China: Foreign Architecture Firms Doing Design Activities in China

The architecture design opportunities in China seem endless. The increased building in preparation for the Beijing Olympics has called on international designers to support China’s efforts to put an international and yet Chinese face to the world for the 2008 Games. In Shanghai, the skyline changes almost daily with dramatic building exteriors complimenting the city’s efforts to have ever taller buildings. This same dramatic architectural opportunity has also reached second-tier cities such as Hangzhou and Ningbo. It is no wonder that foreign firms have sought ways to participate in this exciting market. However, since the advent of Decree 114, many design firms have struggled with finding the best mode of market entry.

Essentially foreign design firms can either: (1) collaborate with a Chinese architecture institute; or (2) set up an architecture enterprise in China ("Architecture FIE") in the form of an equity joint venture, a co-operative joint venture, a wholly foreign-owned enterprise, or part equity acquisition of an existing Chinese architecture institute. The last option creates an FIE that looks like an equity joint venture, but has the benefit of immediate access to the Chinese firm’s licenses, customers, and employees. Recent news shows that AECOM Technology Corp. has followed this last route in acquiring an interest in the China Northwest Municipal Engineering Design and Research Institute. The deal will be closely watched by other investors.

Each of the above options is not without its drawbacks. Collaboration with a local Chinese architecture institute limits the activities of the foreign firm to conceptual design, while the establishment of an Architecture FIE may be problematic, and require numerous regulatory approvals and a high threshold to qualify for certain design activities. An increasing number of architecture firms have begun to adopt an alternative business form by establishing wholly foreign-owned consulting enterprises in China ("Consulting WFOE") in order to provide design consulting for construction projects in China.

This article provides an overview of some of the key issues that foreign firms must consider when planning to carry out design activities in China. We review the following strategies:

1. Long-term: Establish an Architecture FIE or acquire a portion of the equity of an existing Chinese architecture institute;
2. Short-term: Collaborate with Chinese architecture institutes; and
3. Near-term alternative: Establish a Consulting WFOE.

Establish an Architecture FIE or Acquire Equity in an Existing Chinese Architecture Institute

The Chinese government has enacted the following regulations regarding Architecture FIEs:

• Regulation on Management of Foreign-invested Construction Engineering Design Enterprise ("Decree 114") issued by PRC Ministry of Construction ("MOC") and PRC Foreign Related Trade and Economic Commission ("MOFCOM") on September 27, 2002, effective December 2002.

• Implementing Rule of the Regulation on Management of Foreign-invested Construction Engineering Design Enterprise ("Decree 18") issued by MOC and MOFCOM on January 5, 2007, effective since that date.
• Administrative Regulation on Construction Engineering Design Enterprise Qualification ("Decree 93") issued by MOC on June 29, 2001, effective since that date.
• Project Design Qualification Standard issued by MOC on March 29, 2007.

According to these regulations, the establishment of an Architecture FIE to undertake design activities will be subject to strict and complicated approvals. The process and time-line for these approvals are outlined below:

The basic requirements for setting up an Architecture FIE and acquiring the relevant qualification certificates to undertake design activities are:

• Experience requirements for the investors: Both the foreign investor and the Chinese investor (in the case of an equity joint venture or cooperative joint venture) must engage in construction engineering design in their respective home countries, and provide two or more engineering design achievements that were completed outside of China, with at least one of them having been accomplished in their home country.
• Employee requirements for Architecture FIE: The number of the foreign technical employees of the wholly foreign-owned Architecture FIE who have obtained the qualifications of Chinese certified architect and certified engineers shall not be less than 1/4 of the total number of certified practitioners as provided in the Project Design Qualification Standard. In addition, the number of the foreign technical employees who have relevant professional design experience shall not be less than 1/4 of the total technicians as provided in the Project Design Qualification Standard.
• Qualification requirement of the Architecture FIEs: The Architecture FIE is prohibited from undertaking design activities in China prior to obtaining the qualification certificate from the provincial level MOC. Its design activities should comply with, and should not extend beyond, the scope of its qualification certificate.

