On November 25, 2009, the State Council discussed and adopted the Opinion on Promoting the Development of Tourism Industry ("Opinion") on its standing meeting. In the Opinion, the State Council aims to develop China's tourism industry into a pillar industry to support the national economy strategy. Due to the promulgation of the Opinion, it is expected that an increasing number of tourism companies will need funding to grow and expansion their business. However, tourism companies must solve the historic issues in their business operation and business model during restructuring and before going public.

I. Scope, Qualification and Legality of Business

A. Scope of Core Business

According to the Administrative Rules for Famous Scenery Parks (1)("Park Rules") implemented on December 1, 2006, the admission fees to famous sceneries shall be paid to famous scenery park administrative authorities ("Park Authorities"). The Park Authorities shall manage the revenues generated from admission fees and paid use of facilities in famous scenery parks separately. Park authorities shall not designate other companies or individuals to exercise their administrative authorities in planning, administrating and supervising scenery parks. Therefore, after the Park Rules came into effect, the admission fees to scenery parks can no longer be included in the revenues of a tourism company once the company goes public. (2)

If a tourism company wishes to list its shares in the securities market, it must exclude any park admission revenue from the revenues generated from its core business. Where park admission revenues consist a substantial portion of its core business revenues, the company should consult with its underwriters and accountants regarding whether such exclusion will be regarded as the core business of the company has changed in the past three years.(3)

However, according to the existing PRC law and the recent IPO reviews of China Securities Regulatory Commission ("CSRC"), a tourism company which applies for IPO may include park admission revenue in its core business revenues if the park is not at a famous scenery location. (4)

B. Legality of Exclusive Operation in the Park

The existing listed tourism companies in China mainly engage in sightseeing bus, cable car, yacht and hotel services.These companies provide one or more of the said services in a specific scenery park exclusively.

Pursuant to the Park Rules, the providers of the transportation and other ancillary services in a specific park shall be decided by the competent park authority via public bidding and other means promoting fair competition in compliance with relevant laws, regulations and the planning of the park.However, most tourism companies in China started providing tourism services long before the promulgation of the Park Rules. In other words, the qualification for providing tourism services of these companies is not acquired via public procedures or fair competition.Instead, their qualification is a matter of fact. As the bar set for a qualified tourism service provider is becoming higher, it will be difficult for new companies to enter this market.

When formulating the restructuring plan, tourism companies, which have acquired the qualification for providing tourism services before the promulgation of the Park Rules, should not only satisfy the requirements of the existing laws and regulations, but also take into account the sustainability and long-term development of their business and the scenery park they provide services to.(5)The assistance and advice of underwriters on formulation of the restructuring plan of these companies is a must.

II. Key Assets

A. Whether the land is government-allocated land or is collectively owned

Many of tourism companies are state-owned enterprises ("SOEs"). The land they use is usually allocated by the government and is also collectively owned.(6)During restructuring, these companies should make sure that their land ownership or land use right is clear and perfected. Where any problem exists in the land ownership or use right, these companies should examine whether such problem will have a negative impact on its day-to–day business operation and what costs they should bear to fix such problem.

B. Determination of Ownership of Road and Other Assets

Companies providing tourism services (e.g. sightseeing bus, hotel and accommodation and cable car) often own the roads and other maintenance facilities (such as revetments, railing, and drainage channels) in the scenery park. The companies often receive these assets as capital contribution or additional capitalization. Alternatively, the local government may also transfer or allocate these assets to the companies to streamline administration.

Whether tourism companies are entitled to the ownership of roads and other infrastructures remains a question. A literal interpretation of the PRC Property Rights Law (7)seems to indicate that organizations and parties other than the State are not excluded from the ownership of roads. (8)However, relevant authorities are yet to form a consensus regarding the ownership of roads. In practice, these authorities tend to get around this problem. (9)

For the said reasons, uncertainty still exists in the establishment of the ownership of roads and other infrastructures. Such uncertainty is likely to create barriers for tourism companies to go public. In addition, tourism companies need to bear high depreciation expenses every year, as these assets do not generate profits.A solution to such a problem for tourism companies may be to transfer these assets to the local Park Authority and pay the authority annually to utilize and maintain these assets. With this solution, tourism companies are able to establish clear ownership on their assets and to lower their costs.But tourism companies should make sure that the said asset transfer will not interrupt the sustainability and continuity of their business operation.

In addition to roads, tourism companies often own the reservoirs and water tanks in the scenery park.The companies may manage their ownership of these assets following similar principles as those apply to roads.

