Apart from number of more specific and clearer provisions, the draft decree proposes various significant and debatable requirements which need to be further considered by the government


A long-awaited draft decree, replacing Decree 108 and guiding the execution of the Law on Investment, contains many debatable requirements which the government should carefully weigh up before its approval to avoid undermining the business climate in Vietnam, writes Dang Duong Anh, executive partner and Nguyen Vu Quynh Lam, senior associate of Vilaf law firm.

In the most updated report from the Ministry of Planning and Investment’s (MPI) Foreign Investment Agency, the total foreign direct investment capital registered in the first 10 months of 2011, including capital of both newly-registered and expanded projects, reached $12.27 billion.

It accounted for only 78 per cent of the registered capital reported in the same period of 2010.

The decrease in attracting foreign investment is only one aspect of dark news about the entire economic picture. Inflation, tightening of banks’ lending policies and increase of loan costs, uncontrolled escalation of gold and foreign exchange rates, gloomy securities market and a frozen real estate market are hurting investors’ confidence. Meanwhile, the Vinashin case is likely to do serious damage to the state since it is likely to face a lawsuit initiated by international creditors.

In the stated context, the government has introduced more specific and detailed legal framework on investment, attempting to overcome the legal short comings as well as improve the effectiveness in management of foreign investment. The latest draft decree (draft decree) replacing Decree 108 guiding the Law on Investment (Decree 108) was recently introduced.

Apart from number of more specific and clearer provisions, the draft decree proposes various significant and debatable requirements which need to be further considered by the government before passed so as not to create unfavourable changes in the investment and business environment in the country.

Minimum equity ratio and restriction on the timing to raise loan capital

The draft decree requires that the equity capital must not be less than 30 per cent of the total investment capital of the relevant project, unless otherwise provided by specialised laws. This requirement existed under the old Law on Foreign Investment back in 1996. However, the Law on Investment of 2005 has removed this requirement. The minimum equity ratio was required in only certain sectors being subject to the relevant specialised laws such as laws on real estate, minerals and electricity. The revival of this requirement under the draft decree would go inconsistent with the Law on Investment.

The ratio of 30 per cent proposed under the draft decree to some circumstances in conjunction with specialised laws appears to be unreasonable. The minimum equity ratio for real estate business is 15-20 per cent, for power projects is 20-30 per cent and for build-operate-transfer (BOT) projects is 10-15 per cent only. It is “unreasonable” since the proposed prescribed ratio introduced in the draft decree (i.e. 30 per cent) would bring in weird situation where those projects, which are now not being subject to any mandatory equity ratio, will become subject to such a ratio even substantially higher than the required equity ratios of specialised projects as above stated.

Apart from the above, certain issues relating to the proposed 30 per cent equity ratio remain unclear in the draft decree. The draft decree has not dealt with the projects which have been licenced for the equity capital less than 30 per cent of total investment capital. The draft decree is also silent on the projects of which the applications have been submitted but pending. Neither has the draft decree guided on how to deal with those projects which have been licenced with equity ratio of less than 30 per cent but in the future they intend to apply for increasing the charter capital or total investment capital for expansion of the project, re-investment of their profits or otherwise.

Restriction on raising loan capital

The draft decree for the first time provides that an investor will only be entitled to raise the loan capital after having contributed in full the equity/charter capital in accordance with the schedule registered under the investment certificate (IC).

The investors in limited liability companies (LLCs) are allowed under Decree 102 guiding the Law on Enterprises to contribute the charter capital within three years after the establishment of the companies. According to the new requirement of the draft decree, investors to LLCs will unlikely enjoy the stretched schedule of three years if they need to raise loan capital in full before the construction or production. The requirement for the compliance with the “contribution schedule” as approved under the IC to be eligible for raising loans will potentially bring in more issues, specifically:

* Can a foreign-invested company (FIC) raise loans if the investor(s) has contributed the charter capital but later than the approved schedule of contributions?

* Can the FIC raise loans and sign loan agreements for entire loan capital amount (say 70 per cent of the total investment capital) or can it only be allowed to raise an amount of loan which is in proportion to the portion of the charter capital that the investor(s) has contributed at the relevant point of time? If the latter is correct understanding, the following will be considered by the government before approving the draft:

-The restriction on raising loan capitals would materially prevent investors from arranging the financing for their entire investment project. To this end, we are of view that the existing restriction under the Law on Corporate Income Tax would already be sufficient. That said, if a portion of the charter capital is not contributed duly in accordance with the schedule, the interest over the corresponding portion of the loan capital will not be accounted as deductible expenses for calculating the corporate income tax of the relevant FIC.

