Hina AW Eporter: April 2011 Volume 7, Issue 1 China Committee Leadership

CHINA LAW REPORTER
中国法律报道
April 2011
Volume 7, Issue 1
China Committee REPORTING ON DEVELOPMENTS IN THE FOUR LEGAL SYSTEMS OF

Leadership GREATER CHINA
Co-Chairs
Adam F. Bobrow
abobrow@doc.gov
Russell K.L. Leu Happy Year of the Rabbit!

rklleu@yahoo.com
Welcome to the 2011 Spring edition of the China Law Reporter. The
Vice Chairs editorial team has done another excellent job of updating us on the latest
Paul B. Edelberg legal developments in China. As Co-Chairs, we truly appreciate the
pedelberg@foxrothschild.com submissions of our authors and the hard work put in by our editorial team.
Justin Evans
juwevans@alumni.iu The editorial board invites submission of articles for its next issue that fall
Robin Kaptzan within the mission of the China Law Reporter. Inquiries and submissions
kaptzan.r@grandall.com.cn can be made to Senior Co-Editors Russell Leu (rklleu@yahoo.com) or
Adam Li Paul Edelberg (PEdelberg@foxrothschild.com ).
liqi@junhe.com
Malcolm McNeil This issue’s articles include coverage of the much-discussed new national
MMcNeil@foxrothschild.com security review process for foreign investments. Coupled with the
Susan Ning coverage of new structures for private equity investors seeking to develop
Susan.ning@kingandwood.com
funds in China, we see a changing trend on the type of foreign investment
Richard Lawton Thurston
dick_thurston@tsmc.com that will be favored in coming years. With a new emphasis on growth in
Stephen Vogel seven strategic industries also highlighted in the 12th Five Year Plan
svogel@fulbright.com adopted last month during the annual session of the National People’s
Adria E. Warren Congress, we anticipate that foreign-invested enterprises will continue to
AWarren@foley.com have to demonstrate the ways they contribute to Chinese economic
growth.
Newsletter Editors
Russell K.L. Leu Another full-length article in this issue provide us with a better sense of
(Senior Editor)
leu@taftlaw.com
how the global economic downturn is playing out in cases in Chinese
Paul B. Edelberg courts related to commercial transactions. In recent years, Chinese courts
(Senior Editor) have followed a Supreme Court Judicial Interpretation allowing parties to
pedelberg@foxrothschild.com seek court relief to modify or rescind a contract if there was shown a
Jamilia Wang “fundamental changes of circumstances.” Most recently, Chinese courts
jamiliaw@gmail.com have displayed a more cautious attitude, distinguishing “fundamental
changes of circumstances” from normal commercial risks. The specific
Editorial Staff cases covered in this article will be of great use to practitioners working in
Kevin Blood China or with clients with significant Chinese business.
Kevin.blood@asu.edu
Alice Leung
aliceleung_ca@yahoo.ca As we welcome you to the Spring Meeting of the International Law
Section of the ABA with this issue of the China Law Reporter, we hope
you will enjoy the China Committee sponsored and co-sponsored
programs on the agenda. These programs should serve to remind
members that there are many ways to get involved and develop as a leader
ST1 27240v1 04/05/11

CHINA LAW REPORTER
中国法律报道
April 2011
Volume 7, Issue 1
China Committee REPORTING ON DEVELOPMENTS IN THE FOUR LEGAL SYSTEMS OF

Leadership GREATER CHINA
Co-Chairs
Adam F. Bobrow
abobrow@doc.gov Co-Chairs Message, continued
Russell K.L. Leu

rklleu@yahoo.com within the Section and especially within the Committee. As the Co-
Chairs, we will always be happy to provide advice and support for any
Vice Chairs programming, publication and policy initiatives proposed by our
Paul B. Edelberg Committee members. We have active chapters in both Shanghai and
pedelberg@foxrothschild.com Beijing and the Section can support a wide variety of activities for
Justin Evans
juwevans@alumni.iu Committee members. Please do not hesitate to reach out to either of us.
Robin Kaptzan (Our email addresses are below.) And if you need guidance on what
kaptzan.r@grandall.com.cn programs are available, please feel free to simply express interest—we’ll
Adam Li help you get started!
liqi@junhe.com
Malcolm McNeil All the best,
MMcNeil@foxrothschild.com
Susan Ning Adam Bobrow, Co-Chair (abobrow@doc.gov)
Susan.ning@kingandwood.com
Russell Leu, Co-Chair (rkleu@yahoo.com)
Richard Lawton Thurston
dick_thurston@tsmc.com
Stephen Vogel Adam Bobrow is the Senior Advisor for China Policy Coordination for
svogel@fulbright.com the Secretary of Commerce.
Adria E. Warren
AWarren@foley.com Russell Leu is an attorney with the Beijing office of the law firm Taft,
Stettinius & Hollister LLP.
Newsletter Editors
Russell K.L. Leu
(Senior Editor)
leu@taftlaw.com
Paul B. Edelberg
(Senior Editor)
pedelberg@foxrothschild.com
Jamilia Wang
jamiliaw@gmail.com
Editorial Staff
Kevin Blood
Kevin.blood@asu.edu
Alice Leung
aliceleung_ca@yahoo.ca
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Volume 7, Issue 1 China Law Reporter
Page 3 of 30
April 2011 中国法律报道
RECENT DEVELOPMENTS
CHINA ADOPTS PROCESS FOR NATIONAL SECURITY

REVIEWS OF MERGERS & ACQUISITIONS INVOLVING
FOREIGN INVESTORS
By Libin Zhang and Casey Rubinoff

When China’s former leader Deng Xiaoping gave permission to Dr. Armand Hammer to
fly his private plane into China in 1981 for negotiation of China’s first joint venture for a
coal mine in Antaibo, little did China’s government at the time think about national
security concerns involving foreign investment. Since then, China has become a focal
point for foreign investors worldwide. In 2010, China received $105.7 billion in foreign
direct investment (FDI). The World Bank reported that roughly 20% of all FDI going to
developing countries from 2000-2011 went to China.1 However, over the last five years
the Chinese government has created new policies and governmental bodies to safeguard
the domestic economy and national security in the face of the vast influx of investments
and mergers and acquisitions.
The most recent development is the State Council’s February 12, 2011 promulgation of
the Notice of the General Office of the State Council on Establishing a Security Review
Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors
(Notice), which came into effect on March 5, 2011. The Notice sets forth a national
security review system for investments in and acquisitions of domestic companies by
foreign investors that may raise national security concerns. The security review process
under the Notice is intended by the Chinese government to be a regulatory review process
regulating M&As by foreign investors in China.
As a supplement to the Notice, on March 4, 2011, the Ministry of Commerce

(MOFCOM) issued the Tentative Provisions of the Ministry of Commerce on Issues
Related to the Implementation of the Security Review Mechanism for Mergers &
Acquisitions of Domestic Enterprises by Foreign Investors (the “Provisions”). The
Provisions call for submission of opinions and comments by the public to MOFCOM
from the date of publication through April 10, 2011. The Provisions set forth further
details and regulations for implementation of the security review process provisionally
until August 31, 2011.
1
http://web.worldbank.org/WBSITE/EXTERNAL/EXTCHINESEHOME/EXTCOUNTRIESCHINESE/EX
TEAPINCHINESE/EXTEAPCHINAINCHINESE/0,,contentMDK:22648814~menuPK:3885991~pagePK:
2865066~piPK:2865079~theSitePK:3885742,00.html
The Section of International Law: Your Gateway to International Practice

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国际法分部：你的跨国执业之门
Volume 7, Issue 1 China Law Reporter Page 4 of 30
Background
The national security review is not necessarily ‘new’ as China already has review
mechanisms in place to block deals that are not in line with its national strategy and the
establishment of a national security review has long been anticipated. In August 2006
MOFCOM along with several other agencies published the Rules on Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors, which, for the first time,
required notification and review of deals that had the potential to impact the country’s
economic stability. Then, in August 2008 China’s Anti-Monopoly Law (the “AML”)
went into effect, requiring further review of the impact of acquisitions of domestic
companies. Article 31 of the AML states:
Where a foreign investor participates in concentration of business operators

through a merger or acquisition of a domestic enterprise or any other method and
national security is involved, a state security review shall be conducted in
accordance with relevant state provisions in addition to the examination of the
concentration of business operators conducted in accordance herewith.
In April 2010, the PRC State Council issued Several Opinions on Further Improving the
Work of Utilizing Foreign Investment (“Opinions”). The Opinions advised the
government to accelerate the creation of a national security review mechanism for M&A
activity by foreign investors. The February 3, 2011 issuance of the Notice formally
established this review process and the scope of the review, which is independent from
the AML review process. Obviously, the national security review process is simply a
more codified way of conducting the reviews with the specific aim of protecting national
security. It should also be noted that a security review of mergers and acquisitions of
domestic financial institutions will be provided separately at a later date.
Affected Sectors
The Notice provides that mergers and acquisitions related to any military enterprise (1-3
below) and investments in the business sectors identified and outlined in number 4 below
where a foreign investor obtains “actual control” (to be discussed later), are subject to the
security review:
1. military and military supporting enterprises;