C. Whether the Construction Projects in the Park is Approved by Relevant Authority

According to the Administrative Regulation for Development of Famous Scenery Parks promulgated by the Ministry of Construction ( now Ministry of Housing and Urban-Rural Development) on December 20, 1993 and other local rules, a project of constructing hotels and similar facilities in a national famous scenery park shall first be reviewed by the competent provincial construction authority, then submitted to the administrative authority of construction under the State Council or an authority designated by the authority under the State Council for approval. Where the construction project is in a provincial or county level famous scenery park, the project shall be approved by the competent provincial administrative authority of construction or an authority designated by the provincial authority.(10) The location and design of key construction projects in key national famous scenery parks shall be reviewed and approved separately. These projects should first be approved by the competent construction authority at municipal or county level, then approved by the competent provincial construction authority and filed with the construction authority under the State Council. The location and design of other construction projects in key famous scenery parks shall be approved by the construction authority at municipal and county level. (11)]In addition to the said requirements, key construction projects in key national famous scenery parks are also subject to other requirements for construction and environmental protection. These requirements are stricter than those for regular construction projects.

In practice, certain tourism companies do not obtain approval as required before constructing some of their projects.(12)Although such irregular practice exists, tourism companies may face substantial barriers during IPO application if they do not obtain approval before constructing projects in scenery parks.Therefore, tourism companies planning to go public should require their legal counsel to conduct meticulous investigation on the legality of the construction projects in scenery parks. These companies should strictly comply with the required approval procedures when obtaining approval for projects constructed during their restructuring or IPO application.

D. Customs Regulation for Duty-free Importation of Equipment and Facilities

Some of the imported equipment and facilities that tourism companies use are entitled to preferential or zero tariff treatment as they are "goods used in a specific geographic area, by a specific company and for special purposes." Imported good entitled to the said preferential tax treatment should be inspected by the customs authority during the statutory term in which they are subject to customs regulation according to law, and shall be only used in a specific geographic area, by a specific company and for special purposes. These goods shall not be used for other purposes without the approval of the custom authority and without paying required tariff. (13)Neither shall these goods be transferred to another party or disposed by other means. If the relevant tourism company does not comply with the said requirements, their imported equipment and facilities as well as the illegal income generated from illegal use of these facilities may be seized by the customs authority. Moreover, breaching companies which fail to comply with the foregoing law may also be subject to fines or criminal liabilities when the noncompliance is serious. (14)

Certain tourism companies locating in areas where minority nationalities reside are entitled to zero tariff treatment for importing equipment and facilities. These companies sometimes transfer the said equipment and facilities within the term in which they are subject to customs inspection without the knowledge of the said customs rules. To ensure there is no defects in the ownership of its key operation equipment and facilities, such a company should submit an application at the customs authority to get approval for the company's preferential treatment, or alternation of the status of customs regulation. Alternatively, such a company may also pay tariff in exchange for release of customs regulation.However, neither of the said solutions is ideal - the first solution involves complicated approval procedures and is time consuming, and the second solution is very expensive.Therefore, tourism companies should pay attention to relevant customs regulation to avoid any noncompliance that may create substantial obstacles for the IPO of the company.

III. Equity Structure and Historic Compliance

A. Shareholders and De Facto Controller

According to the Park Rules, the Park Authorities shall not engage in profitable business operation activities. In other words, the Park Rules prohibit the Park Authorities from establishing companies to make profits.

However, in practice, many tourism companies have received investments from the local Park Authorities. Some companies were or are even controlled by such authorities. A tourism company will not meet the rules regarding shareholder qualification set forth in the Park Rules, if it still receives investment from or is controlled by the local Park Authority during the restructuring. When such situation exists, it is recommended that such a company should correct such irregularity before it is restructured into a company limited by shares. Alternatively, such a company shall consult with the CSRC regarding a solution with the assistance of its sponsor. (15)

When correcting the problems with their shareholders and de facto controller, tourism companies should also keep in mind that any current or past transfer of their equity by the Park Authority may cause the de facto controller of the company to change in the past three years. If this is the case, then the progress of their IPO will be prolonged.

B. Historic Legality and Compliance

Many of the existing tourism companies are owned by the State or collective entity. Usually, they were established many years ago when the local economy was not active. The incorporation of these companies often did not strictly follow the legal procedures.

Therefore, when assisting these companies applying for IPO, the legal counsels should focus on a number of important issues, including 1) the shareholders’ initial capital contribution, the historic increase and decrease of registered capital, equity transfer, cancellation of business registration; 2) whether the company has performed the legal procedures, especially state-owned assets administrative rules; and 3) whether the disposition of collectively-owned assets satisfied the local collectively-owned assets administrative rules at the time when the disposition took place.

IV. Corporate Governance

A. Executives, Supervisors and Senior Managers Wearing Two Hats in the Company and the Park Authority

According to Article 39 Paragraph 2, the officers of a Park Authority shall not hold posts in the tourism company administrated by the authority. This rule aims to separate the functions of government agencies from those of tourism companies to prevent government officers from taking advantage of their positions to seek personal interests.