-It may cause difficulties for the FIC in raising loans for next times from other lenders for the reasons such as mortgaged assets having been taken by the first lender and also become costly for FIC in splitting in a number of small loans in proportion to the different contributions of charter capital under the approved schedule.

Setting up subsidiaries by FIC by itself and alone

Article 10.2(a) of the draft decree permits an existing FIC by itself and alone to set up its own subsidiary(ies) in Vietnam in the form of a wholly foreign-owned company (WFOC). This may be the green light from the government to allow the regime of investment holding companies in Vietnam to develop.

Investment performance security

The draft decree or Article 70 proposes a new requirement that an investor which is leased or allocated land for implementation of their project must enter into a security agreement on performance of an investment project with the licencing authority. The security agreement is signed at the time when the IC is issued.

The security agreement will have the term/duration as agreed to between the investor and the licencing authority. The performance security can be arranged in one of the following forms: deposit, escrow deposit or guarantee. The value of the security interest must account for at least equal to 1 per cent of the total investment capital but not exceeding VND20 billion ($960,000). As the security agreement will be signed at the time of issuance of the IC, investors may be worried that the licencing authority will tend to delay the issuance of the IC until the security amount has been deposited.

As a matter of current laws, investment performance security have been applied to certain special projects. The proposed application of the requirement for security interest to all projects, which may be expected by the government to help stopping the current waste of land unused by FICs for the investment projects, would unexpectedly make investors more sceptical in putting their capital in the country.

This new requirement will, if passed by the government, inevitably impose financial burdens on investors in arranging security interest. In addition to the current project costs, investors will have to estimate and incur additional costs for maintaining the security interests, i.e. deposit, escrow deposit arranging and maintaining fees or, in case of bank guarantees, the guarantee fee. Another issue is that there is no fixed timeline or specific criteria for determination of the term of the security interest. It will be determined by the licensing authority and may result in inconsistency in applying security conditions amongst different provinces and cities.

Foreign investors acquiring share/equity capital in companies incorporated in Vietnam

Licencing procedure and requirements for foreign investors to acquire share/equity capital in companies incorporated in Vietnam are one of the most confused issues under the current laws. The licencing practice has still not been consistent and varied from province to province given the provisions of current Decree 108, which is considerably less specific than and inconsistent to Decree 102 implementing the Law on Enterprises. The draft decree now confirms and clarifies in detail the treatment in consistency with Decree 102.

Under the draft decree, a foreign investor’s acquisition of share/equity capital in companies incorporated in Vietnam will only be subject to the amendment to their business registration certificate (BRC) or IC, respectively. In more detail, if the target company is a domestic one, the relevant provincial department of planning and investment (DPI) will refer the application file to its business registration division for the amendment to the BRC.

If the target company is an FIC, the DPI will propose to the relevant provincial People’s Committee (PC) for amendment to the IC. In the case where the foreign investor acquires share/equity capital in a company incorporated in Vietnam which is registered with conditional business line(s), the DPI will first assess and determine the satisfaction of the relevant conditions such as foreign ownership limitation and investment conditions.

If the conditions are satisfied, the DPI will refer the application file to its business registration division or the provincial People’s Committee for further steps as stated.
The draft decree, as same as Decree 102, does not require for foreign investors to submit their investment project when they acquire share/equity capital in a domestic company which has not had any investment project at the time of the acquisition.

This is expected to adjust the criticised prevailing practice that foreign investors must submit their investment project upon their acquisition of share/equity capital in a local target company. However, there are certain issues which need to be further discussed and addressed in order to ensure the practical application of this guidance in the draft decree:

* The Law on Investment requires that “foreign investor investing in Vietnam for the first time” must register an investment project. Decree 108 defines this phrase in a very general manner which does not bring in any further clarification on it. Given this, it has been interpreted that foreign investors acquiring share/equity capital in companies incorporated in Vietnam are considered as investing in Vietnam for the first time.

Therefore, they must have investment projects upon their acquisition. The draft decree has just deleted this definition. Without a clear and consistent definition of “foreign investor investing in Vietnam for the first time,” it would still be arguable that whether the guidance (i.e. investment project being not required for foreign investor’s acquisition) in the draft decree is in compliance with the Law on Investment.

* The Ministry of Industry and Trade (MoIT) has officially taken the view that foreign investors acquiring share/equity capital in Vietnamese companies are considered as investing in Vietnam for the first time. Accordingly, MoIT ever took the view that in the case where the target companies carry out trading or distribution business, a prior consent from MoIT must be obtained before the issuance of the IC to the target company. The PI as the drafting agency of the draft decree should consult with the MoIT to achieve a consistent opinion on this matter.