2. enterprises in the vicinity of major and sensitive military facilities;
3. other entities associated with national defense and security; and
4. domestic enterprises engaged in sectors related to national security such
as:
a) important agricultural products;
b) important energy and resources;
c) important infrastructure;
d) important transportation services;
e) key technologies; and
f) major equipment manufacturers.
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The Notice does not define the words ‘important,’ ‘key,’ or ‘major’ as used in the Notice.
Additionally, it is interesting to note that some of the sectors listed above that will be
under particular scrutiny for M&A activity such as energy and agriculture, are areas in
which foreign investment had previously been encouraged under China’s Foreign
Investment Industrial Guidance Catalogue (the “Catalogue”). The Catalogue, as recently
amended by the PRC’s National Development and Reform Commission (the “NDRC”) in
2007, categorizes various industry sectors as ‘encouraged,’ ‘restricted,’ or ‘prohibited’
for foreign investment and is updated periodically by MOFCOM and the NDRC. Several
of these sectors fall under the nine “pillar industries” announced in December 2006 as
sectors in which State-owned enterprises should play leading roles.
Actual Control
Under the Notice, foreign investment in the sectors mentioned above in which a foreign
investor obtains actual control of a Chinese company is subject to the national security
review. The concept of ‘actual control’ is a broad one, encompassing not only
investments where foreign investors obtain a majority of equity interest, but also those in
which a foreign investor is able to exercise ‘material influence’ or control over company
decisions, although it may obtain only a minority interest in the target. As defined by the
Notice, actual control occurs when ‘a foreign investor becomes a holding shareholder of
or has actual control of a domestic enterprise after the merger and acquisition.’ This
includes the following circumstances:
1. The foreign investor, holding parent company or held subsidiary obtain

more than 50% of total shares after the merger or acquisition.
2. After the merger or acquisition two or more foreign investors aggregately
hold more than 50% of total shares.
3. Although the equity held by a foreign investor is less than 50% after the
merger or acquisition, the voting rights represented by the equity held by
them is sufficient to substantially influence the resolutions of the
shareholders meeting, shareholders assembly or the board of directors.
4. Any other circumstance in which actual control of a domestic enterprise’s
operational decisions, finances, personnel, technology, or other matters is
transferred to the foreign investor.
Application and Review Process
If a target company’s scope of business falls under one of the categories described in the
Notice, the foreign investor shall submit an application for security review with
MOFCOM. According to the Provisions, if more than one foreign investor is involved,
the foreign investors can either jointly submit an application or elect one of the parties to
submit the application on behalf of them all. The wording of the Provisions suggests that
it shall be the foreign investor and not the Chinese target who is responsible for
submitting the application and relevant materials. If a foreign investor does not submit an
application, but the local government finds that the transaction falls under the scope of
ST1 27240v1 04/05/11

the security review, the local government will not accept the application for the M&A
transaction and will instead request that the parities submit a security review application
to MOFCOM.
Moreover, any relevant department under the State Council, any national industry
association, any enterprise in the same industry, or any upstream or downstream
enterprise may propose to MOFCOM to conduct the security review on a particular
transaction by submitting relevant information on the transaction and its supposed impact
on national security. This creates the potential for competitors of the target company to
ask MOFCOM to conduct security reviews on transactions that they oppose.
Article 3 of the Provisions stipulates that applicants may consult with MOFCOM prior to
filing an application regarding procedural issues. However, neither the Notice nor the
Provisions allows for lobbying during the review process or the possibility of appealing a
decision.
For filing for the national security review, the applicant should prepare, inter alia, an
application report and description of the transaction signed by the legal representative or
authorized representative of the applicant, the background information on the foreign
investor and its affiliated enterprises (including its actual control or parties acting in
concert), and statement on relationship with the government of relevant countries and the
background information on the target domestic enterprise including Articles of
Association, business license (copy), audited financial statements for the previous year,
structural chart before and after the M&A, company’s subsidiaries and relevant business
licenses (copy).
The applicant should also submit the Articles of Association, JV Contract or Partnership
Agreement of the foreign-invested enterprise that is planned to be established after the
M&A transaction and a list of proposed senior executives. In the case of an M&A
transaction involving equity transactions, the applicant shall submit the share transfer
agreement or subscription agreement, the relevant shareholder resolution of the target
domestic enterprise, and the relevant asset assessment report. In the case of an M&A
transaction involving assets transfer the applicant shall submit the resolution on the sale
of assets approved by the owner approving the asset sale, the asset purchase agreement
(including the checklist and status of assets to be purchased), a statement on the
information of all concerned parties of the agreement and a corresponding asset
evaluation report.
Finally, the application should also include a statement of the impact of voting rights
enjoyed by foreign investors to the resolution of the shareholders’ meeting and the
resolution of the board of directors, or to the enforcement of partnership affairs, statement
on other issues that may result in transfer of actual controlling power in relation to
decision-making, finance, human resources, technologies or other aspects to foreign
investor or its domestic or foreign affiliated enterprises, or agreement or documents
related to the aforementioned circumstances. MOFCOM has discretion to request
additional documents for filing.
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After a foreign investor who intends to acquire a domestic company files an application
with MOFCOM, MOFCOM will analyze the transaction for its potential impact on
national defense and security, economy stability, basic social order, and the domestic
capability to research and develop key technologies related to national security. Should
the transaction fall within one of the identified business sectors of the security review,
MOFCOM, within 5 working days, will request a security review by the Joint
Committee, which consists of the State Council, NDRC, and MOFCOM along with
relevant departments from the sector and industry under review.
The review process begins with a general review of the transaction, which can last up to
30 working days. If a transaction does not obtain approval after the general review, it
will then be subject to a special review, which can last up to another 60 working days.
After the review, the Committee can approve or terminate the transaction or may approve
of the transaction subject to certain conditions to address the national security concerns.
Transactions can also be modified by the parties during the security review process and
resubmitted to the Committee.
Necessity, Ambiguity and Uncertainty
What lies behind the legislation is that China’s government needs to constrain foreign
investment and protect and boost domestic industries. As it is for every country, national
security is a real issue for China. After decades of encouraging investment, the country
has a legitimate concern for national and economic safety and arguably needed to
implement a control measure.
However, some have voiced their disapproval of the mechanism, claiming that it has been
created simply to give the government the power to block more deals by foreign investors
in order to protect domestic industries. Some commentators viewed the establishment of
the national security review as a way for China to ‘turn the tables’ on those nations that
have previously blocked Chinese investment and serve as an economic tool of
reciprocity.
Fairly speaking, China is not the first, nor will it be the last, country to implement a
national security review mechanism. The U.S., Germany, Russia, Canada and Australia,
among others, have each either considered or already implemented a foreign investment
review process based on national security risks. Several of these countries have even
used their own security review mechanisms to block investments and acquisitions by
Chinese companies. Some observers said that the review has been established to ‘get
back’ at these countries that have hindered Chinese business and investment abroad.
They are concerned that China’s security review mechanism may go beyond the ‘typical’
security review mechanisms of other countries by creating another level of bureaucratic
control and encompassing matters outside of the scope of national security such as
economic and social stability.
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The extent to which this mechanism has the potential to be abused by the government to
block deals in the name of national security remains to be seen. In the long run, China,
while moving in its uphill rise in the process of industrialization and globalization, cannot
afford to antagonize foreign investors and should still actively encourage foreign
investment. While there is a risk for abuse of this new power, history shows that the
Chinese government has been conservative in exercising its ability to block deals.
According to a US-China Business Council report in 2010, since the AML’s inception,
MOFCOM has reviewed over 140 M&A cases and approved 95% of those cases without
conditions (seven cases with conditions).2 MOFCOM has only rejected one case, Coca-
Cola’s proposed acquisition of Huiyuan Juice Company.3 However, these numbers do not
reflect those that felt inhibited from going through with an M&A transaction because of
China’s AML review.
National security reviews have been increasingly politicized in many countries and used
as tools of protectionism, perhaps in the face of the global economic recession. However,
countries must keep in mind that protectionism is a losing game when security reviews
move away from actual security concerns and have the potential to be mutually
economically destructive to the concerned parties.
Indeed, many countries’ legislations on national security reviews have intentionally left
the term ‘national security’ undefined and the language of the legislations has typically
been vague and general. Indeed, this is also the criticism of some commentators on the
Notice. The lack of definitions has left many fearful that the government will use its
discretion to define the scope of the terms set out in the Notice in their broadest sense.
Part of the problem in the vague language is that foreign investors who plan to comply
with the review process may be unaware whether the target business falls under a ‘key’
sector because the Notice does not list specific sub-sectors. Additionally, the ambiguity
of terms such as ‘social stability’ and ‘actual control’ means that what constitutes a risk
to national security or a controlling investor will be left to the judgment of MOFCOM
and the Joint Committee during review.
Chinese legislations have occasionally been known to be vague and general due to the
need to have provisional legislation for experimentation and thus leave room to provide
detailed rules in later notices and regulations. It is also possible that the language of the
Notice was intentionally left vague and undefined by the regulators so that transactions
will be judged on a case-by-case basis to stay in line with national plans; a tactic that
many countries use to their advantage when adopting legislations relating to national
security reviews of foreign investment.
Advice to Foreign Investors
In light of the above, we think foreign investors should consider the following before
acquiring any PRC domestic companies. First, foreign investors should keep a close eye
on development of the process of the review mechanism, particularly during the test
2
http://www.uschina.org/members/publications/cmi/2010/december/22/04.html
3
Disclosure: A partner of Broad & Bright represented Coca-Cola in this case.
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period of the Provisions. Second, foreign investors planning M&A in China should
thoroughly assess the effect that the national security review legislation will have on their
transactions and whether they will need to file for review. It is uncertain how things will
play out in reality of the implementation of the legislation and certainly many lessons will
be learned by both investors and the government. What is certain is that the legislation
regarding national security review will develop further and become more sophisticated
over time, whether for better or for worse.
Libin Zhang is a partner at Broad & Bright in Beijing and can be reached at Tel: 86-10-
85131818 or by email: Libin_zhang@broadbright.com
Casey Rubinoff is a paralegal at Broad & Bright and can be reached by email:
casey_rubin@broadbright.com
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U.S. FUNDS LOOK TO RMB FUND

