Monday, April 16, 2007

China: Germany - The EU Favorite For Chinese Investors - Part I

China: Germany - The EU Favorite For Chinese Investors - Part I

16 April 2007

Originally published December 2006

By Thomas Busching and Stefan Peters in Squire Sanders’ Frankfurt office.

According to a recent survey of top executives from the largest Chinese companies, Germany is the number one destination for Chinese companies establishing operations in Europe. The reason: favorable conditions that suit international first-timers. The main factors cited by the 96 respondents were Germany’s cost of operations, legal infrastructure and tax system. According to the survey, Chinese companies seek to establish European operations mainly to find new markets for Chinese goods and acquire new management as well as technology.

The choice of Germany for Chinese companies seems to make sense. The largest market within the European Union, Germany is highly regarded for its technology in the automotive, aerospace, logistics, pharmaceutical and chemical, machinery and mechanical engineering industries. Beyond those traditional industries, Germany leads the field in several new industries such as renewable energies, medical technology and optoelectronics, as well as nano- and biotechnology. Also, as one of the leading export nations, Germany has managers who are well-versed in trade at the international level. In essence, by establishing operations in Germany, Chinese investors can kill three birds with one stone.

The fastest and, in most instances, most costefficient way of entering a new market is by acquiring a local company with an established brand, distribution channels, technology, management, know-how and know-who. When entering the market via an acquisition, an investor will be in a much clearer position to calculate the costs of entering the market and to immediately see what he is receiving for his investment – which may be different with greenfield investments, in which unpleasant surprises and uncertain returns are more likely than not.

Given these basics, the standard M&A procedure for a Chinese company investing in Germany involves several steps. Here, we provide a brief overview of the main legal and tax parameters for German investment by a Chinese investor, starting with the approvals required by China.

1. Chinese Approval Procedures

Generally, cross-border investments by Chinese corporations and individuals are subject to government approvals. The legal effectiveness of key transaction contracts executed by Chinese investors, and the ability of these investors to complete various procedures and formalities relating to foreign exchange controls, tax matters, customs regulations and other matters necessary for an investment offshore, are usually subject to governmental approvals or, at least, to application for such approvals. The authority to approve overseas investments in nonfinancial sector businesses is shared between the State Development and Reform Commission (SDRC) or the State Council, depending on the size and nature of the specific investment, and the Ministry of Commerce (MOFCOM). The SDRC or the State Council approves policy-related aspects of overseas investments, while MOFCOM reviews and approves transaction documents related to investments.

Additionally, overseas investments must comply with registration and approval requirements imposed by the State Asset Supervisory and Administration Commission (SASAC), if the Chinese investor holds state-owned assets.

However, the main obstacle for Chinese overseas investments is China’s currency system. All PRC investors investing in or acquiring overseas companies must go through the process of foreign exchange-related examinations and registrations with the State Administration on Foreign Exchange (SAFE) or its local equivalent. A PRC investor is not able to remit foreign exchange out of China until it has completed the necessary SAFE examinations and registrations. SAFE slightly relaxed its regulations in 2006, specifically with regard to payment of preliminary costs for an overseas investment to be remitted out of China, but SAFE approval is still one of the biggest concerns related to Chinese overseas investments.

Once Chinese domestic issues surrounding a Chinese investment in Germany have been addressed, the Chinese investor can focus on the German issues.

2. Mergers and Acquisitions in Germany

In principle, the process of an acquisition in Germany structured in the form of a share deal does not differ very much from the M&A process in China. The procedure may be summarized as follows:

Please note that the standard procedures may need to be adjusted to the specific deal structure and legal status of the target (e.g., in an asset deal; under bidding, antitrust, impending or ongoing insolvency conditions; for listed companies, partnerships, etc.).

3. The General Investment Environment in Germany

With no foreign ownership restrictions, Germany provides very favorable conditions for foreign investments. Chinese investors may invest in any industry and own the whole business if they wish. This is equally true for the purchase of freehold real estate property. Capital and profits may be moved freely across borders. There are no currency restrictions, and the euro floats freely with all other currencies. In most cases, business licenses are either not required or are readily obtained – and have already been approved if an existing company is acquired.

One of the most common corporate forms used by German businesses is that of a "GmbH," described below.

4. The GmbH

A. Nature of a GmbH

A GmbH is a limited liability company used for small businesses, medium-sized family businesses or even large businesses. An incorporated entity with its own legal personality, it can be established for any lawful purpose. Its share capital is determined in its Articles of Association and corresponds with the sum of its shareholders’ capital contributions.

Only the company is liable to creditors for debts incurred by the company.

A GmbH is the simplest and least expensive form of corporate entity available in Germany. The particular advantage of a GmbH is its flexibility. As with a corporate entity in China, the Memorandum and Articles can be drafted in many different and flexible ways. A GmbH is subject to less severe regulations than a public limited company (AG); its formation is less formal and is, therefore, simpler and less costly.

In the case of small GmbHs, a supervisory board is not required. There are no restrictions on the sale of shares other than the need to have their transfer notarized by a notary public. However, the Articles may make the sale and transfer of shares dependent on other requirements; for example, they may be dependent upon the approval of the other shareholders.

B. Main Features

The GmbH is a capital-based company; unlike a partnership, the main feature is not an agreement to work together, but the assembly of capital contributions. However, it is a more personal form of entity than a public limited company (AG). The minimum capital required is €25,000.

A GmbH is a separate legal entity from its shareholders. It has its own organization, objectives and corporate bodies. The activities of a GmbH are determined by its Articles of Association, director or directors and its general meeting of shareholders. The directors are required to adhere to the instructions of the shareholders. A supervisory board may be appointed, but such a board is necessary only for larger GmbHs. Shareholders are not personally liable to creditors once their capital contributions have been paid to the company in full.

C. Shareholders of a GmbH

There is no requirement that a GmbH have a minimum or maximum number of shareholders. It is even possible for only one person to form a GmbH. Additionally, the citizenship of the shareholders is not restricted. They may be either individuals or legal entities, domestic or nondomestic.

The company’s name may be freely chosen, so long as it is not misleading or in conflict with existing companies’ names. The abbreviation "GmbH" must be added to the company’s name.

D. Formal and Publicity Requirements

The initial Articles of a GmbH must be certified by a notary, and every subsequent amendment or adjustment must also be certified. The Articles must include the following particulars: company name, registered office, object of business, amount of share capital and amount payable by each shareholder to the share capital. Otherwise, flexibility is permitted in drafting the Articles.

However, it is advisable to include information covering the following areas in the Memorandum and Articles: duration of the company; rules for appointment of managers; the extent of the representative powers of managers; rules for the convocation of a general meeting; rules for allocation of votes; rules for disposals of shares and inheritance of shares; rules for production of annual accounts, allocation of profits, repurchase of shareholdings, disposal of shares and disputes; rules on formation costs; an exemption from the ban on managers contracting with themselves; and arbitration and noncompetition clauses.

Upon notarization of the Articles, the shareholders must produce valid identification documents to prove their identities. If the person appearing is an agent for someone else, the agent must have a formal written power of attorney, or his or her actions must be certified retrospectively in notarially certified form. If a notary outside Germany is performing the certification, a legalization is required. This can be obtained from a German consulate or embassy. If the founders include a legal entity, the existence of this corporate entity must be proven in the form of a certified extract from the commercial register (or the equivalent official registration documents, such as, in the case of non-German entities, certificates of incorporation).