Major foreign companies and several Chinese companies with U.S. stock-exchange listings are at risk of running afoul with Chinese authorities once a proposed law banning certain corporate structures is approved.
Under the law, which was proposed by China's Ministry of Commerce in January, companies that use the variable interest entity (VIE) corporate structure might not be able to continue operations or may have to sell controlling stakes in the operations to Chinese nationals.
Some of the companies that appear to be at risk from the proposed regulations include the Chinese operations of Amazon.com, Pearson PLC, and CBS, the Wall Street Journal reported on Sunday. U.S.-listed Chinese Internet companies such as Sina Corp., Autohome, Inc., and Weibo are also threatened because they are controlled by foreign investors.
However, most Chinese Web firms like those of Alibaba Group and Baidu, which also use the VIE structure, do not seem to be at risk because they are ultimately controlled by Chinese nationals, the Wall Street Journal said in its report
VIE structures are especially common among U.S. technology companies in China who are looking to gain access in sectors where foreign investment is restricted by the government.
"You can't walk down the street in Palo Alto without tripping over a VIE situation, because if you are in the Internet space and looking at China you are looking at VIE," said Tom Shoesmith, head of the China practice at the Pillsbury Winthrop Shaw Pittman LLP law firm.
In a VIE, a foreign company signs a contract with a Chinese-owned operating company, which invests in the restricted sector, that gives them effective control of the operating company but not ownership. However, the newly proposed law introduces a "negative" list of restricted and prohibited sectors, where only companies controlled by Chinese nationals could operate even if structured as VIEs.
"[Without regulatory relief] the foreign-controlled VIE entity would have to either sell its controlling stakes in the VIE entity to Chinese nationals [so that the stakes would be controlled by Chinese nationals] or liquidate the VIE entity under applicable Chinese law," said Winston Zhao, a partner in the law firm of McDermott Will & Emery LLP.
The legality of the VIE structure has long been ambiguous, with some legal experts saying that it has never been legal per se. The proposed legislation would remove the ambiguity by legalizing some VIE operations controlled by Chinese nationals, but for others this law would make these operations clearly illegal, Shoesmith said.
However, industry observers also caution that the draft law, which was published for comment earlier this year, is subject to change and is not likely to become law in any form for at least two years.
"It's a little bit too early to say they are in great danger," said Zhao.