STRUCTURES IN CHINA
By Paul B. Edelberg
Until recently, U.S. private equity funds were limited under Chinese law to investing in
China through offshore vehicles. They could opt to invest through a wholly owned
subsidiary in China (commonly called a “WFOE”) or by creating a Sino-foreign joint
venture company with the target. The establishment of a foreign-invested WFOE or
joint venture company has required regulatory approval from the Ministry of Commerce
(known as “MOC”) and the State Administration of Industry and Commerce (“SAIC”) or
their respective provincial or local offices, and in some cases from other government
agencies, through a lengthy and laborious process. Among the various requirements are
minimum registered capital requirements established by these government agencies.
Typically, 15% of the registered capital has to be transferred to RMB accounts in China
within 90 days after approval, with the balance being due typically within two years.
This requires careful planning for funding investments and keeping capital at work. In
addition, foreign investors under this process have been subject to the Catalogue of
Industrial Guidance for Foreign Investment (the “FIE Industry Guidelines”)4, under
which industries are classified as encouraged, restricted or prohibited for foreign
investment (or, if not listed, presumed to be permitted) for acquisition by foreign-invested
entities. In most cases, separate approvals are needed for each investment. If not
properly structured and approved, foreign funds cannot be converted into RMB.
In 2003 the Chinese Government authorized private equity investments through an

onshore vehicle called a foreign-invested venture capital investment enterprise (a
“FIVCE”) as discussed below, but this structure has been subject to many of the above
requirements in addition to others. While a number of foreign PE funds have
successfully invested in China and have followed this difficult process, the obstacles have
hindered foreign PE investment in China.
In response to these hurdles, the Chinese Government over the last several years has
implemented regulations and made pronouncements to promote alternative onshore
structures for foreign private equity investment, called “RMB funds”. This article will
discuss recent legal developments and will explore which structures U.S. private equity
firms might consider using in structuring their funds in China.
4
Catalogue of Industrial Guidance for Foreign Investment, issued by the National Development and
Reform Commission and the Ministry of Commerce (Nov. 7, 2007, effective Dec. 1, 2007).
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Recent Developments
The domestic PE industry in China has grown rapidly over the last several years. With
the increase of domestic wealth in China, together with excess government funds,
Chinese PE funds are able to raise capital domestically with relative ease. It has been
difficult for foreign PE funds to tap Chinese wealth, since regulations issued in 2006 have
made it difficult to restructure Chinese domestic companies as Chinese-owned offshore
companies or to move Chinese capital offshore. According to Zero2IPO Research Centre,
in 2009, for the first time more capital was raised for investment in China by domestic PE
firms than by foreign PE firms.5
Foreign PE funds are competing against domestic funds for deal flow, and there are more
funds available for investment than there are mature targets. Domestic PE funds do not
have to undergo the approval process that foreign PE funds do, which gives them a
distinct advantage. In addition, the national, provincial and municipal governments and
other state-owned entities have all set up sovereign wealth funds to invest into certain
geographic areas or certain industries.
In 2010 China’s Central Government announced that it would encourage the flow of
foreign capital into China, particularly in the high technology, high-end manufacturing,
renewable and clean energy and environmental industries. In Several Opinions of the
State Council on Utilizing Foreign Capital, Opinion No. 9, issued by the State Council
on April 6, 20106, the State Council declared a national policy towards easing restrictions
and facilitating the growth of foreign investment through foreign-invested PE funds and
directed the various government agencies to issue regulations implementing this policy.
On June 10, 2010, MOC issued its Circular on Delegating Approval Authority over
Foreign-Invested Enterprises7 that delegated approval authority for investments under
US$300 million by FIVCEs to provincial and local MOC authorities and shortened the
approval times for these investments.
On November 25, 2009, the State Council announced the Administrative Measures for
the Establishment of Partnership Enterprises by Foreign Enterprises and Individuals,
effective March 1, 2010 (the “Foreign Partnership Measures”)8. These Measures for the
first time allow foreign investors to establish foreign-invested limited partnerships
(known as “FILPs”). In essence, the authorization for FILPs enables foreign PE firms to
create onshore limited partnership funds.
5
http://www.allbusiness.com/banking-finance-markets-investing-funds/13773433-1.html.
6
Several Opinions of the State Council on Further Utilizing Foreign Capital, Guo Fa [2010] No. 9, issued
by the State Council (April 6, 2010) (“Opinion No. 9”).
7
Circular of the Ministry of Commerce on Delegating Approval Authority over Foreign Investment to
Local Counterparts, Shang Zi Fa [2010] No. 209, issued by the Ministry of Commerce (June 10, 2010),
Art. 4.
8
Administrative Measures for the Establishment of Partnership Enterprises by Foreign Enterprises and
Individuals, Order of State Council (Guo Wu Yuan Ling) [2010] No. 567, issued by the State Council
(Nov. 25, 2009) (“Foreign Partnership Measures”).
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Another development of note is the encouragement of foreign private equity in certain

cities, particularly Shanghai, Beijing and Tianjin. Tianjin, which has been designated by
the Central Government for private equity development, is competing with the other two
well-known financial centers for private equity growth. Because of the lack of clarity at
this early stage in Chinese private equity law, these cities have issued regulations to
authorize certain PE activity not yet specifically authorized under national law. These
cities have also offered certain tax incentives to encourage foreign-invested PE entities to
form and register in those cities.
The use of an offshore structure is still a viable option and may still be preferable in
certain instances. However, these recent developments have opened the way for foreign
private equity firms to create onshore RMB funds, which many believe will be the
preferred path for foreign private equity firms seeking to be serious players in the
Chinese market.
Types of Onshore Fund Entities
The historical onshore form used by foreign private equity firms has been the FIVCE.
However, recent developments have opened the possibility of other onshore structures.
FIVCE
A FIVCE may be formed with a Chinese partner as a legal person, such as a Sino-joint
venture company (also known as an equity joint venture), or as a non-legal person, such
as a contractual joint venture.9 The minimum capital requirement is US$5 million if an
equity joint venture and US$10 million if a contractual joint venture.10 At least one
investor must invest at least 30% of the registered capital.11 15% of the registered capital
must be paid within 90 days, and the balance must be paid within 5 years.12 Both US
dollars and RMB can be contributed.13 If a contractual joint venture, the parties will
benefit from pass-through tax treatment14; otherwise, an equity joint venture will be taxed
as an entity, and dividends received from the portfolio companies will under most
scenarios be subject to China’s Enterprise Income Tax Law at the entity level.
Management of a FIVCE may be delegated to a domestic management company, a

