New rules will further restrict foreign investment in China.

On May 23, 2007, the Ministry of Commerce ("MOFCOM") and the State Administration of Foreign Exchange ("SAFE"), jointly issued the Circular on Further Strengthening and Regulating the Examination, Approval and Supervision of Foreign Investment in the Real Estate Industry [Jing Zi Han [2007] No. 50] ("Circular 50"). In addition to reiterating several of last year's Circular 171 requirements and restrictions with respect to foreign investment in China real estate, Circular 50 set forth additional requirements with respect to approvals of new foreign investment enterprises ("FIEs") in the real estate investment sector.

Circular 50 requires local counterparts of MOFCOM (at the provincial or lower levels) that approve a real estate FIE to immediately transmit a copy of such approval to MOFCOM for its record and filing (Bei An). Without filing completion, SAFE or any designated foreign exchange bank will not process (or approve) the conversion of foreign currency to fund the capital account of a real estate FIE. The filings will provide MOFCOM with an opportunity to substantively review local approvals and, pursuant to the provisions of Circular 50, take corrective measures for real estate FIEs that have been improperly approved. Note that Circular 50 does not provide for a time period for MOFCOM to review the filing, and does not specify what document, if any, will be issued by MOFCOM to evidence the filing completion.

Circular 50 comes less than 10 months after the significant restrictions on foreign investment in the China real estate sector set forth in Circular 171 and continues a Chinese regulatory trend towards both tightening such restrictions and their enforcement. Circular 50 provides:

Filings: Copies of all new local approvals of real estate FIEs shall be immediately filed with MOFCOM.

Currency Conversion: No SAFE approvals of real estate FIE capital account foreign currency conversions will be granted without filing completion.

Project Company Principle: Foreign investors conducting real estate development or real estate operations in China must establish FIEs to conduct such activities.

Project Ownership: Prior to applying for establishment of a real estate FIE, the investors must have (i) obtained land use rights or real estate improvement ownership, (ii) entered into a land grant contract or land use rights transfer contract with a land authority or land developer, or (iii) entered into a presale or sale contract with an owner of real estate. We have been informed that certain local authorities are taking the position that a simple letter of intent or a memorandum of understanding will not be sufficient to satisfy this requirement.

Business Scope: If an existing foreign-invested enterprise desires to engage in real estate development or operation, or if an existing real estate FIE desires to engage in the development or operation of a new real estate project, such enterprise is required to apply with the relevant approval authority for an expansion of its business scope to permit such activities.

No Fixed Return: Chinese and foreign partners of joint venture real estate FIEs are prohibited from providing any investor with a fixed return or any disguised form thereof.

Round-trip Investment: MOFCOM will strictly regulate round-trip investments in Chinese real estate.

Filing requirement and the role of MOFCOM and SAFE prior to Circular 50, filing of local approvals with MOFCOM (or its predecessor, MOFTEC) was required for all FIEs investments, including those in the real estate sector. In practice, however, once a local FIE approval was granted, it was rare for such local approval to be subject to rescission and the related SAFE registration and approval was generally granted in a timely manner. Circular 50 requires the completion of the filing prior to SAFE approval so that real estate FIEs will not be permitted to receive foreign currency capital contributions or shareholder loans or other foreign debt until such filing is complete. Note that, as stated above, Circular 50 does not specify the meaning of filing completion, nor does it indicate what document will be issued or what action will be taken, if any, to evidence such completion.

Circular 50 provides that MOFCOM may take corrective measures with respect to real estate FIEs that receive improper local approvals. The language of the circular indicates that the filing (and its completion) may, in practice, become a substantive MOFCOM review of the underlying transaction and the related local approval. Circular 50 does not provide for a time period for the completion of the filing with (or review by) MOFCOM, nor does it indicate at what point the filing will be deemed completed by MOFCOM or SAFE. Without further clarification from MOFCOM or SAFE, it is likely that the real estate FIE approval process will be prolonged. Also, without a limitation on review timing, MOFCOM would, in theory, have an open ended right to review and correct local approvals.

Although not expressly provided in Circular 50, it is widely believed that Circular 50, and its enforcement, will be used to reduce real estate FIE foreign debt (including shareholder loans) and information has been released to the market that certain local MOFCOM counterparts are now requiring new real estate FIE applications to be accompanied by an undertaking letter providing that the real estate FIE will not be funded with (or apply for the registration of) foreign debt. In cities where such undertaking is not required, it appears that it is becoming more difficult to obtain offshore shareholder loan or other foreign debt approval.

As with last year's Circular 171, we expect there to be a period of uncertainty in the market as the meaning of Circular 50 becomes more clearly understood. It does appear clear, however, that central level MOFCOM and SAFE authorities will become more active in supervising the actions of their local counterparts in complying with national level directives and policies with respect to foreign real estate investment and that one of those policies is to further restrict such foreign investment in order to attempt to control rising real estate prices.

* David Blumenfeld is a partner, and Chen Yi a corporate department associate, at Paul, Hasting, Janofsky & Walker LLP.