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CHINESE REAL ESTATE PROJECTS

THIS MEMORANDUM PROVIDES AN OVERVIEW OF BASIC LEGAL PRINCIPALS AND ISSUES APPLICABLE TO REAL ESTATE PROJECTS UNDERTAKEN BY FOREIGN INVESTORS IN THE PEOPLE’S REPUBLIC OF CHINA (“CHINA” OR THE “PRC”). THE DISCUSSION IS INTENDED TO ASSIST PROSPECTIVE FOREIGN INVESTORS IN MAKING DECISIONS ABOUT THEIR PARTICIPATION IN CHINESE REAL ESTATE PROJECTS. PLEASE NOTE, THIS MEMORANDUM IS NOT DESIGNED TO PROVIDE COMPREHENSIVE ADVICE REGARDING ANY PARTICULAR PROJECT AND DOES NOT SET FORTH THE FULL RANGE OF LEGAL AND STRUCTURING OPTIONS, PROBLEMS OR SOLUTIONS WHICH MIGHT BE APPLICABLE TO A PROJECT. ADDITIONALLY, ATTACHED TO THIS MEMORANDUM AS EXHIBIT A IS A CHART SHOWING THE VARIOUS TAXES GENERALLY APPLICABLE TO CHINESE REAL ESTATE PROJECTS.

You should note in particular that the Chinese government has taken extraordinary steps since 2006 to cool the Chinese real estate market, mainly through the issuance of new laws and regulations restricting foreign investment. These new rules have created an environment of regulatory uncertainty as their scope has yet to be defined. This is a common state of affairs in China, and we do not expect this regulatory uncertainty to be dispelled in the near future as the Chinese government is focused on curbing inflation and cooling the real estate market. Nevertheless, we maintain a “bullish” attitude towards the Chinese real estate market and are optimistic about the ability of foreign investors to complete major projects in China with acceptable terms and risk profiles.

James Tervo

I. Land Use Rights

A. Types. In China, all real estate is either state-owned or collectively-owned. Private persons may not own real estate. Instead, the government grants enforceable land use rights to private persons. Ranked in order from unmarketable to most marketable, the types of land use rights are as follows:

Collectively-owned land use rights – Collectively-owned land is land owned by a local collective (the former communes). It may not be used for real estate development and can only be used for arable uses or the development of villages and towns. It must be converted to state-owned land before the associated land use rights can be granted to private persons.

State-owned land use rights – State-owned land is land held by the central government. The associated land use rights can be granted to private persons either by allocation or by grant.

Allocated land use rights – Allocated land is state-owned land allocated to a state-owned or private enterprise without compensation. This occurs only in special circumstances (for example, with land to be used for public projects). In order to be transferred, allocated land use rights must first be converted to granted land use rights.

Granted land use rights – Granted land use rights are the most secure form of land use rights. They are freely transferable with a maximum term of up to 70 years for residential use, 50 years for industrial use, or 40 years for commercial, tourism or entertainment uses. In some instances, granted land use rights may contain restrictions on transfer or other development conditions, such as prohibitions on mortgaging, transferring or leasing the underlying land if certain conditions are not met.

B. Acquisition. Generally, the acquisition of land use rights is a straightforward process involving either an acquisition of granted land use rights from the government or a purchase of marketable land use rights from a private person. When a project is located on a piece of collectively-owned land, the land must be converted to state-owned land before it may be transferred to a private person. Following conversion, the government may grant the initial land use rights, a process which the local land bureau supervises. If the land use rights pertain to a piece of land zoned for commercial, tourism, entertainment, commodity housing or industrial uses, the grant must be through competitive bidding.

C. Documentation. Ownership of land use rights is evidenced by a land use rights certificate entitling the holder to transfer, mortgage or lease the land. Ownership of improvements is evidenced by either a building ownership certificate or real estate ownership certificate. Separate registries are used to register each type of certificate. In Shanghai, Guangzhou, Shenzhen and some other large cities, the two certificates have been combined into a single ownership certificate.