foreign-invested enterprise or an offshore entity.15
9
Administrative Regulations of Foreign-Funded Venture Capital Enterprises, issued by the Ministry of
Foreign Trade and Economic Cooperation, the Ministry of Science and Technology, the State
Administration for Industry and Commerce, State Administration of Taxation and SAFE [2003] No. 2, ,
(Jan.30, 2003, effective Mar. 1, 2003), Art. 4.
10
Id.,. Art. 6(2).
11
Id., Art. 7.
12
Id., Art.13(1).
13
Id., Art.6(2).
14
See Circular of the Ministry of Finance and the State Administration of Taxation on Issues Concerning
the Income Tax Levied on Partners of a Partnership Enterprise, Cai shui [2008] No. 159.
15
Id., Art.21.
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There are limitations to a FIVCE that make it disadvantageous for many foreign PE
firms. First, establishment of a FIVCE requires approval from central MOC if registered
capital (i.e., the amount to be contributed by both parties) is in excess of US$300
million.16 Second, each investment must be approved and is subject to the restrictions
and prohibitions in the FIE Industry Guidelines.17 Acquisitions of domestic targets for
transaction amounts of US$300 million (and in some cases, a lesser amount) require
central MOC approval, rather than local MOC approval, which will cause considerable
delay and uncertainty. Third, investments are limited to high technology and new
technology companies.18 Fourth, a FIVCE is not permitted to invest in listed
companies.19 Fifth, no debt is allowed to be used in acquisitions. Sixth, approval of the
Ministry of Science and Technology (“MOST”) is required to form a FIVCE because of
the limitations on the industries in which the fund can invest.20 Approvals in compliance
with China’s anti-monopoly law are also required where applicable.
With registered capital requirements and timing requirements for registered capital
infusions, maximizing fund deployment becomes complicated. Too many funds are
chasing too few deals, and transaction size in China is generally between US$50 million
to US$200 million. If the FIVCE’s registered capital is too high, the FIVCE may not be
able to timely deploy its assets effectively. One remedy is to set up a series of funds
seriatim, each no greater than the amount needed for two or three transactions. Another
problem of the capital requirements is the length of time for investment approvals, which
puts the FIVCE at a timing disadvantage to domestic RMB funds, which do not need
similar approval.
FILP
The Foreign Partnership Measures became effective as of March 1, 2010.21 Those

measures permit foreign entities and individuals to form a general or limited partnership
under Chinese partnership law, as modified by the Foreign Partnership Measures. The
approving authority is the local SAIC office, rather than MOC or its local offices,
although SAIC is required to notify the local MOC office of a FILP registration.22
Foreign entities with advanced technology business or with management expertise that
form FILPs to boost the modern service industry in China are viewed favorably under the
Foreign Partnership Measures.23 While the Foreign Partnership Measures state that the
foreign currency of the foreign partners shall be “freely exchanged”, it also states that
issues involving foreign currency, among others, shall “be handled according to relevant
laws, administrative regulations and relevant provisions of China.”24 Finally, the
16
Para. (16), Opinion No. 9, supra n. 3.
17
Id., Art.32(1).
18
Id., Art.3.
19
Id., Art.32(2).
20
Id., Art.8(3).
21
Foreign Partnership Measures, supra n. 5.
22
Id. Art. 5.
23
Id. Art. 3.
24
Id. Arts. 4 and 11.
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withdrawal of a foreign general or limited partner will necessitate applying to the local
SAIC office for modification of its registration.25
SAIC issued its Administrative Regulations on Registration of Foreign-Invested

Partnership Enterprises to implement the Foreign Partnership Measures, also effective
March 1, 2010.26 The regulations allow both general partnerships and limited
partnerships, the latter of which is relevant for private equity enterprises.27 A FILP is
limited to a maximum of 50 partners.28 While the Foreign Partnership Measures state
that MOC approval is not required, SAIC’s administrative regulations reserve the right to
require local MOC approval in specified instances. In addition, industry-specific
approvals and approvals of investments under the FIE Industry Guidelines may still be
required. 29 Approvals in compliance with China’s anti-monopoly law are also required
where applicable.
The two most obvious advantages of a FILP are the tax pass-through treatment and the
bypass of central or local MOC approval in most instances. The latter will expedite and
simplify the approval process. FILPs also are not subject to all of the restrictions of a
FIVCE, such as the limitation on types of investments. Moreover, there are no minimum
registered capital requirements, and no timing requirements for funding, thereby allowing
the funds to more easily raise capital on a committed basis and to better manage
deployment of assets. Another benefit is that FILPs are allowed to establish a branch
office without further approval (although registration of the branch is required). On the
other hand, there are limitations in using FILPs, partially due to regulatory limitations
and partially due to lack of clarity until further regulations are issued. With certain
exceptions, MOC or other government authorities must approve each investment. Each
investment is subject to the restrictions and prohibitions in the FIE Industry Guidelines.
FILPs are not eligible to access the public capital markets in China as an exit strategy.
Approvals in compliance with China’s anti-monopoly law are also required where
applicable.
A major obstacle is the lack of express authorization under national Chinese laws for an
onshore WFOE or joint venture as a general partner or management company of a FILP
formed for equity investments. In Circular 142 issued by the State Administration of
Foreign Exchange (“SAFE”) in 2008 to regulate the conversion of foreign funds of
foreign-invested enterprises (which include WFOEs and Sino-foreign joint ventures) into
RMB,30 SAFE took the position that it will prevent FIEs from converting foreign
currency into RMB if the purpose of the investment is not within the scope of the FIE’s
25
Id. Art. 8.
26
Administrative Regulations on Registration of Foreign-Invested Partnership Enterprises, issued by State
Administration for Industry and Commerce (Jan. 29, 2010).
27
Id. Art. 11.
28
Partnership Enterprise Law of the People’s Republic of China (Aug. 27, 2006, effective June 1, 2007),
Art. 61.
29
Foreign Partnership Measures, supra n. 5, Arts. 38 and 64.
30
Circular No. 142 of the State Administration for Foreign Exchange on Relevant Business Operations
Issues Concerning Improving the Administration of the Payment and Settlement of Foreign Exchange
Capital of Foreign-Funded Enterprises (Aug. 29, 2008).
ST1 27240v1 04/05/11

business license. Despite the language regarding free convertibility in the Foreign
Partnership Measures, the conflicting language in the same Measures requiring
compliance with relevant foreign exchange laws and regulations has been interpreted to
restrict conversion pursuant to Circular 142. For a FILP to constitute a viable structure
for a U.S. private equity firm seeking to funnel its own capital or its own foreign
investors’ funds into its Chinese investments, this hurdle must be overcome.
Shanghai, Beijing and Tianjin have adopted local rules to address some of the
impediments and uncertainties under the Foreign Partnership Measures and Circular 142.
Shanghai’s Pudong New Area reached an agreement with SAFE in 2009 to allow a
foreign general partner of a FEIMC to convert to RMB up to one percent of the total
capital raised by the fund. That rule was apparently superseded in January of this year
under the Implementation Measures on the Pilot Program of Foreign-Invested Equity
Investment Enterprises in Shanghai (the “Shanghai Fund Implementation Measures”).31
The local rules are discussed below.
FEIMC
Until recently, there were no relevant regulations authorizing or specifically regulating

foreign-invested management companies in China other than foreign-invested venture
capital management companies established to manage FIVCEs. While the Central
Government has yet to issue any such regulations, in the last few years Shanghai, Beijing
and Tianjin have issued local rules specifically authorizing and regulating foreign-
invested management companies, called “foreign-invested equity investment
management enterprises” (a “FEIMC”).32 All three cities permit FEIMCs to be formed as
equity joint ventures, WFOEs and FILPs. The FEIMC must be engaged in equity
investment management for private equity funds. The professional managers must satisfy
prescribed experience requirements. Each city offers tax benefits for forming a FEIMC
within its jurisdiction.
The Shanghai Fund Implementation Measures became effective January 23, 2011. The
Measures require minimum capital of US$2 million, of which 20% must be paid within
90 days and the balance within 2 years. A FEIMC may establish funds, manage
investments and provide private equity investment consulting services. The
promulgation of the local FEIMC rules is the first legal authorization for equity
investment management companies outside of the FIVCE context.
31
Implementation Measures on the Pilot Program of Foreign-Invested Equity Investment Enterprises in
Shanghai Hu Jin Rong Ban Tong [2010] No. 38 (Jan. 11, 2011, effective Feb. 10, 2011) ( “Shanghai Fund
Implementation Measures”).
32
See Circular on Printing and Distributing the Provisional Measures of Shanghai Municipality on the
Establishment of Foreign-Invested Equity Investment Management Enterprises in the Pudong New Area,
Pu Fu Zong Gai [2009] No. 2; Provisional Measures for the Establishment of Foreign-Invested Private
Equity Fund Management Enterprises in Beijing, Jing Jin Rong [2009] No. 163; Trial Implementation
Measures on Registration, Record Filing and Management of Equity Investment Funds and Equity
Investment Management Companies (Enterprises) in Tianjin (Nov. 5, 2009).
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The Shanghai Fund Implementation Measures
The Shanghai Fund Implementation Measures are far reaching and extend beyond
authorizing FEIMCs, which had been previously authorized under the 2009 Pudong rules
mentioned above. The Shanghai Fund Implementation Measures also authorize
simplified procedures for establishing RMB funds in Shanghai, eliminate or minimize
disparities between foreign owned funds and domestic funds and permit conversion of
foreign currency investments by a foreign owned FEIMC and by certain qualifying
foreign limited partners.
A foreign-invested fund established under the Shanghai Fund Implementation Measures

