China: What Businesses are Open to Foreign Investors?

Excerpt from article in Practical China Tax and Finance Strategies prepared by By Janet Jie Tang , partner at the US law firm Akin Gump Strauss Hauer & Feld LLP and based in Beijing.

The threshold issue for every foreign investor investing in China is whether the business area it plans to invest is open to the foreign investor; if it is open, how open is open to the foreign investor. This threshold issue directly goes to the fundamental policy of the Chinese government regarding the Chinese industries.

One of the key legislations in this regard is the Catalogue Guiding Foreign Investment in Industries (the “Foreign Investment Catalogue”). The Foreign Investment Catalogue lists the business sectors where the Chinese government forbids, restricts (which means it is not forbidden but it is particularly regulated by the Chinese government) or encourages foreign investment. Anything outside of the Catalogue is deemed as a sector that the Chinese government allows for foreign investment. With the development of the Chinese economy and the adjustment of the industry policy due to such development, the Foreign Investment Catalogue, since it was initially issued in 1995, has been amended four times respectively in 1997, 2002, 2004 and 2007. The latest amendment became effective December 2007.

From the latest amendments to the Foreign Investment Catalogue, we can see the changes of the Chinese government’s attitudes towards foreign investment. For example,
(1) Purely export-oriented industries are no longer encouraged (this reflects our government’s adjustment of its policy on trade facing the tremendous trade surplus and rapid growth of the foreign exchange reserve in China);
(2) high-tech industries (such as new materials manufacturing) and certain service industries (such as modern logistics) are encouraged;
(3) For those industries involving natural resources that are non-renewable, they are either forbidden or restricted;
(4) For those business sectors, which may impact the national economic security, such as news websites, services of Internet audio-visual programs, business sites that provide Internet access services and Internet culture operations, they are no longer permitted for foreign investment, and now are forbidden for foreign investment.

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Foreign Investment in the US: President Issues New Order

Excerpt of article by Reginald J. Brown, Lynn R. Charytan, Jamie Gorelick, Stephen W. Preston, Wilmer Cutler Pickering Hale and Dorr LLP in WorldTrade Executive's International Finance & Treasury

On January 23, President Bush issued an Executive Order (Order) amending Executive Order 11858, concerning foreign investment in the United States. The Order provides guidance concerning the implementation of the Foreign Investment and National Security Act (FINSA), which was signed into law on July 26, 2007. Such "guidance," which was issued pursuant to the President's "executive power" under Article II of the Constitution and under the Defense Production Act of 1950, has the full "force and effect of law" and is binding on the executive agencies that are members of the Committee on Foreign Investment in the United States (CFIUS or the Committee).[i]

The Executive Order has been the subject of speculation and some dispute for several months. Rumors abounded in CFIUS-watching circles that the Order was intended to empower the pro-business agency members of CFIUS, such as the Treasury Department, while reducing the role of the national security agencies. In response, the latter agencies, as well as members of Congress, made clear their view that this would undermine a key intention of the CFIUS reform enacted by FINSA.
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European Patent System: Significant Changes Introduced

By Sebastian Moore (Herbert Smith LLP)
in 1/15/2008 Issue of EuroWatch published by
WorldTrade Executive, Inc.

The European Patent Convention (“EPC 2000”) came
into force on 13th December 2007, introducing significant
changes to the European patent system and the text of the
original EPC 1973.

Stakeholders should be aware of how the changes to
the European patent system may affect the granting and
enforcement of European patents. Many of the changes
are complex and technical and, given the importance of
value attaching to patents, it is inevitable that some of the
questions arising out of the scope of these amendments
will need to be clarified by the EPO and the national
courts.

The EPC has been updated for a number of reasons.
In particular, account had to be taken of developments
in international law, including the TRIPS agreement and
the Patent Law Treaty 2000. For example, the EPC 2000
clarifies the fact that, in accordance with the requirements
of TRIPS, patents can now be granted for any inventions
in all fields of technology provided they are new and
comprise an inventive step.

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Selling Chinese Goods to the U.S. Via Canada – Not for Amateurs

By Greg Kanargelidis (Blake, Cassels & Graydon LLP)
excerpt from article in 11/30/07 North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

Canadian businesses are well positioned to take advantage of their
close proximity to the U.S. market and can, where sales are properly
structured, sell competitively to U.S.-based customers. This is especially
the case where Chinese-origin goods are shut out of the U.S.
market due to antidumping duty or countervailing duty orders.

Canada and Canadian businesses have a comparative advantage
in selling to U.S.-based customers over other suppliers, even
over U.S.-based suppliers of Chinese goods. This results
from the provisions of the North American Free
Trade Agreement (NAFTA) under which trade between
Canada and the U.S. has been fully duty-free for
qualifying goods since January 1, 1998.