D. Land Policy. The supply of new land available for development is subject to local, regional and national policies that are directed, most often, at limiting corruption and restraining runaway growth in the real estate sector. Since 2006, the government has (i) halted the supply of new land for single family houses; (ii) restricted supply for high-end, low density residential projects; (iii) restrained the demolition of older properties for redevelopment; (iv) required that local governments maintain development of units under 90 sq. m. at a minimum of 70% of total development and construction area approved for a project; and (v) authorized land bureaus to charge fees and terminate or amend development plans for land that is left undeveloped for 12 months after the date that development was scheduled to begin pursuant to the original land use rights grant contract.

E. Eminent Domain. The Chinese constitution protects individual property rights. Accordingly, the government may take land subject to a grant of land use rights but must give proper compensation to the land use rights holder.

F. Term. Land use rights, upon expiration of the applicable term, must be surrendered to the government without charge. The land use rights holder may negotiate to renew or extend the land use rights, but in doing so, will likely have to pay a new purchase price Interestingly, China’s Property Law, for the first time in the history of the PRC, provides that land use rights pertaining to land zoned for residential use will be automatically renewed upon expiration.[1] Whether a renewal fee will be charged is not specified.

II. Entities

A. Types. The Opinions on Regulating the Entry into and the Administration of Foreign Investment in the Real Estate Market (“Circular 171”), issued on July 11, 2006, prohibit foreign investors, on a going forward basis, from using a foreign entity to directly purchase, acquire or otherwise hold Chinese land use rights.[2] Instead, foreign investors must now form a Chinese entity to acquire and hold land use rights.

There are three forms of legal entities in China: a limited liability company (an “LLC”), a joint stock company and a partnership. The LLC is the entity of choice for real estate projects. As in other countries, the Chinese LLC provides limited liability for its investors, with investor liability limited to the amount of their subscribed capital (including any unpaid portion). Foreign invested Chinese entities (“FIEs”) can be further divided into three categories:

Equity Joint Ventures – In China, a joint venture (a “JV”) refers to a distinct legal entity. Typically, foreign-invested JVs are equity joint ventures (an “EJV”), formed under China’s Law on Chinese-Foreign Equity Joint Ventures (the “EJV Law”). This was the first law passed to govern foreign investment in modern China. Because of its relatively long history, it also benefits from a great many implementing regulations, additional clarifying regulations, measures, decrees and notices dealing with most aspects of the establishment and operation of an EJV.

To qualify as an EJV, there must be at least one foreign investor and at least one Chinese investor. Foreign investment should in general be no less than 25%. An EJV must be an LLC.

The EJV Law requires that investors contribute registered capital in the form of either : (i) cash, (ii) non-cash property, or (iii) intangible property (such as intellectual property or land use rights). EJV investors must receive profits and bear risks and losses in proportion to their capital contribution, making it illegal for any party to receive a guaranteed return on its equity investment.

Cooperative Joint Ventures – For many reasons, motivated foreign investors were not satisfied with EJVs. In response, the cooperative joint venture (“CJV”) was created. The CJV is very similar to the EJV. The main differences are:

• CJV investors can agree not to share returns and losses in proportion to their equity investment;

• CJVs must have unanimous approval of the board to mortgage the CJV’s assets; and

• CJVs can be set up as either an LLC or an unincorporated joint venture (e.g. a partnership).

In recent years approval authorities have discouraged the use of CJVs. Moreover, the recently issued Notice of the Ministry of Commerce and the State Administration of Foreign Exchange on Further Strengthening and Regulating the Examination, Approval and Supervision of Foreign Direct Investment in Real Estate Industry (“Circular 50”) restricts the types of arrangements upon which CJV investors can agree.[3] Most important among these restrictions, the ability for certain investors to receive a fixed income or not share returns and losses in proportion to their equity investment, which is typically permitted under a CJV, is no longer available for real estate CJVs.

Wholly foreign-owned enterprise – A wholly foreign owned enterprise (a “WFOE”) is an LLC formed solely by foreign investors. This is by far the most popular form of FIE.

A WFOE is more flexible than the other FIEs (i.e. EJVs and CJVs). For example, unlike both EJVs and CJVs, where a board of directors must act as the highest authority of the company, WFOEs are allowed to act by shareholder meeting. Furthermore, although agreements among EJV or CJV investors must be approved by the applicable approval authority, and the unanimous consent of all investors must be secured before taking certain corporate actions, WFOEs face fewer statutory requirements on shareholders’ voting rights. For instance, shareholders can arrange for different shareholder rights through shareholder agreements with no need to register the agreements with the government or apply for government approval. In addition, WFOE shareholder agreements may be governed by foreign law, unlike JV agreements, which are required to be governed by PRC law.

