conversion of SOEs into joint stock limited companies, and the number of such companies is expected to grow, the total number of potential share purchase targets is still quite small. The number of completed direct share deals is even more limited (see Table).
      Part of the reason for the slow growth of share purchase transactions lies with the Beijing Light Bus acquisition in 1995. Shares of the listed bus company that were intended for Chinese legal persons were sold to Isuzu Motors Corp. and Itochu Trading Co. Upset with this attempt by foreign companies to acquire shares not proper for them to hold, in September 1995 the State Council issued the Notice from the State Council on the Suspension of the Transfer of State-ow ned Shares and Legal Person Shares of Listed Companies to Foreign Investors (the Notice). The Notice imposed a moratorium on similar purchases of State-owned shares or legal person shares in any listed company until regulations were formulated to govern such transactions. No specific regulations have yet been promulgated. But certain subsequent decrees provide that a holder of State-owned shares may transfer its shares to a PRC legal or natural person inside or outside China, which, by implication, permits sales to foreigners. These decrees include the March 1997 Opinion on Standardization of the Exercise of Share Rights by Holders of State-owned Shares in Joint Stock Limited Companies (the State-owned Shares Opinion), issued by the State-owned Assets Bureau and the State Commission for Restructuring the Economy. An explicit repeal of the moratorium, however, would certainly serve China's policy interests as well as the interests of the foreign M&A community.
      In the meantime, foreign investors can pursue share-purchase transactions through private placement transactions with unlisted companies. The State-owned Shares Opinion appears to rescind an unfortunate policy codified in earlier regulations in which the holder of State-owned shares is required to have a controlling interest in a joint stock limited company. The State-owned Share s Opinion instead provides that any requirement for State control must be determined with reference to relevant regulations. Current regulations do not otherwise prescribe State control except in a few identified industries.
• Indirect acquisitions Many early investors in China were Hong Kong or overseas Chi nese entrepreneurs who set up their investments in FIEs in China through Hong Kong or other offshore corporations, such as those located in the British Virgin Islands. As these businesses have developed, many investors have sought to realize profit by selling all or part of their business to multinational corporations. In this type of investment, the foreign investor acquires the shares in the target company either directly from the shareholder or from the offshore company in the form of newly issued shares. PRC law need not govern the sale and purchase of shares of investments with offshore structures--including those in Hong Kong, since the Special Administrative Region maintains its own legal system. Typically, the parties designate Hong Kong law, English law, or New York law. The documentation for such transactions is therefore consistent with any international M&A deal, and both reliable courts and international arbitration are available to ensure effective remedies--unlike many direct transactions, in which PRC law must govern and ultimate enforcement of any remedies rests with the People's Courts.
• Mergers Mergers in China are governed by specific provisions of the Company Law. Two forms of merger are identified: first, merger by absorption, in which one company absorbs one or more other companies and the absorbed companies are dis solved; and second, merger by establishment, in which two or more companies are merged into a newly created company and the parties to the merger are dissolved. (The Equity Joint Venture Law also mentions mergers, but only in the context of a requirement that the board of directors unanimously consent to any merger involving the joint venture.) The Company Law requires the parties to enter into a merger agreement and to prepare balance sheets and asset lists prior to any merger. There are detailed procedures for notifying the merging parties' creditors and a requirement that the debts be either repaid or "guaranteed" by the parties. In fact, this latter provision seems unnecessary because the Company Law stipulates that the surviving company succeeds to the claims and debts of each party to a merger.

The mechanics of an M&A transaction

An important step in the acquisition of PRC shares or assets is thorough financial and legal due diligence. Where the acquisition involves the purchase of an interest held by a foreign company, the due diligence process may be routine, since the parties and their advisers tend to have had experience in such matters. But due diligence is still a relatively new process to SOEs and other domestic PRC entities, and may meet with some resistance. Only a few years ago, allowing foreign lawyers, accountants, and investmen t bankers liberal access to financial and operating records and documents of an SOE would have constituted a violation of the PRC's State secrets regime and could have subjected the offenders to severe punishment. Even today, the culture of secrecy continues to survive in some parts of the country, and especially among certain industries. As a result, M&A participants and their advisers must begin early in the transaction to explain the due diligence process to the Chinese target's senior management, and to enlist its active participation and cooperation. Due diligence questionnaires in Chinese are a necessary initial step in the process and, at a minimum, should cover licenses and approvals; financial statements; land-use rights; title to assets; taxes; foreign exchange; labor; environment; operating agreements; litigation and arbitration; and any special circumstances.

