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Business> Legal-Ease
UPDATED: December 28, 2007 NO.1 JAN.3, 2008
Conducting Due Diligence in China
By CHRIS DEVONSHIRE-ELLIS
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Ninety percent of problems when setting up business in China can be avoided by the deployment of due diligence at the front end of the investment planning. Here we point out some of the areas that can hinder a sensible approach to due diligence, the hidden risks and basic checks. The process does not have to be expensive.

Land use rights

These relate to the status of the land on which your Chinese partner has his premises. Land use is heavily monitored in China, with specific permission for appropriate commercial and industrial use being granted and only able to be altered by the Central Government.

China possesses 20 percent of the

population of the world, but only 5 percent of its arable land. Accordingly such land is precious to the government and cannot be used for commercial or development use without state-level approval.

You must insure the land you have, or that will be injected as an asset into the joint venture (JV) has the pertinent land use rights. If not, you can lose your entire investment if the state becomes aware inappropriate land has been used for development purposes. It is a very real and very common problem. Many foreign investors have been caught out.

Checks can be conducted at the local land bureau over title and the given land use permission to ensure all is in order. State-owned enterprises do not possess land use rights certificates, so they must be asked specifically to obtain one and present it to you.

How do you determine if they can use the land? Two types of land use rights exist:

- Allocated rights: These are issued to a venture for a period of years (check the timeframe) but only give the right to use the land. If the agreement over the land is between the Chinese partner and the landowner directly, what happens if your Chinese partner defaults on the rental? You can be thrown off the land. Check this out and ensure you have agreements in place in terms of letters of intent from the landowner directly to circumnavigate this eventuality. It's also important to ascertain whether or not your intended Chinese JV partner actually has the right of using the land he is "injecting" as part of his capital in any potential JV.

- Granted rights: Again, these are issued for a period of years, but give title to the land during the timeframe. From a legal point of view, you may want to consider having granted rights, especially if significant investment is taking place onsite. Yes, of course it costs more to "buy the land," but if such rights are issued in your JV name, you may use them to raise loans in China (giving the granted rights as security) and even profit from any sale of the rights later on. For long-term strategy, this secures your China future.

Timescales

License periods may not be consistent with liabilities they are entering into, such as the case of the projected 10-year JV with a Chinese partner whose license was due to expire in three months! Check this out and make sure you know whom you are really dealing with.

Copies of accounts

These can be difficult to extract from your partner. The accounts your partner presents may understate profitability and inflate overheads and business costs to reduce tax liabilities. If in doubt, ask for an accounting firm to conduct an "asset appraisal report," which will provide a private confirmation of assets. This probably should not be conducted from the Chinese partners' usual accountants. Alternatively, retain a firm to evaluate any books as presented to you and ask for a professional opinion.

The author is with Dezan Shira & Associates

In Issue No. 3 we will continue discussing due diligence procedures in China.

 



 
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