B. Business Scope. Each Chinese company receives a business license upon its establishment that specifies its permissible scope of business. It is not possible, as it is in many jurisdictions, to form a company for “any legal purpose.” For real estate development, and the sale of real estate, additional requirements come into play. Circular 171 requires that a foreign invested real estate company (a “Real Estate FIE”) be established for real estate development or project operation. The business scope of a Real Estate FIE may be limited to the specific acquisition, development or operation of a project.[4] When a Real Estate FIE is established, it will automatically have a one-year temporary qualification with a class decided in accordance with the size of its development project. The Real Estate FIE needs to comply with the relevant requirements for its class and apply for the permanent qualification within the one-year period.

In order to engage in the business of developing and selling real estate, a company must first obtain a qualification certificate for the grade of project to be undertaken. There are a total of four classes and the highest grade of certificate is Class 1 which has no restrictions on its development activities. The qualification certificate is issued based upon the developer’s capital, previous experience and the professional qualifications of its senior and managerial personnel.

C. Foreign Invested Entities. All company formations involving foreign investment must be approved by the Ministry of Commerce in Beijing (known as “MOFCOM”) or one of its local branches (often called COFTECs). Application reviews are conducted by the central government in Beijing for all projects with a total investment of US$50 million or more involving the development of tract land or construction of high-end hotels, villas, premium office buildings, international conference centers and large theme parks, and for all other projects with a total investment of US$100 million or more. Other projects with lower investment amounts can be approved by the local branches of the relevant approval authority. Prior to the above described incorporation approval, real estate projects will also be reviewed by the National Development and Reform Commission (known as “NDRC”) and or one of its local branches. In most cases, local approval is faster and may facilitate special incentives from local governments. For this reason, projects are sometimes “broken up” into smaller phases that qualify for local approval. This is often a technical violation and casts doubt on the validity of the company’s formation.

D. Investment Restrictions. Regulations governing FIEs have varied as the Chinese government has sought to encourage or restrict foreign investment in specific sectors of the economy. In general, an enterprise will be placed within regulatory categories based on the scope of its business and not its legal form or ownership structure.

The Catalog of Industries for Guiding Foreign Investment (the “Catalog”), the most recent version of which was issued in December 2007, sets forth which business activities foreign investors may pursue in China. The Catalog is regularly updated to reflect the government’s current policy on specific sectors in which it seeks to encourage or restrict foreign investment. Foreign-invested activities are divided into four categories: (i) Encouraged, (ii) Restricted, (iii) Prohibited, and (iv) Permitted. The Catalog lists the business sectors that are covered under the first three categories - Encouraged, Restricted and Prohibited. If an activity is not listed under any of the three categories, then it is considered Permitted. Investment in the Prohibited category is not allowed, while investment in other categories will give rise to varying levels of local, provincial and central government regulation and incentives. Companies that fall into the Encouraged category may enjoy preferential tax treatment and expedited incorporation and registration,[5] while companies in the Restricted category will be subject to stricter scrutiny.

Most real estate projects are Permitted, though certain projects involving (i) the development of tract land, (ii) construction of high-end hotels, villas, premium office buildings, (iii) international conference centers, and (iv) large theme parks fall into the Restricted category.[6] For Restricted projects, the Real Estate FIE must receive both project approval and incorporation approval from the authorities at the provincial level or higher.

E. Registered Capital Requirements. Chinese companies, including FIEs, must have a minimum registered capital amount that is approved by the government. This “registered capital” will equal the amount of capital contributed or subscribed by investors. In addition to registered capital, an FIE will also have a government-approved total investment amount. A FIE’s “total investment” is the total amount of funds, including infrastructure development costs and working capital, required for a project and approved by the government.[7] The difference between total investment and registered capital is the amount of debt an FIE is authorized to assume, also known as the “Borrowing Limit”.

To avoid undercapitalized companies, China requires specific ratios of registered capital to total investment. In the case of real estate developers, the ratio is as follows:

|Total Investment |Ratio of Registered |Ratio of Borrowing Limit to Total Investment |

| |Capital to Total Investment | |

|< US$3 million |>70% |50% | ................
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