To assuage the concern of an apprehensive Chinese target, it is useful (and often necessary) to sign a non-binding letter of intent containing a confidentiality undertaking. Onsite visits by accountants, lawyers, environmental auditors, and structural engineers, and extensive follow-up are usually part of a due diligence exercise. Nonetheless, the dearth of accurate documentation of many PRC intra-group transactions, the near absence of publicly filed documents, and Chinese companies' traditional aversion to revealing internal information, may make it difficult to understand fully the target's operations. Thus, the inclusion of suitable representations, warranties, and indemnifications is crucial.

Together with due diligence, valuation is a critical component in the M&A process. The price paid for assets or shares in China may not be determined solely by the parties, unlike in other jurisdictions. PRC law requires appraisals where a transaction involves either State-owned assets or the interest in an FIE held by an SOE. In a direct-share purchase, Chinese law also imposes certain restrictions on the price the parties may negotiate.

Beijing is particularly concerned about undervaluation of State-owned assets sold or contributed to FIEs. Thus, prior to any transfer of such assets, a State-authorized appraiser must appraise the assets, and the State Asset Appraisal Administration must confirm the assessment. A recurring problem with these asset evaluations is that the Chinese appraisers, who typically base their valuation on replacement value less depreciation, often grossly overvalue the assets to be acquired. Since the asset appraisal largely determines how much the foreign investor must pay for its acquisition, the importance of becoming involved in the appraisal process as early as possible cannot be overemphasized. Typically, once the appraisal has been confirmed, the parties may only agree to a price that differs no more than 10 percent from the apprai sed price. Under the newly enacted Equity Change Regulations, any sale of the Chinese party's interest in an FIE, where the Chinese party had invested State-owned assets, must also be appraised in the same manner.

Discretion to determine the price in the sale and purchase of shares in a joint stock limited company is also subject to certain limitations. New shares must be issued at or above par. The issue of shares above par is subject to approval by the China Securities Regulatory Commission. Under the Company Law, the same price should be paid for each of the shares subscribed for by any unit or individual. But the government has exercised its right to grant waivers under this rule. If the seller is a holder of State-owned shares, the State-owned Shares Opinion stipulates that the price not be lower than net asset value per share and should also take into account such factors as net asset yield ratio, actual price of investment, reasonable price/earnings ratio, and market price, if any.

Because the pricing of shares in an indirect structure takes place beyond the reach of PRC restrictions, it is determined by negotiation between the parties. Multinational investors often determine a suitable purchase price through the discounted cash flow method of valuation, adopting an internationally appropriate multiple for the particular industry.

Another concern in Chinese M&A transactions is financing, whether for acquisition of a target or for operation of the target after completion of the transaction. Acquisitio n financing in China is limited. Banks typically are not prepared to lend without parent corporate guaranties. The Equity Change Regulations address the prospect of a pledge of the equity investment to a lender under the Security Law of the PRC, provided all the other equity holders consent. The pledge is limited to paid-up capital only and must receive government approval. Notwithstanding the availability of financing methods, including the possibility of listing on a PRC or foreign stock exchange or issuing bonds, financing for the operating needs of the target typically still takes the form of foreign shareholder loans or bank loans secured by foreign investor guaranties.

The documentation required for an M&A transaction in China depends on the structure of the deal. If an FIE is established to acquire assets of the Chinese target, the relevant documentation for FIEs must be used. In contrast, if the foreign investor is buying shares in an existing joint stock limited company (or setting up one), the documentation more resembles any international M&A transaction and would include a share purchase or subscription agreement and shareholders agreement with articles of association.

After successful negotiations that culminate in the signing of the M&A documentation, obtaining the necessary government approvals usually marks the final stage in the M&A process. Typically, the Chinese target's represent atives will take the lead in obtaining any required approval, but this should not occur without close consultation with the foreign investor. Both the approval process and approval authority differ depending on the type and structure of the transaction. In a direct transaction, in which the Chinese target's assets are purchased through an FIE, approvals must come from the State Council, MOFTEC, or MOFTEC's provincial, municipal, or county-level counterparts, depending on the project's level of total investment and use of State-allocated resources. The approval may be issued subject to changes made to the transaction documents, but the smart foreign investor will seek to discuss beforehand with MOFTEC any changes they may request, and will seek clarification of, or alternatives to, the changes requested.