(a “Shanghai FIE Fund”) must have minimum committed capital of US$15 million.33
Assuming the Shanghai FIE Fund is established as a FILP, only approval of the local
branch of SAIC is required; no MOC approval is required for its formation.34
There are two categories of Shanghai FIE Funds: those with only Chinese investors
(other than a foreign-owned FEIMC), and those with both Chinese and non-Chinese
investors. With respect to the first, the FEIMC may be partially or wholly owned by
foreign managers seeking to tap capital in China. The FEIMC may convert its foreign
currency into RMB to the extent of 5% of the committed capital of the Shanghai FIE
Fund.35 The fund will be treated the same as a domestic fund. It will not be subject to
the restrictions of the FIE Industry Guidelines, and its investments do not require
approval of MOC or its local offices.
With respect to Shanghai FIE Funds with both Chinese and non-Chinese investors, the
FEIMC is granted the same convertibility rights as a fund with only Chinese investors.
Certain large foreign investors are permitted to invest in foreign currency without
convertibility restrictions. These qualified limited partners must own assets of at least
US$500 million and must have managed at least US$1 billion in assets in the prior year.
These qualified limited partners must also satisfy requirements regarding corporate
governance procedures, experience levels and the absence of recent supervisory or legal
proceedings.36 Those limited partners who do not qualify will be subject to convertibility
restrictions and will be required to obtain the necessary SAFE approvals for each
investment.37 More importantly, Shanghai FIE Funds with both Chinese and non-
Chinese investors will be subject to the FIE Industry Guidelines and will be required to
obtain approval of MOC or its local offices for each investment.38
It is anticipated that Beijing and Tianjin will issue similar measures.
The Shanghai Fund Implementation Measures permit the formation of an onshore fund in
Shanghai managed by an onshore foreign-owned GP and manager. However, it remains
33
Shanghai Fund Implementation Measures, supra n. 28, Art. 14.
34
Id, Art.15 .
35
Id, Art. 24.
36
Id, Art.20.
37
Id, Art.5, 9, 14.
38
Id, Art.6.
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to be seen whether other municipalities will respect these new measures when the
Shanghai-based fund invests in those other municipalities.
RMB Fund without a FIVCE, a FEIMC or a Shanghai FIE Fund
Foreign private equity funds have tried various structures in the past to overcome the
legal restrictions of a FIVCE. Forming a standard foreign-invested enterprise without an
investment purpose within its business scope has not been viable since the issuance of
Circular 142. Others have formed foreign-invested enterprises or used offshore vehicles
to enter into contractual arrangements to manage domestic RMB funds. And others have
used shareholder notes in lieu of capital contributions to avoid being classified as foreign-
invested onshore funds. All of these hybrid methods risk acceptance by applicable
Chinese legal authorities.
Strategies for U.S. Private Equity Funds
Chinese regulation of foreign-invested private equity funds and management companies

is still in its infancy, and the strategies employed by U.S. private equity firms seeking to
enter the China market will need to be fluid to adjust to changing regulations.
Nonetheless, the PE firms will need to rely on the status of existing law and any
anticipated changes at the time it plans on entering China. To analyze which legal
structure to choose, the first step is to define the firm’s objectives.
If a U.S.-based PE firm merely wants to access Chinese capital and raise funds
domestically, the FEIMC and the Shanghai FIE Fund (or any equivalent fund formed
under similar rules of another municipality) provides a sound structure. In Shanghai at
least, the FEIMC (or if a Chinese partner is involved, the foreign partner) can invest and
convert into RMB up to 5% of the total committed amount of the fund it establishes. The
fund can be formed as a FILP, giving pass-through tax treatment. The fund can also be
used as a vehicle for LP investments by large qualifying institutional investors, although
each investment of the fund will then become subject to the FIE Industry Guidelines and
will require governmental approval.
If a PE firm is looking to infuse foreign capital into the Chinese market, a FIVCE
managed by a FEIMC may be the preferred structure. The FIVCE structure specifically
contemplates the conversion of foreign funds into RMB and is a viable structure for
foreign firms seeking to invest in China or to partner with a Chinese PE firm. The major
limitations for U.S. PE firms in a FIVCE are the requirements (1) that portfolio
investments be made in high technology and new technology industries, (2) that a FIVCE
with a legal person status cannot use the FILP as a vehicle, thereby denying investors of
pass-through tax treatment, (3) that a FIVCE must obtain MOC and MOST approval, (4)
that the investments must comply with the FIE Industry Guidelines, and (5) that the
FIVCE comply with timing requirements for pay-in of registered capital as they relate to
deployment of assets by the fund.
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For a U.S. PE firm seeking merely to co-invest its own funds alongside investments of its
Chinese partner, rather than creating a joint fund, it is still unclear whether the formation
of an onshore fund or FEIMC gives the U.S. PE firm any advantage. If the same FIE
restrictions apply to those onshore vehicles as they do to offshore funds, one approach is
to establish relationships with Chinese PE firms and co-invest on an ad hoc basis. The
Chinese PE firm must be willing to accept the restrictions of the FIE Industry Guidelines
and regulatory delays in executing on its potential targets.
It is recommended that legal counsel be consulted in choosing a structure and that advice
be obtained from qualified PRC counsel. Other factors may impact the general
conclusions stated in this article in any particular scenario. Moreover, the regulations
cited in this article have complexities that are beyond the scope of this article, with
numerous exceptions for particular situations, and other regulations may also apply to a
particular situation. Nor does this article discuss in depth the tax implications and exit
strategies available to U.S. private equity firms.
Disclaimer
This article is intended for general information purposes only and should not be construed as legal advice or legal
opinions on any specific facts or circumstances. An attorney-client relationship is not created by reading this article.
The author of this article is not admitted to practice law in China. While this presentation provides a general overview
of structuring options, nuances and changes in Chinese law may impact structuring options and strategies.
Paul B. Edelberg is a partner in the Stamford, Connecticut and New York, New York
offices of the law firm of Fox Rothschild LLP and can be reached by telephone at 203-
425-1521 and by email at pedelberg@foxrothschild.com.
ST1 27240v1 04/05/11

Volume 7, Issue 1 China Law Reporter
Page 19 of 30
CHINESE COURTS ADOPT CAUTIOUS ATTITUDES

IN APPLYING “FUNDAMENTAL CHANGE IN
CIRCUMSTANCES” PROVISION IN
CONTRACTUAL DISPUTES ARISING FROM THE
GLOBAL ECONOMIC DOWNTURN.
By Susan Ning, Tao Huang and Yang Yang1
As was the case throughout the world, the global economic downturn beginning in 2008
caused many in the Chinese markets to face difficulties in fully performing executory
contacts formed prior to the crisis. Many parties to such contracts requested modification
or even rescission of these otherwise valid contracts under these changed circumstances.
In response to this trend, the Judicial Interpretation on Contract Law II2 was issued by
the Supreme People’s Court of the People’s Republic of China (hereinafter the “SPC”) to
further clarify certain legal rules under current Chinese Contract Law3. In particular,
Article 26, Chapter 4 of the Judicial Interpretation on Contract Law II (hereinafter
“Article 26” or the “Fundamental Change in Circumstances” provision) provides
guidance on a party’s right to modify or rescind a valid contract when a fundamental
change of circumstances occurs after contract formation. A fundamental change of
circumstances is differentiated from a force majeure event and does not cover changes
that may arise from normal commercial risks, or under which the purpose of the contract
would be frustrated or performance would result in extreme unfairness.
This article provides an overview of the prima facie elements of Article 26 and the
cautious attitude taken by the people’s courts in its application. In practice, Chinese
people’s courts will closely review the specific facts of each case in order to determine
whether the standards set by Article 26 are satisfied and then seek confirmation from
higher level judiciaries. Part I of this article is an introduction to the roles of the SPC,
Part II will provide an insight on the relevant provisions of Chinese contract law, to
which Article 26 is related; Part III is a detailed explanation of Article 26; Part IV is the
Conclusion.
I. Roles of the SPC
The Chinese legal system is based on civil law, meaning only laws and regulations
promulgated by the legislative bodies and their authorized government authorities are
binding. Court judgments outside the SPC only serve as interpretations of laws and do
not control in other cases.
1
Ms. Susan Ning and Mr. Tao Huang are Partners with King & Wood (PRC Lawyers), Ms. Yang Yang is
an Associate with King & Wood.
2
Judicial Interpretation of the Application of Contract Law of People’s Republic of China II [“Judicial
Interpretation on Contract Law II”], Fashi [2009] 5, art. 26, chap.4 (promulgated by the Supreme Court of
People’s Republic of China on April 24, 2009, effective May 13th, 2009).
3 Contract Law of the People's Republic of China [“Chinese Contract Law”] (promulgated by the Nat’l
People’s Cong. March 15, 1999, effective October 1, 1999).
The Section of International Law: Your Gateway to International Practice