Pursuant to NAFTA, goods shipped from Canada
to the U.S. qualify for duty-free importation, but only
if the goods qualify as “originating goods”. This means
that the goods must satisfy certain “rules of origin”
that are set out in NAFTA. The “rules of origin” range
from the general to the very specific. Where the Canadian
exporter is shipping goods comprising any percentage
of foreign content (subject to a de minimis test),
specific rules of origin at the tariff subheading or tariff
item level must be consulted to determine what level
of processing is necessary in Canada before the goods
may be entered into the U.S. as “duty-free”.

Where the Canadian exporter to the U.S. supplies
Chinese-origin goods, it is important that the specific
rules of origin for the goods be consulted and that
proper care is taken to determine whether the goods
have been sufficiently further processed or transformed
in Canada in order to qualify for duty-free
treatment on entry into the U.S. This may entail sufficient
further processing of the Chinese-origin goods
so that the further processed product is classified in a
different chapter, subheading or, in some cases, tariff
item of the U.S. Harmonized Tariff Schedule on entry
into the U.S.

For more on this topic, visit North American Free Trade & Investment Report
or WorldTrade Executive, Inc.

EC Adopts New Merger Guidelines

By Yannis Virvilis
of McDermott Will & Emery/Stanbrook LLP
published in 12/15/07 EuroWatch p. 3

The European Commission has adopted the final text of the long awaited Non-Horizontal Merger Guidelines. The Commission had previously launched a public consultation with the publication of the draft guidelines at the beginning of the year. The Guidelines apply to vertical mergers between firms that can have a supplier-customer relationship, and also apply to conglomerate mergers where firms are active on closely related markets. The text describes the market conditions that might lead the Commission to have concerns in non-horizontal mergers. In an attempt to increase legal certainty, the text provides a rather low "safe-harbour" of market share (30 per cent) and market concentration (postmerger HHI of 2000), below which it is unlikely that any concerns will arise.

Several articles on this topic appear in the most recent EuroWatch.

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Pitfalls in Asian IP Acquisition Deals

By Alan Adcock and Nicholas Redfearn (Rouse & Co. International)
Excerpt from a recent article in WorldTrade Executive's
Global Intellectual Property Asset Management Report

Merger and acquisition deals in Asia are taking on an increasingly significant IP component. But for a foreign company interested in an Asian target, are there any particularly tricky steps which deserve more attention than you might normally pay? This article identifies 10 major pitfalls, including the following:

The Non Disclosure Agreement – an important first step in deal planning or an over zealous over reaching attempt to look strong?

Obligations of non-disclosure and confidentiality are important for any type of deal touching on IP, not only for technology, IP and trade secret matters which may be the target of the purchase, but also for business strategies, new product ideas and financial and accounting information which are likely useful to decide whether a deal will go forward.

Non-disclosure and confidentiality undertakings are enforceable in Asia provided they be reasonable and fair and not do violate the public interest. Normal western style confidentiality undertakings setting out the agreed terms of what constitutes the “confidential information” and what does not, acknowledgement of proprietary interest in the confidential information and penalties for unauthorized disclosure, etc are also common in Asia.

However, sometimes your Asian counterpart may feel uncomfortable with your standard NDA. He may feel that you are taking too formal of an approach to a relationship he believes should be built on trust rather than legally enforceable rights. This is usually the reaction if the NDA and its obligations are one-sided. While non-reciprocal NDAs may be achievable in terms of a licensor/licensee relationship, a buyer-seller relationship is different and the necessary (and expected) disclosure of information needed to decide whether the deal progresses should be explained to your Asian counterpart. If this still cannot be agreed, then a prudent buyer will ask himself why uncertainty remains and whether this particular target is appropriate.

Sometimes, the non-disclosure undertaking you seek may not be directly with the target, but rather with employees or other third parties connected to the target or to the target IP. If you are not in a position to enter into a NDA directly with those people who know of the confidential information, you can ask your seller counterpart to add its own confidentiality restrictions (as riders to existing or in new agreements) to its own agreements with its employees, agents, etc and you should request copies of these. This is common and we would certainly advise it.

Disclosure Statement – what is the minimum expected and how much can/should you ask for?

The attractiveness of acquiring a business in Asia is not only the prospect of an instant market for goods or services the target already sells or manufactures, but also the ability to acquire valuable IP rights or to source materials at prices often more competitive than in other countries. Having a business here also makes for easy distribution within the Asia Pacific Region. However, when acquiring a business in Asia, it is imperative that you get the seller to identify defects in the IP, in the market and in the business which may effect your purchase price or which will need to be corrected (possibly with the help of the seller). Representations and warranties from the seller should be expressly set out in the acquisition agreement and the Disclosure Statement serves to limit these (save for fraudulent misrepresentation on the part of the seller) by identifying such problems and putting the buyer on notice that they exist. This should be explained carefully to your Asian seller so that he understands that this serves to protect him against future claims you may make for breach of warranties and representations.