After receiving approval, the foreign investor must register with the local SAIC and obtain a business license. A direct acquisition involving the purchase of an existing interest in an FIE also requires approval, usually from the "original examination approval authority"--MOFTEC or the local counterpart that approved the FIE's creation, and SAIC. In a transaction involving a purchase of shares in a joint stock limited company, MOFTEC must approve the purchase if the acquisition involves shares constituting 25 percent or more of the total issued and outstanding shares of the company. If the purchaser is acquiri ng less than 25 percent, the State Economic and Trade Commission's local counterpart (and perhaps other departments as well) must approve the transaction. If the target is a financial institution, including an insurance operation, the Peoples' Bank of China (PBOC) must approve any share transfer of 10 percent or more. In practice, PBOC asserts approval jurisdiction over all share transfers involving financial institutions. Other government ministries may be involved in the approval process if the target is within that ministry's jurisdiction. Though the Company Law requires that any share transfers be effected at an established stock exchange irrespective of whether the company is listed, in practice, this requirement is largely ignored.

The acquisition documents of an indirect acquisition may not need PRC government approval, as they tend to be executed outside of China and governed by non-PRC law. But a purchaser with an interest in an FIE in China may wish to have the FIE's constituent documents amended before closing. The amendment process usually requires approval of the original examination and approval authority and an amended SAIC business registration.

Strategic considerations

As elsewhere, representations and warranties play a critical part in M&A documentation in China, particularly because foreign lawyers often do not have access to government records that confirm title to real estate or e xistence of liens, and because of dubious tax avoidance structures and questionable accounting practices.

In addition to facing restrictions imposed by the Catalogue on obtaining a controlling interest, foreign investors must deal with Chinese statutes that confer important powers on minority equity holders in FIEs. Unanimous consent of the board of directors is necessary for all major actions of a company, such as increasing capital, amending the articles of association, assigning registered capital, merging with another firm, or dissolving the firm. (Joint stock limited companies are not subject to the same unanimity requirements.) The foreign shareholder should therefore be aware that a Chinese partner is able to exert influence far beyond that which its minority shareholding would suggest.

Parties in an M&A transaction may be concerned that the shareholders from which they are purchasing shares, or other shareholders of the target company, intend to compete with the target company. In such a case, parties can formulate covenants not to compete, and not to solicit employees. These covenants are generally enforceable under PRC law if reasonably limited in time and scope. Restrictive covenants with individual employees may not exceed three years and require separate consideration. And when a foreign investor buys into an existing PRC entity, or when an FIE acquires all of the assets of an SOE (and intends to h ire its employees), careful consideration must be given to the pre-existing legal obligations owed to such employees.

Another strategic issue is that of exit options for investors. The objectives of financial investors usually differ from those of operating companies making strategic investments in China. Financial investors envision a shorter term of involvement and seek some type of exit strategy exercisable within three to five years of making the investment. Financial investors will want to include exit provisions in the acquisition documents. This may take the form of a put option allowing the investor to sell its equity back to the seller, or an obligation to cause the holding vehicle to undertake a public offering so the financial seller can dispose of its shares. In an indirect structure, a financial investor buying shares in an offshore holding company should be free to incorporate such obligations. In direct structures not involving joint stock limited companies, the statutory preemptive and veto rights of each equity holder and the non-share issuing nature of the enterprises pose potential obstacles for an exit strategy. Such transactions might be restructured to allow the financial investor to hold its interest in a single-purpose, offshore holding company, to facilitate both the exercise of a put option (relating to the shares of the offshore company rather than the PRC-based company) without being subject to preemptive or veto rights as well as a possible future listing. If a listing is not contemplated, the financial investor may want to try to arrange waivers of preemptive rights and consents in advance (although enforceability is uncertain under PRC law). Any assignment of an interest in an FIE is further subject to government approval.

Overseas investors should also be aware of the tax implications of their M&A transactions in China. PRC tax authorities recently issued regulations covering M&A deals to provide guidance on the tax consequences of mergers (see The CBR, November-December 1997, p.26). Mergers are treated as a non-taxable event; in general, the parties' pre-merger tax treatment is preserved after the merger. As before, an enterprise's income tax must be paid on gains resulting from asset assignment or an FIE restructuring. Other tax considerations include value-added tax on the sale of machinery and equipment, and business tax assessed on intangible property rights. A stamp tax is also imposed on the transfer of shares in a Chinese joint stock limited company and on a contract for the assignment of registered capital in an FIE.

The start of a new era

M&A transactions in China will continue to increase as China attempts to reform its State sector and foreign investors ply China's investment waters. The well-worn path of asset acquisitions through FIEs remains the favored and most predictable structure for investors, but the future promises more options for share purchases in both listed and unlisted Chinese entities. A secondary market for interests in FIEs in China in which early foreign (mainly Hong Kong and overseas Chinese) investors are eager to sell, often at a healthy premium, now exists. Despite China's progress over the past 17 years, M&A participants are sure to encounter pitfalls, including a complicated legal system that is hardly a steady foundation for M&A deals. Thorough due diligence, well-crafted documents, and proper government approvals are essential. Regardless of such difficulties, however, China promises to be near the forefront of the continuing wave of global M&A transactions.