ST1 27240v1 04/05/11
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The National People’s Congress (“NPC”) and its permanent committee, the Standing
Committee of the NPC are the primary legislative bodies that promulgate laws. The State
Council and its branches promulgate administrative regulations. Regulations
promulgated by the State Council, its ministries and organizations apply throughout the
nation, while regulations promulgated by local counterparts only apply to those local
administrative areas.
According to the Law of the Organization of the People’s Court of the People’s Republic
of China, people’s courts exercise nationwide judicial authority.4 The SPC is also
responsible for issuing judicial interpretations which provide guidance for all people’s
courts on the application of laws and regulations.5 Thus far, the SPC has issued two
judicial interpretations related to the Contract Law: (1) Judicial Interpretation on Contract
Law I;6and (2) Judicial Interpretation on Contract Law II.7 These interpretations provide
important guidance on the resolution of contract disputes.
II. Principles of Chinese Contract Law
Similar to most jurisdictions, under Chinese contract law, a valid contract is formed
through offer and acceptance. However, under certain circumstances, the contract itself
may be revocable8 or even void.9
Under PRC law, a contract may be revocable when it is unfair to a party at contract
inception, or the contract is made based upon significant misunderstandings or mistake
between the parties. A contract is void if a party has committed fraud, was coerced into
entering the contract, if the contract has an illegal subject or purpose, or if it contradicts
with mandatory laws or regulations.
The basic principle of Chinese contract law is that in valid contracts, a contractual party
must perform their respective obligations in accordance with the terms of the contract.
Neither party is allowed to unilaterally modify or rescind the contract;10 otherwise, it will
be liable for breach of contract. However, besides modification or rescission by mutual
agreement, Chinese contract law also provides some circumstances under which the
parties may be entitled to modify or rescind the otherwise valid agreement. These
circumstances include: (1) events of force majeure;11 (2) before the expiration of the
performance period, a party expresses explicitly or indicates through its acts, that it will
4
Law of the Organization of People’s Court of the People’s Republic of China [“Chinese Court Law”] art.
2-3, chap.1 (promulgated by the Nat’l People’s Cong. October 31, 2006 effective January 1, 1980).
5
Chinese Court Law, art.32, chap.2.
6
Judicial Interpretation of the Application of Contract Law of People’s Republic of China I [“Judicial
Interpretation on Contract Law I”], (promulgated by the Supreme Court of People’s Republic of China on
December 29, 1999 effective December 29, 1999).
7
Supra note 2
8
Chinese Contract Law, art. 54, chap. 3.
9
10
Chinese Contract Law, art.8, chap. 1.
11
Chinese Contract Law, art. 117, chap. 7
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not perform its principal debt obligations; (3) a party delays in performing its principal
debt obligations and fails, after being urged, to perform them within a reasonable time
period; (4) a party delays in performing its debt obligations or commits other acts in
breach of the contract so that the purpose of the contract is not able to be realized, and (5)
other circumstances provided by law.12
In short, if the parties desire to rescind a contract, they have three options: (1) mutually
agree to rescind the contact,(2) have provisions in the contact listing the events or
conditions which give rise to a rescission,13 or (3) rely on the above listed exceptions.14
For all three potential options to rescinding a contract, the legal procedures are the same.
First, the party requesting the rescission will serve notice upon the receiving party. If the
receiving party does not object, the contract will terminate. If the receiving party objects,
the requesting party must bring an action before the people’s court or an arbitration
commission subject to an arbitration agreement.15 The receiving/objecting party may
also file counterclaims to demand continued performance of the contract.16 The lawsuit
must be filed within a specific period as agreed by the two parties. If the two parties do
not agree on any specific period, the parties must file a lawsuit within 3 months of receipt
of the notice for rescinding the contract.17
III. Article 26 or the “Fundamental Change of Circumstances” Provision
The “fundamental change of circumstances” provision was not originally included in the
Contract Law, but was issued as a judicial interpretation during the recent global
economic downturn. The provision gives a contracting party the right to request
modification or rescission of a contract under “fundamental change of circumstances,”
but also sets up very strict conditions. Article 26 states:
“After a contract is legally formed, in view of objective circumstances not

anticipated by the parties when the contract was formed, not caused by
force majeure nor commercial risks, and significant changes occur so that
continuing the performance of the contact is unfair and inequitable to one
party or the objective of the contract cannot be fulfilled, then a party or both
parties may request the people's court to modify or rescind this contact.
12
Chinese Contract Law, art.94, chap.6.
13
Chinese Contract Law, sec.2, art. 93, chap. 6
14
Supra note 12.
The parties to a contract may rescind the contract under any of the following circumstances:
(1) The purpose of the contract is not able to be realized because of force majeure;
(2) One party to the contract expresses explicitly or indicates through its acts, before the expiry of the performance
period, that it will not perform the principal debt obligations;
(3) One party to the contract delays in performing the principal debt obligations and fails, after being urged, to perform
them within a reasonable time period;
(4) One party to the contract delays in performing the debt obligations or commits other acts in breach of the contract
so that the purpose of the contract is not able to be realized; or
(5) Other circumstances as stipulated by law.
15
16
Judicial Interpretation on Contract Law II, art. 24, chap. 4.
17
Id.
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The people’s court shall abide by the principle of fairness and consider the
actual situations involved in this case before making a decision on
modifying or revoking the contract at issue.”
Accordingly, there are four elements that must be present in order to establish a prima
facie case so a request may be made to a court to modify or rescind a valid contract:
A. objective circumstances exist that were not anticipated by the parties when
the contract was formed;
B. the change of circumstances is not caused by force majeure;
C. the change of circumstances is not a result of a normal commercial risks;
and,
D. the continuing performance of the contact would be unfair and inequitable
to one party or the objective of the contract cannot be fulfilled.
In deciding whether to grant a request for modifying or revoking a contract, the people’s
courts will primarily consider (1) the principle of fairness and (2) the surrounding facts
involved in each individual case.
In addition, the SPC announced two additional policies after Article 26 which further
clarify the application of the Article: (1) Guidance for Trials on Contract Litigation in the
Current Environment18 ; and (2) Announcement on Serving the State and Communist
Party by Correctly Applying Judicial Interpretation of the Application of Contract Law of
the People’s Republic of China II 19. In particular, the Guidance for Trials on Contract
Litigation in the Current Environment provides four policy objectives that we will
discuss further. These policies are very important to ensure fair and unified application
of Article 26.
A. Objective Circumstances Unanticipated by the Parties when the

Contract was formed.
The Guidance for Trials on Contract Litigation in the Current Environment provides
standards for the interpretation of “unanticipated circumstances.”20 Standards are based
on: a reasonable person in common society standard, whether the level of risks is beyond
a reasonable person’s expectations, whether the risks can be avoided or controlled, and
whether transactions are of a high risk or high return nature. The people’s courts will
consider the circumstances involved in specific cases and make decisions on a case-by-
case basis.
18
Guidance for Trials on Contract Litigation in the Current Situation [“Guidance on Contract Trials”]
(promulgated by the Supreme Court July 7, 2009, effective July 7, 2009).
19
Announcement on Serving the State and Communist Party by Correctly Applying Judicial Interpretation
of the Application of Contract Law of People’s Republic of China II, (Fa [2009] 165) (Promulgated by the
Supreme Court.
20
Supra note 18.
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Some recent cases may provide insight into the meaning of “unanticipated objective
circumstances.” In April, the Beijing Municipal Government issued an announcement
that prohibited banks from issuing mortgage loans to home purchasers who already
owned two residential units. At the time this announcement was issued, many real estate
purchasers that already owned two or more units had entered into additional purchase
agreements. Therefore, many residential unit purchasers filed lawsuits with the people’s
courts claiming that due to this announcement, they could not obtain mortgage loans and
therefore could not afford to perform their end of the purchase agreements. In July, the
Beijing Haidian District Court announced the courts would recognize this development as
an “unanticipated objective circumstance.”
B. What is Force Majeure
Force majeure under Chinese Contract Law is defined as an extraordinary circumstance

that is unforeseeable, unavoidable and out of the control of any party.21 In practice, events
of force majeure mainly include natural disasters, wars, strikes, riots, civil commotions,
fires, explosions, sabotage, terrorism, or embargos. In 2003, the Chinese Supreme Court
issued an announcement that recognized “SARS” as an event of Force Majeure.
Article 26 requires that the objective circumstance unanticipated by the parties is not
caused by events of force majeure. However, Article 26 does not provide definitions for
the differences between force majeure and fundamental change of circumstances. From
the Beijing Haidian District Court’s decision referred to above, it seems that changes in
laws may also be recognized as a fundamental change in circumstances. Article 26 was
issued last year and more time is needed to fully understand the courts’ attitude in
differentiating between the two.
C. Difference between “Fundamental Change of Circumstances” and