Due to historic reasons, many officers simultaneously hold (or held) posts in the tourism company and the local Park Authority administrating the park to which the company provides services. Some tourism companies even share the same personnel with the local Park Authorities. When such irregularity exists in a tourism company and the company is seeking to go public, the company must correct such problem to qualify for IPO.

When solving the said problem, the company should be very careful. The restructuring and IPO of the company will be unnecessarily prolonged, if the solution will cause the change of executives or senior manages in the company in the past three years.

B. Independency

Tourism companies may lack independency in their assets or organizational structure. Some of their assets and organizational functions are managed by or shared with the key stake holders, such as the local government and the controlling shareholder. In some cases, the fund of these companies may be misappropriated by the controlling shareholder. These companies may also provide guarantee to their majority shareholder or actual controller. In addition, as tourism companies are often the primary source of income for the local government, the local government may create significant impact on the day-to-day operation of these companies.

For the said reasons, the independency of tourism companies as legal entities is also an important issue for legal counsels to review. However, as their independency involves the interests of many parties, tourism companies should formulate a solution that reasonably balances the interests of all stakeholders.

V. Projects Funded by IPO

Tourism companies usually conduct IPO to support their business development, e.g. the development of new scenery parks, upgrade of facilities and construction of luxury hotels. The companies may carry out these projects by acquiring the equity or assets of another party or constructing the projects themselves.

Before committing to a project, tourism companies should keep in mind that if they finance via asset or equity acquisition, the target company may also have the problems or irregularities discussed in the preceding paragraphs. Therefore, these companies should conduct meticulous due diligence investigation to assess the investment value of the project and whether the implementation of the project faces substantial legal barriers. If a company plans to construct the project itself, it should strictly follow the existing laws and regulations and perform all required approval procedures. If the company plans to develop tourism programs in a natural reserve or a famous scenery park, the project will need approval of a higher level authority and additional time to prepare. (16)Therefore, to ensure the efficiency of the IPO application, applicants should start internal planning and due diligence investigation for projects to be funded by IPO as early as possible.

VI. Conclusion

As the development of tourism companies relies on the local tourism resources, which are owned by the State, these companies and local governments are inter-dependent. On one hand, the growth of tourism companies is supported by the government’s development and maintenance of local resources and preferential policies. On the other hand, tourism companies generate a significant source of incomes for the local government and perform the government’s functions to maintain facilities in scenery parks, propel the local economic and cultural development, create employment opportunities, provide hospitality services and promote the image of the local region. The special nature of the tourism industry and tourism resources is the reason that tourism companies may have certain problems and irregularities.

During restructuring, tourism companies may have to deal with the interests of various stakeholders. If these companies are unable to handle this issue properly, they and the local government need to pay a substantial cost. It is also likely that their legal counsels will be encounter ethical responsibilities. Therefore, the legal counsel of tourism companies should conduct thorough due diligence investigation and assessment to see whether to list the existing company or incorporate a new company for IPO purpose. When a company faces substantial problems and the solutions may not be ideal (especially when many important historic documents are missing), incorporating a new company and listing the company after three years of operation may be a less expensive and more feasible plan for exit purpose.

(This article was originally written in Chinese, the English version is a translation.)

* Xiong Chuan is an associate of King & Wood's Sichuan office.

Notes:

(1) The Administrative Rules for Famous Scenery Parks were promulgated by the State Council on September 9, 2006.

(2) Before 2006, the admission revenue was included in the revenues of listed tourisms companies. For example, the Huangshan Tourism Development Co. Ltd (stock code 600054) disclosed that the company entered into an agreement with the Huangshan Scenery Park Administrative Committee, which designated the company to manage admission revenue of the park. The agreement remains valid until 2036. According tot the agreement, the company will pay the committee quarterly 50% of the admission revenue after deducting turnover tax and costs as the royalty for park admission franchise. After the promulgation of the Park Rules, the said practice is no longer permitted.

(3) See Article 12 of the Administrative Rules for Initial Public Offering and Listing. The Rules were promulgated by the CSRC on May 17, 2006 and became effective as of May 18, 2006.

(4) For example, Wuhan Sante Cableway Group Co. Ltd., a company went public in 2007, included the ticket revenue from Nanwan Monkey Park, Hainan Tropical Birds Park and Hubei Pinbaying Natural Park in its revenues. The CSRC required the company to confirm whether these parks were regulated by the Ministry of Housing and Urban-Rural Development ("MHURD"). The company's legal counsels later confirmed that these parks were not regulated by MHURD upon investigation.