Many times, sellers may not be able to answer all of the buyer’s questions on existing IP portfolio defects, disputes or business concerns. This is particularly true if the IP has not been carefully maintained (which occurs frequently in Asia with local domestic counsel and registries themselves making mistakes). There may be disputes over the IP both in Asian IP registries as well as on the ground with infringers or with others who claim that the IP you wish to buy infringes their rights. Sometimes, a seller’s business is stong in some countries, but not in others. You should be wary of any seller who paints only a rosy picture and fails to disclose any problems. In many Asian jurisdictions, the time and costs of litigating representations and warranties can be extremely high and will likely take years to resolve (if at all). This, of course, may delay rollout of your business plans. More

Dealing (and Dealmaking) with Mexican Grupos

Excerpt from
North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.
by Alyssa A. Grikscheit and Javier Fierro
(Goodwin Procter LLP)


Grupos are the large family conglomerates that dominate the Mexican economy. If you are a strategic or private equity investor attracted to the increasing opportunities in Mexico what kind of structural issues are you going to encounter if you invest with Grupos?

In Mexico, Grupos have impeded competition, keeping near-monopolies in certain industries. For instance, there are only two beer companies, two major food processors, two television networks and six radio chains in the country.Some Grupos have successfully expanded outside of outside of Mexico.

There are three main common characteristics found in a Mexican Grupo. First, the Grupo will typically run several businesses, and often these businesses will operate within various industries. Second, the Grupo will generally be composed of more than one family, but their connections run deep. And third, the organizational structure is predominantly based on kinship.

Dealing with Grupos can be a thorny issue, especially when trying to exit the investment Some Grupos may not want to exit their investment because they want to pass down the business to their offspring. Other less scrupulous Grupos may use
their political and economic muscle to shift assets to other investments within the
Grupo.

On the other hand, a Grupo on an investor’s side can
be a significant ally in an emerging market. By integrating with
a Grupo, an investor will gain political power, acquire local
knowledge of the country, and avoid contractual problems
with other local firms, all while avoiding expensive search
costs. The question therefore arises: how to find a suitable
Grupo? As with any other investment opportunity, finding a Grupo will inevitably require the investor to do its homework.


Due Diligence
First and foremost, the investor needs to perform a background check on the family. The investor needs to identify red flags such as young and inexperienced family members in key management positions within the company. In addition, the investor needs to review their resumes. Are they educated professionals or are they simply in their positions because of their family name? A strong kinship bond within the Grupos sometimes displaces sound business judgment and good corporate governance.

The investor should also identify the family patriarch within the Grupo. Sometimes knowing who holds the power within the family may not be readily apparent because of the complexity of the Grupo network. Understanding the family organizational hierarchy will prove invaluable when a conflict arises. The investor should also verify whether the Grupo has the political and economic muscle they claim to have; sometimes it may just be pure bravado.

In addition, the investor should check to see if the Grupo has commitments with other foreign firms. Such commitments may mean a Grupo has already been required to keep family assets and company assets separate and to meet certain corporate governance standards. It may also mean the Grupo’s reputation will be affected by a major fallout with a foreign investor. While checking the Grupo’s commitments, the investor should also check for potential conflicts of interest that may arise from the transaction.

It is critical to identify the keyplayers in the Grupo. This is particularly important in the negotiation process. Negotiating with a family member with insufficient authority may mean that concessions made by the Grupo are later reversed, effectively giving the Grupo two bites at the apple.

It is also critical to build a relationship based on mutual trust. Although many Grupos have been successful in jurisdictions outside of Mexico where deals may go to the highest bidder regardless of emotional or other connections, they still tend to rely on building relationships before crafting and executing deals. Finally, it is crucial to note the long-term memory of most Grupos. Because of their family connections, management is typically not very fluid. The investor’s management team may change several times, while the Grupo’s team remains more or less intact. Perceived injustices by the investor will not be easily forgotten, and may impact future dealings with the Grupo.

Setting a Price
Earnouts can be a powerful tool in dealmaking with Grupos. They ensure that performance incentives are aligned and serve as both “sticks” and “carrots”. The stick is essentially the investor’s bargaining power in the event of future disputes, and the carrot, quite simply, is cash, which may be in short supply in Grupos that do not include a captive bank.

There are other possible leverage points as well. Sometimes a private equity investor will try to position itself as the information gatekeeper. The investor may try to hold certain valuable information or intellectual property separately from the portfolio company. Holding such information or intellectual property directly may allow the investor to exert external pressure on the Grupo without having to rely on weak institutions for enforcement. However, this approach may not be practical in Grupos where the management (and members of the Grupo) has an inherent information advantage. More