• Currently, the design qualifications in China are divided into the following three categories, according to the Project Design Qualification Standard:

  1. Comprehensive Engineering Design ("CED"): An Architecture FIE with this qualification may undertake design activities for all industries and projects in China.
  2. Industry Engineering Design ("IED"): This qualification applies to 21 industries, including, but not limited to, the petrochemical industry, construction industry, and road transportation industry, etc. The Architecture FIE should apply for the qualification certificate for its particular industry.
  3. Special Engineering Design ("SED"): This qualification is for special projects, such as curtain wall. The Architecture FIE should obtain the precise qualification for the project prior to beginning work.

  The IED and SED design qualifications are further subdivided into Grade A, Grade B, and Grade C categories based upon the scale and complexity of the project. It is important to note that under Decree 93 an Architecture FIE can only apply for a Grade B or Grade C IED or SED qualification during its first two years of operation.

• Minimum registered capital requirement for Architecture FIEs: Depending on the type of design activity, a minimum level of registered capital is required to undertake the project. For example, a CED qualification requires a registered capital investment of RMB 60 million, and a Grade B IED qualification requires a registered capital investment of RMB 2 million.

Establishing an Architecture FIE can be cumbersome due to the stringent capital requirements, employee hiring, and the complex and time-consuming qualification process. Foreign architecture firms can merge or acquire an existing local Chinese architecture firm and convert it to an Architecture FIE. As noted above, AECOM just acquired part of the equity of China Northwest Municipal Engineering Design and Research Institute, a large scale architecture institute in China, thus converting the latter into a FIE.

Collaborate With Chinese Architecture Institutes

The Provisional Regulations on the Administration of Foreign Enterprises Engaging in Construction Engineering Design Related Activities ("Decree 78") was issued by MOC on May 10, 2004, effective on June 10, 2004. Decree 78 allows foreign architecture firms to undertake offshore conceptual or schematic engineering design work. This includes enacting construction engineering preliminary design (basic design), and shop drawing design (detailed design) in recent projects under collaboration with locally qualified Chinese engineering design institutes ("Chinese Collaborator").

Under this strategy, the foreign architecture firm is not required to establish a separate entity in China, or to acquire the qualifications in China for its conceptual design work for construction projects in China. However, the local Chinese Collaborator must possess a qualification certificate issued by the relevant Chinese construction authorities that will allow it to carry out the requisite design activities for the project.

Currently, there is no regulation that clearly distinguishes between conceptual engineering design and design work that goes beyond the conceptual design stage. Foreign architecture firms should use the language of Decree 78 in describing their activities under a contract to facilitate the collection of fees.

As an architecture firm’s activities would be limited to "conceptual design," we recommend that foreign architecture firms consider such collaboration only as a short-term strategy for doing business in China.

Consulting WFOE

The current trend is for many foreign architecture firms to create wholly foreign-owned consulting enterprises ("Consulting WFOE") that provide consulting services on design and project management activities in China under the PRC Law on Foreign-Funded Enterprise ("PRC WFOE Law").

The Catalogue for Guidance of Foreign Investment Industries does not prohibit a Consulting WFOE from providing consulting services relating to construction design and project management in China. Under this strategy, no qualification certificate or collaboration is needed to engage in "consulting activities relating to the design and project management work." Note, however, that the enterprise is precluded from engaging in direct design or project management work.

The line between what is and is not permissible in design- and project management-related consulting activities may become ambiguous in practice. However, one thing is clear: only an entity with the appropriate qualification certificate may enter into a design or project management agreement. The Consulting WFOE can review third-party drawings and provide conceptual drawings. Also, the Consulting WFOE could enter into contracts under its own name, but such contracts could not explicitly cover design or project management. The Consulting WFOE will be able to hire employees directly. However, the foreign architecture firm will still be limited in its ability to directly bid and obtain design work on projects in China.

The market entry strategy depends on the company’s short- and long-term views on its potential to grow in the Chinese construction market. These approaches are not exclusive of one another, and the company may wish to consider implementing, in tandem, a short- and a long-term business plan. Even with the proper vehicle for entry, competition with Chinese firms is steep. Remember that once a company gets over these initial regulatory hurdles, the company will still encounter the realities of a competitive market. U.S. companies, bound by Sarbanes-Oxley and the FCPA, may feel that the field is still not entirely level. Similarly, foreign firms will still bear higher overhead costs because of expatriate management within and outside of China. Getting the permits, approvals, and the projects takes a lot more time and effort than architecture firms are accustomed to expending in the U.S. market. As a company moves forward in the China market, the biggest task may be managing expectations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.