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BUSINESS & TECH

Doing Business in China: Land-Use Checks Take Digging, but Critical to Sowing Success

By Doug Young

“It’s all about the land, Scarlett.”

OK, so maybe those weren’t the exact words uttered by Gerald O’Hara to his headstrong daughter in the classic “Gone With the Wind.” Fans of the novel will know the real line is, “The land is the only thing in the world worth working for, worth fighting for, worth dying for, because it’s the only thing that lasts.” But however you phrase it, the idea leads nicely into my choice for this week’s column, which focuses on land-use rights and the many minefields they can pose when doing business in China.

I had no idea how complex the issue was in China until I began asking around. Luckily, most foreigners doing business here will never have to deal with such matters since the vast majority will work for other employers in big urban office buildings that are someone else’s responsibility.

But for anyone with thoughts of manufacturing in China, or doing business like property development or agribusiness, the issue of land rights is critical to setting up shop. Investors in Chinese companies also should be aware of the issue since use of land without necessary authorizations is a big no-no that could technically force a firm to close, relocate or engage in costly remedial actions.

I got to thinking about the issue after a recent lunch with a former student who now works in a private equity firm sorting out corporate messes. Her current project involves a resort managed by a major Western company on Hainan Island, China’s answer to Hawaii and the Maldives. Everything was hunky-dory and the resort was built and operating according to plan when suddenly it came to everyone’s attention that the land was designated for research and educational use.

Later it turned out the developer had obtained rights to use the land for a fraction of what proper resort-use land should have cost, and built the property with knowledge that protection would come from a local official who was aware of the situation and willing to let things proceed with a wink and a nod. The problems began when the official got implicated for corruption, which is increasingly common in the current climate.

The bottom line is that the official is now serving out a prison sentence, and my student’s company is trying to sort out the mess. That could technically result in the resort’s forced demolition, but instead will probably end with a huge fine and redesignation of the land for resort use.

Another friend at a domestic drugmaker told a similar tale that saw his company agree to buy a small maker of traditional Chinese medicine, only to discover the factory was built on land designated for agricultural use. That case also evolved the way it did due to a similar wink and nod from local officials, though those same officials were still free at the time and happy to sort out the mess and get the land properly designated.

Rooted in socialism

All of this has its roots in a system where all land was owned by the government under China’s old socialist system, and private development didn’t exist. That system was dismantled in the reform era as China moved to a market economy, though all land to this day still remains government property, so to speak. What’s changed is that local governments can sell long-term rights to use individual pieces of land to private entities, and such sales are now a major source of fiscal revenue. Lengths of land leases vary, but generally seem to range from 40 to 70 years.

Nearly all land has been designated for specific kinds of use under central government guidelines, with industrial, commercial and agricultural being three of the largest categories. But even those can carry conditions, since, for example, agricultural might be designated specifically for forests rather than crop-growing, according to one of my sources who has worked on cases involving this issue.

He noted that land used to be very badly managed in the early days of the reform era, with the result that conflicts like the ones I’ve described above were numerous. But the situation has improved markedly since the mid-1990s, he added, since land sales have become one of the most important sources of local-government revenue and therefore it’s important to get things right.

Another contact pointed out that even when you get things right, overzealous local government officials looking to boost their revenue can still cause shenanigans to happen behind the scenes. He noted one frequent case type can see local government officials offer land to big-name companies for high-profile projects. But as those projects get built, the companies may suddenly notice concurrent development of homes or other unrelated properties on adjacent land. When the situation finally becomes clear, the company may discover such development was part of a sweetheart backdoor deal piggybacking on the high-profile project.

That contact gave the frequent refrain about the importance of doing extensive due diligence in any situation involving land development. My pharmaceutical friend said every city- and county-level government has a land office, or “guotuju,” where ownership and usage records can be verified. Such steps may prove costly and time-consuming, but at the end of the day could very well prevent costly or even business-killing remediation required when a costly state-of-the-art R&D facility shoots up in the middle of land designated for rice paddies.

Doug Young has lived in Greater China for two decades, including a 10-year stint at Reuters, where he led China corporate news coverage. Send your questions or comments to DougYoung@caixin.com.

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