“Commercial Risks”
Both Article 26 and the Guidance for Trials on Contract Litigation in the Current
Environment stress a fundamental change of circumstances shall not include changes
arising from normal commercial risks. Generally, common commercial risks can be
reasonably anticipated and are assumed by the parties.
During the global economic downturn, most disputes seeking application of Article 26
refer to changes in commercial markets, such as price fluctuations in raw materials or
commodities. When distinguishing “fundamental change of circumstances” and
“commercial risks,” the courts are generally taking a cautious approach and will consider
whether the event could have been reasonably anticipated by the parties.
The Guidance for Trials on Contract Litigation in the Current Environment provides that
when it comes to a significant increase or decrease in prices of raw materials, changes in
supply and demand, insufficient cash flow and other similar reasons, the people’s courts
shall strictly abide by the principle of fairness and carefully scrutinize the objective
21
Chinese Contract Law, art.117, chap. 7.
ST1 27240v1 04/05/11

circumstances alleged by a party.22 Generally, prices of raw materials, supply and

demand, and cash flow issues usually contain lower or more manageable risks than other
market factors such as currency fluctuations or interest risks. Market participants may
conduct routine transactions involving the same raw materials in the same territories.
Such risks are more likely to be seen as routine commercial risks.
For some higher-risk areas, the Supreme Court has called for a strict approach. The
Guidance for Trials on Contract Litigation in the Current Environment requires much
stricter inspection on commodities that are extremely active on the market such as
petroleum, coal, nonferrous metals, or commodity price indexes and financial product
contracts such as stocks and futures.23
In a recent arbitral award related to swap contracts, the China International Economic and
Trade Arbitration Commission did not recognize the global economic crisis as a
“fundamental change of circumstances.” This decision was based on two reasons:
(1) The global economic crisis was in many respects a gradual process instead
of an abrupt event which caught market participants off guard. The
rationale behind this reason is that as the downturn unfolded, market
participants were able to anticipate and seek solutions to control risks; and
(2) The underlying index of the swap contracts involved in this arbitration
was the Libor interest rate which was recognized as high risk derivative
trading. All parties were aware of such high risks at the time of
contracting. The rationale behind this reason is that if parties are aware of
higher risks through the reasonableness standard, they shall bear such
anticipated risks. In addition, parties that enter into high risk transactions
are hoping to achieve high returns and correspondingly they shall bear any
losses that may arise in these transactions.
This arbitral decision implies that the people’s courts will impose increased scrutiny on
the financial derivative contracts. The global economic crisis will not be generally
recognized as an unanticipated circumstance because these transactions are considered
by a reasonable person to contain high commercial risks.
D. Continuing Performance of Contact is Unfair and Inequitable to One

Party or Objective of Contract Cannot be Fulfilled
This element is the same as that of mandatory rescission whereby a party is entitled to
rescind a contract if the other party breaches ancillary debt obligations after the
expiration of the performance period and such breach frustrates the objective of the
contract.24 Generally, the contract purpose may be described in the contract or inferred
from the negotiations and execution between the parties.
22
Supra note 18.
23
Supra note 18.
24
Supra note 12.
ST1 27240v1 04/05/11

On August 25, 2009, the Beijing Chaoyang District People’s Court issued a decision on
an exclusive license agreement suit brought by Song Ying, etc. against Beijing Chang
Xiang Bang Pet Information Consultancy Service Center. In this case, the courts held
that failure to obtain a required license, which partially contributed to a default, would be
considered as a situation where “the objective of the contract cannot be fulfilled.”
This case provides guidance for what may frustrate the purpose of a contract, such as
failure to obtain a required license by one of the parties. In addition, this case provides a
basis whereby if a party’s fault partially contributed to any event which will frustrate the
purpose of the contract, it would be unfair to have the other party perform the contract
and incur losses.
E. Procedures for Claiming Article 26 and the Mediation Policy of the

People’s Courts
A party may request application of Article 26 by filing a request at a people’s court either
as (1) an application to modify an existing contract or as (2) an application to rescind a
contract. Under Article 26, any notice for rescinding a contract by itself does not
effectively rescind the contract.
The Announcement on Serving the State and Communist Party by Correctly Applying
Judicial Interpretation of the Application of Contract Law of People’s Republic of China
II25 provides two policy considerations for applying Article 26: (1) to maintain and
promote a stable financial system and economic growth; and (2) to actively mediate
disputes between parties. These two policies encourage people’s courts to actively
conduct mediations to mutually modify a contract towards a feasible and practicable
resolution.
In practice, if a party requests a contract be rescinded, the people’s courts will first try to
modify the contract based on the principle of fairness. If modification of the contract is
unfair or inequitable to a party, only then will the court will consider the application to
rescind the contract.
F. Cautious Attitudes of People’s Courts on Applying Article 26

The Guidance for Trials on Contract Litigation in the Current Environment provides a
policy objective for the people’s courts to protect the interests of parties who have
performed their contractual obligations in accordance with a valid contract.26 Moreover,
the policy is designed for people’s courts to not permit debtors to escape from performing
their debt repayment obligations.
25
Announcement on Serving the State and Communist Party by Correctly Applying Judicial Interpretation
of the Application of Contract Law of People’s Republic of China II, (Fa [2009] 165) (Promulgated by the
Supreme Court.
26
Supra note 18.
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The SPC requires all people’s courts to conduct very strict reviews on the unanticipated
circumstances alleged by parties seeking modification or rescission.
If, based on the specific situations of individual cases, the court considers applying this
provision, the trial court must first report this case to the high court at the provincial level
for examination and approval. When necessary, the case may also be reported to the SPC
for examination and approval. Having the high court at the provincial level as the
primary authority for applying Article 26 ensures unified application at least by province.
IV. Conclusion
According to the policies discussed above, the SPC is very concerned with the
application of Article 26 and has instructed all people’s courts to be cautious in applying
this provision. In addition, all people’s courts must conduct a strict review on
“fundamental change of circumstances” and must consider specific situations involved in
individual cases. People’s courts must abide with the principle of fairness, which
includes protecting the interests of parties who have performed their contractual
obligations and prohibiting debtors from escaping contractual obligations. What’s more,
only the high court at the provincial level or the Chinese Supreme Court has the power to
make a final decisions on applying Article 26.
Therefore, parties who wish to rely on Article 26 to rescind a contract and avoid
performing contractual obligations may not easily succeed based on its judicious
application. However, this judicial interpretation remains to be further clarified in trial
practice.
Susan Ning is a Senior Partner at King &Wood at their Beijing and New York offices and
can be reached at Tel. 86-10-5878 5588 or Email: susan.ning@kingandwood.com
Tao Huang is a Partner at King &Wood at their Beijing and Qingdao offices and can be
reached at Tel. 86-10-5878-5588 or Email: huangtao@kingandwood.com
Yang Yang is an associate at King & Wood at their New York office and can be reached
at Tel. (212) 319 4755 or Email: yangyang2@kingandwood.com
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ITEMS OF INTEREST
Selected Recent English Language Books on Chinese Law
CHINESE CAPITAL MARKET TAKEOVER AND RESTRUCTURING GUIDE, by Chengwei Liu,
Kluwer Law International 2010 536 p. ISBN: 9789041132109
http://www.kluwerlaw.com/Catalogue/titleinfo.htm?ProdID=9041132104&name=Chines
e-Capital-Market-Takeover-and-Restructuring-Guide
From the publisher: “Although several useful entry guides to China for business investors
have appeared in recent years, this is the first book to focus on a business strategy that is
becoming increasingly important – and attractive – to businesses in China: the takeover
and restructuring of a listed company. This practice orientated book has an additional
value, moreover, in that it fully takes into account not only the relevant regulations, most
of which were promulgated or updated from 2005 to 2010, but also the actual structures
and procedures of nearly ninety announced deals, right up to September 2010.”
CHINESE IMMIGRATION LAW, by Guofu Liu, Ashgate 2010 234 p. ISBN: 9781409409403
http://www.ashgate.com/default.aspx?page=637&calcTitle=1&title_id=10145&edition_i
d=13340
From the publisher: “This book provides a comprehensive, up-to-date, and readily-
accessible reference to Chinese immigration law. It provides the necessary detail, insight
and background information for a thorough understanding of this complex system. The
book has been written on the basis of Chinese statutes while also including coverage of
the relevant international instruments. The work draws on and compares Chinese and
English language sources, making it an invaluable resource for both Chinese and non-
Chinese readers alike.”
THE DEVELOPMENT OF THE CHINESE LEGAL SYSTEM: CHANGE AND CHALLENGES, edited
by Guanghua Yu, Routledge 2010 332 p. ISBN: 9780415594202
http://www.routledge.com/books/details/9780415594202/
From the publisher: “In recent years the Chinese legal system has undergone many
reforms and this book brings the literature up to date, offering a contemporary account of
the law and administration in China. This book is the result of collective efforts in
analysing the political, economic and social factors which affect the development of
Chinese law. The volume contains contributions from a number of experts and scholars
of Chinese law who examine some of the most important areas of Chinese law. The book
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covers constitutional law, criminal law, property law, mortgage law, intellectual property
law, corporate law, securities regulation, banking regulation, civil procedural law,
arbitration law, environmental law, and the regulation of telecommunications services.”
SECURED FINANCE LAW IN CHINA AND HONG KONG, by Mark Williams, Haitian Lu &
Chin Aun Ong, Cambridge University Press 2010 450 p. ISBN: 9780521519342
http://www.cambridge.org/gb/knowledge/isbn/item2708252/?site_locale=en_GB
From the publisher: “This book examines systematically the current systems of secured
lending in China and Hong Kong, where companies or individuals offer personal
property as security for credit advanced by a lender. Valid and enforceable security
reduces the risk to the lender and so lowers the cost of credit to the borrower. However,
the Hong Kong system, being largely derived from English law, is highly complex and in
need of root-and-branch reform. The forces of inaction have triumphed and valuable
opportunities to create a modern, rational and efficient system have been squandered. In
China, on the other hand, a completely new system has been created in the last twenty
years which, whilst it has various problems and defects, has some notable advantages
over the common law equivalent found in Hong Kong.”
Selected English Language Legal Articles
Environmental Criminal Law in China: A Critical Analysis, by Michael G. Faure & Hao
Zhang, 41 ENVTL. L. REP. NEWS & ANALYSIS 10024 (2011). From the authors: “The goal
of this Article is to present and discuss environmental criminal law in China. There is
increasing attention to the role of environmental law in promoting sustainable
development and effective environmental governance in China, but so far, less has been
published (at least in English) on the effectiveness of various enforcement mechanisms
that could be used to support material environmental law. The goal of our Article is to
identify the way in which public sanctioning systems (mostly criminal law, but to some
extent also administrative law) can be employed in an effective way to induce
compliance with environmental legislation.”
Leaping over the Great Wall: Examining Cross-Border Insolvency in China under the
Chinese Corporate Bankruptcy Law, by Steven J. Arsenault, 21 IND. INT'L & COMP. L.
REV. 1 (2011). From the author: “This Article examines the cross-border insolvency
provisions of the Chinese Corporate Bankruptcy Law within the context of the primary
academic approaches to cross-border insolvency: territorialism and universalism. It
compares the Chinese approach to the United Nations Commission on International
Trade Law Model Law on Cross-Border Insolvency and the U.S. approach under Chapter
15 of the U.S. Bankruptcy Code. The Article concludes with a proposal for adjustments
to China's bankruptcy law to more effectively deal with the problems associated with
cross-border insolvency cases.”
Professional Responsibility in an Uncertain Profession: Legal Ethics in China, by Judith