Converting FIC into local companies and setting up FIC’s branches

For the first time the government has detailed procedures for converting from FICs into local companies under the draft Decree, addressing number of concerns and confusions in practice. Under Article 57 of the draft decree, the relevant FIC will first apply for a BRC to have it converted to a purely domestic company. After the BRC is issued, the converted company will apply for replacement of its existing IC by a new IC which will record only and exactly the investment project registered in the existing IC.

This procedure is specific. However, a two-step procedure would be superfluous, and appears to be contrary to the one-door policy of the government with respect to this simple procedure. In addition, the draft decree is not clear as to the application documents to be submitted by the converted company in the second step of the procedure. In the absence of an express list of application documents, the licensing authority may, in dealing with the second step, require different converted companies to submit different documents for issuance of the new IC.

As to the procedure for an FIC to setting up a branch, the FIC will first carry out the procedure under the regulations on business registration for setting up the branch. Thereafter, the FIC will conduct the procedure for registration of the project to be operated by the branch. Lastly, the FIC will apply for supplements to its IC with information about its branch which is established in another province or a foreign country.

The draft decree has not guided on how to proceed with the last step in the case where the branch is established in the same province. The draft decree is silent as to whether the branch’s investment project will be registered in the branch’s IC or the FIC’s IC or both. It is also unclear under the draft decree as to whether or not the IC of the FIC will first need to be amended for increase of the charter capital and business lines to cover the branch’s project before applying for the registration of the branch’s project. The draft decree has neither dealt with other legal and practice issues met by FICs in setting up manufacturing branches in provinces other than the one where the FIC’s head office locates.

Investment incentives to re-registered FICs

The draft decree states that re-registered FICs will continue enjoying the investment incentives as stated in their ICs if foreign investor(s) holds not less than 30 per cent of the charter capital of the relevant FIC. This requirement goes contrary to one of principal rules of the Law on Investment on protection of investors in the case of unfavourable changes in laws.

This requirement also goes contrary to Decree 101 on re-registration of FICs, which expressly provides that the re-registered FICs shall succeed all rights that they were entitled to before the re-registration and have the rights in accordance with the Law on Investment and Law on Enterprises, which is not subject to the foreign ownership of 30 per cent or more. One may raise a question as to whether or not non-registered FICs in which the foreign investors hold more (or even less) than 30 per cent of their respective charter capital shall be entitled to the continuance of investment incentives. The draft decree is not clear on this point.

More difficult for adjustment to the investment projects

For any project which suffers from loss for three consecutive years, the application for adjustment to the project and amendment to the IC shall be refused, except for the reason of force majeure event or for the reason that is the new investment project and the loss for three consecutive years have been foreseen and specified in the application for the original Investment Certificate (Article 53.3 of the draft decree).

Given the fact that majority of FICs operating in Vietnam have gotten lost for long time and particularly in the financial crisis in recent years (around 40-60 per cent of the total FICs operating in the country, subject to information sources), this condition shall, if approved, prevent investors from attempting to find the way getting out of the bad financial situation.

Signal of tightening the use of foreign labourers

The draft decree now limits the recruitment and use of foreign labourers doing the managerial or technical jobs and foreign experts not only in meeting the “need of production and business” (as currently permitted by Decree 108) but also in accordance with the “provisions of laws” (Article 16.1). The additional words from Decree 108 appears that the government will possibly tighten the recruitment and use of foreign employees after strong criticism about the loose management of the foreign labourers worked for FCIs in Vietnam.

Liquidation and termination of investment projects

The draft decree introduces additional causes for the licencing authority to terminate investment projects. The licensing authority can terminate an investment project if the investor has breached the reporting and statistical regulations. This sanction is too severe for such kind of breach and should be deleted from the draft decree.

Otherwise, it should be amended so that the sanction can only be applied in the case of the investor having committed an extremely serious breach of the reporting and statistical regulations, which should also be elaborated by the draft decree.

With respect to a project using house or land, the licencing authority can terminate if the project no longer has had the right to use the house or land or the right to lease the house or land. This provision is too broad and vague and need further discussions on its rationale and specific circumstances and conditions where termination can be exercised.

Apart from certain positive changes, the proposed new requirements under the draft decree may bring in substantial concern to the business community given significant disadvantages and adverse effects to investors being for the first time introduced. Those unfavourable changes may easily turn down the investors’ enthusiasm in their investment in Vietnam.

The drafting authority is expected to thoughtfully consider the necessity and reasonableness of the proposed requirements and open those issues for public discussions before the draft decree is passed.

Written for VIR by Dang Duong Anh and Quynh Lam of VILAF