Cole R. Capener (crc@bakernet.com) is a partner of the international law firm of Baker & McKenzie in Hong Kong. This article is based on the author's book A Guidebook to Mergers & Acquisitions in China. The author expresses his thanks to Erik Leyssens for his research assistance in preparation of this article.

A New Investment Vehicle

A desire both to tap into the nascent capital markets and to gain greater autonomy from intrusive government supervisory organs has prompted many State-owned enterprises (SOEs) to convert into joint stock limited companies (also translated as co mpanies limited by shares) over the past six years. To many PRC policymakers this "corporatizaton" was a natural step in the evolution of reforming the State sector. Late last year, the 15th Party Congress suggested that the "joint stock limited company" should replace the "State-owned enterprise" (guoyou qiye) as the preferred State asset vehicle and that the government could even be satisfied with a minority position in such companies. Since the 1994 Company Law, which governs the formation of joint stock limited companies, contains few specific provisions relating to foreign investment in such companies, the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) supplemented it by promulgating the Provisional Regulations on Several Issues Concerning the Establishment of Joint Stock Limited Companies with Foreign Investment in January 1995 (the Provisional Regulations). The Provisional Regulations created a new foreign investment vehicle: the Sino-foreign joint stock limited company. Unlike equity and cooperative joint ventures and wholly foreign-owned enterprises, the Sino-foreign joint stock limited company is a share-issuing vehicle more akin to its Western counterparts. Under the Company Law and Provisional Regulations, domestic or foreign-invested joint stock limited companies can be established either by "sponsorship" or by "share offer." If by sponsorship, all shares must be subscribed for by the company sponsors (of which more than half must be domiciled in China) and no shares may be issued to the public. If by share offer, shares must be issued to the public, but the sponsors must subscribe to a minimum of 35 percent of the total share issue. Foreign-invested enterprises (FIEs)--but not holding companies--may act as either sponsors or shareholders subject to certain limitations. Unlike FIE legislation, the law governing joint stock limited companies grants fewer minority shareholder protections, such as power to block corporate actions and share transfers. The Provisional Regulations also permit the conversion of an FIE into a joint stock limited company. The minimum registered capital requirement for the establishment of a foreign-invested joint stock limited company is RMB 30 million ($3.6 million). Significantly, however, all foreign-invested joint stock companies must be approved by MOFTEC in Beijing regardless of the size of the total investment. The transfer of shares in a joint stock limited company nonetheless requires clearer legislative guidance. Under the Company Law, shareholders are permitted to transfer their shares "according to law." But there are few laws that explicitly deal with transfers, particularly those involving foreigners. Moreover, the policy issue of whether it is permissible to sell foreigners shares previously reserved for SOEs and Chinese legal persons has not been finally resolved. As China moves toward eliminating differences between domestic-invested and foreign-invested entities, it may eliminate the troublesome classification of shares based on the identity of the shareholder. Investors also hope that the cumbersome provisions of Article 144 of the Company Law that require the transfer of shares "at securities trading places established by law" will be clarified. Such a provision may make sense for transactions involving the transfer of shares listed on a stock exchange, but is inappropriate for unlisted companies and seems, in practice, to be ignored. Indeed, China Securities Regulatory Commission officials have informally opined that Article 144 does not apply to the transfer of unlisted shares. Instead of establishing an FIE to acquire the assets of a PRC target, it is now possible to establish a foreign-invested joint stock limited company as the acquiring entity. According to press reports, Eastman Kodak Co.'s recently announced $1 billion investment in China was effected in part through the use of a foreign-invested joint stock limited company, the shares of which are owned by Kodak and two SOEs whose assets have been acquired by the new entity. The growing prevalence of joint stock limited companies may translate into more share transactions overall. Under MOFTEC's regulations, domestic enterprises may also convert into joint stock limited companies with foreign investment. This is po ssible either by listing B shares on the Shanghai or Shenzhen stock exchanges, or by a private placement sale to foreign investors. In either case, the foreign party is required to purchase the shares with freely convertible currency and take a stake of at least 25 percent in the company. The target company must also have been established with official State approval and have been profitable for the last three years. This avenue of investment may be particularly interesting for foreign portfolio investors, as it offers an exit strategy compatible with their short-term objectives. Cole R. Capener