A. McMorrow, 43 AKRON L. REV. 1081 (2010). From the author: “The goal of this essay
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is to explore the challenges facing Chinese legal education and the Chinese legal
profession as it develops norms of legal ethics. This essay starts with two simple
questions: Why do law schools in China have so little discussion of legal ethics? Why do
students not press or seek more discussion of this topic? The essay then looks at the
creation of norms of legal ethics from a top-down perspective and the inadequacy of that
approach. Both a bottom-up and top-down examination identify the tremendous
challenges facing the Chinese emerging legal culture in building a coherent model of
lawyering that can serve as the foundation for a system of legal ethics.”
Waste No Land: Property, Dignity and Growth in Urbanizing China, by Eva Pils, 11
ASIAN-PAC. L. & POL'Y J. 1 (2010). From the author: “The Chinese state does not allow
rural collectives to sell land, but takes land from them and makes it available on the urban
property market. In this process, rural land rights are obliterated, while newly created
urban rights in what used to be rural land enjoy legal protection. The state justifies this
practice by the need for urbanization and economic growth. Land takings from rural
collectives have in fact been a precondition for the growth of the real estate market, and
resulted in an impressive contribution of the construction and property sector to state
revenue and GDP growth. Yet they have also led to unjustifiable suffering on the part of
members of rural collectives, who have been evicted from their land and homes, and
whose rights have in many cases been violated. The example of Chinese rural takings
practices shows that certain economic theories of property rights that originated in the
west and came to be embraced in China are consistent with invidious discrimination. In
particular, this example compels us to reject the claim that property rights are desirable
because they serve economic growth. The discussion here contributes to an understanding
of property in terms of dignity, rather than wealth and growth.”
Selected English Language Legal Articles

Submitted by Kara Phillips, Collection Development Librarian/Associate Director,
Seattle University Law Library. Kara Phillips can be reached at: Phillips@seattleu.edu
.
ST1 27240v1 04/05/11

Volume 7, Issue 1
April 2011
About the China Committee
China Law
This committee supports ABA members with interests in China-
Reporter related legal matters. Committee work, both in the U.S. and in
中国法律报道 Greater China (the Chinese mainland, Hong Kong, Taiwan and
Macau), includes review, analysis, comment and information-sharing
on matters of law, legal practice and related policy. Within Greater
Visit the China China, the China Committee works to facilitate links and
Committee Online at: understanding between US and local legal practitioners and law
students and to further the development of the rule of law, including
http://www.abanet.org/d implementation by China of its WTO commitments.
ch/committee.cfm?com=I
C860000
Subscribe to the China About the China Law Reporter

Committee Listserve:
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Send an email to the Section of International Law of the American Bar Association.
listserv@mail.abanet.org Editors are Russell K.L. Leu, Esq. (Senior Editor), Counsel to the
with the text “subscribe law firm Taft, Stettinius & Hollister LLP and Co-Chair of the China
INTCHINALAW” Committee (leu@taftlaw.com), Paul B. Edelberg, Esq. (Senior
followed by your FIRST Editor), Partner in the Stamford, Connecticut and New York, New
NAME LAST NAME. York offices of Fox Rothschild LLP and Vice-Chair of the China
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want, including the questions regarding such articles should be directed to the author(s)
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ST1 27240v1 04/05/11

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CHINA LAW REPORTER

China Committee REPORTING ON DEVELOPMENTS IN THE FOUR LEGAL SYSTEMS OF

Russell K.L. Leu Happy Year of the Rabbit!

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China Committee REPORTING ON DEVELOPMENTS IN THE FOUR LEGAL SYSTEMS OF

Russell K.L. Leu

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CHINA ADOPTS PROCESS FOR NATIONAL SECURITY

By Libin Zhang and Casey Rubinoff

As a supplement to the Notice, on March 4, 2011, the Ministry of Commerce

The Section of International Law: Your Gateway to International Practice

Where a foreign investor participates in concentration of business operators

1. military and military supporting enterprises;

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1. The foreign investor, holding parent company or held subsidiary obtain

Application and Review Process

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Necessity, Ambiguity and Uncertainty

ST1 27240v1 04/05/11

Advice to Foreign Investors

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U.S. FUNDS LOOK TO RMB FUND

In 2003 the Chinese Government authorized private equity investments through an

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Another development of note is the encouragement of foreign private equity in certain

Types of Onshore Fund Entities

Management of a FIVCE may be delegated to a domestic management company, a

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The Foreign Partnership Measures became effective as of March 1, 2010.21 Those

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SAIC issued its Administrative Regulations on Registration of Foreign-Invested

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Until recently, there were no relevant regulations authorizing or specifically regulating

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The Shanghai Fund Implementation Measures

A foreign-invested fund established under the Shanghai Fund Implementation Measures

It is anticipated that Beijing and Tianjin will issue similar measures.

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RMB Fund without a FIVCE, a FEIMC or a Shanghai FIE Fund

Strategies for U.S. Private Equity Funds

Chinese regulation of foreign-invested private equity funds and management companies

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CHINESE COURTS ADOPT CAUTIOUS ATTITUDES

I. Roles of the SPC

The Section of International Law: Your Gateway to International Practice

II. Principles of Chinese Contract Law

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III. Article 26 or the “Fundamental Change of Circumstances” Provision

“After a contract is legally formed, in view of objective circumstances not

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A. Objective Circumstances Unanticipated by the Parties when the

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B. What is Force Majeure

Force majeure under Chinese Contract Law is defined as an extraordinary circumstance

C. Difference between “Fundamental Change of Circumstances” and

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circumstances alleged by a party.22 Generally, prices of raw materials, supply and

D. Continuing Performance of Contact is Unfair and Inequitable to One