(5) In fact, the investments of these companies (most of them are SOEs) in terms of capital, manpower and facilities supported the initial development of the corresponding parks, improved the parks' environment and built the roads in the parks. Therefore, it is fair for these companies to get payback from their investments. If these companies are required mandatorily to follow public procedures and re-obtain a legal qualification to operate in the parks, they will lose their existing operation qualification and suffer economic losses. Once they are out of business, it will be difficult for the Park Authorities to maintain the quality of tourism services to the parks and implement environment protection measures. The tax income of the local government and the local employment market will also be affected.

(6) These companies may lease or purchase, without following legal procedures, land use right from local collectives for business operation purpose.

(7) The PRC Property Rights Law was adopted on the fifth session of the 10th National People's Congress on March 16, 2007 and was implemented as of October 1, 2007.

(8) Article 52 Paragraph 2 of the PRC Property Rights Law provides that the State owns railways, roads, power facilities, oil and gas pipelines and other infrastructures that should be owned by the State.

(9) According to the Interpretation and Application of the PRC Property Rights Law complied by the Property Rights Law study group of the Supreme Court, when hearinga case, the people's courts should follow the principle of State ownership when determining the ownership of railways, roads and other infrastructures that should be owned by the State according to law. For the ownership of infrastructures built with private investment, the courts should follow the principle that "the party invests in the property is entitled to profits from such property". The courts should accurately define State ownership and other types of ownership and properly interpret and apply the legislative intent of the law.

However, the Bureau of Transportation of Sichuan, and the Road Office and the Legal Affairs Office of the Bureau have provided different answers to public inquiry regarding the ownership of roads and other infrastructures. One type of opinion is that all roads should be owned by the State and private investors shall be entitled to the right to operate, instead of the ownership of, these infrastructures. A second type of view is that officers tend to get round the ownership of roads, instead, they look into the right to operate and maintain roads. A third type of opinion is that private investors may be entitled to the ownership of roads, however, such a conclusion is to be confirmed in practice as the existing PRC law is unclear about this issue.

(10) See Articles 5 and 6 of the Administrative Regulation for Development of Famous Scenery Parks.

(11) See Articles 6 and 7 of the Administrative Rules for Development of Famous Scenery Parks in Sichuan Province.

(12) A typical example is that a tourism company invested RMB200 million and constructed a four-star hotel in a 4A national famous scenery park without pre-approval.

(13) See Article 57 of the PRC Customs Law. The PRC Customs Law was adopted on the 19th session of the Standing Committee of the Sixth National People's Congress on January 22, 1987 and was amended on the 16th session of the Ninth National People's Congress on July 8, 2008. The amendments became effective as of January 1, 2001.

(14) For relevant rules, see Articles 37, 57, 82 and 86 of the PRC Customs Law, Articles 49 and 55 of the Tariff Rules, Articles 75 and 76 of the Administrative Rules for Tariffs on Import and Export of Goods of Chinese Customs, Articles 7, 9, 18 and 23 of the Implementing Rules for Administrative Penalties by Chinese Customs, and Articles 153 and 154 of the PRC Criminal Law.

(15) According to our research, the de facto controllers of a number of tourism companies, which have completed their IPO, (including Emei Shan Tourism Company Limited, Huangshan Tourism Development Co. Ltd., and Guilin Tourism Corporation Limited), is the local Park Authority. However, these companies should not be regarded as examples that such irregular practice stands, as their IPOs were completed long before the Park Rules were promulgated.

(16) For example, the 2004 Catalog of Government Approved Investment Projects for Sichuan Province provides that an investment project requires the approval of the investment authority under the State Council, if it is 1) a tourism program development or resource preservation project with a total investment of RMB50 million or more in a key national famous scenery park, national natural reserve, key historic relic preserved by the State; or 2) a similar project with a total investment of RMB30 million or above in a world natural reserve or cultural heritage preservation area.

Other projects should be approved by the corresponding industrial authority under the State Council or the investment authority under the competent provincial government according to the relationship of subordination. An investment project requires the approval of the investment authority under the competent provincial government, if it is 1) a tourism program development or resource preservation project with a total investment between RMB30 million and RMB50 million in a key national famous scenery park, national natural reserve, key historic relic preserved by the State; or 2) a similar project with a total investment of less than RMB30 million in a world natural reserve or cultural heritage preservation area; 3) a similar project with a total investment of RMB50 million or more in a key provincial famous scenery park, provincial natural reserve or key historic relic preserved by the province, or forest or geologic park at the provincial or a higher level. A project with a total investment of RMB200 million or more shall also be approved by the corresponding provincial government in addition to the competent provincial investment authority.A project with a total investment of less than RMB200 million may be approved by the investment authority of the competent municipal or county government.

In addition, according to our communication with the Sichuan branch office of National Development and Reform Commission ("NDRC") by phone, before committing to a construction project, regardless of its total investment and location, a tourism company shall first submit a writing application to the branch office of NDRC at municipal or county level, then obtain approval according to the dollar amount of total investment.