Whenever an impactful revised law is issued in China, our lawyers see two things happen: panic by those now caught operating illegally, or dismissal by those motivated to make all things China seem rosy.
Recently, there has been much concern and buzz around the latest revision to China’s laws on the Implementation of the Private Education《中华人民共和国民办教育促进法实施条例》,which will take effect on September 1, 2021. Here are some of the reactions we are seeing from investors and interested parties in this sector:
- VIEs (Variable Interest Entities) banned!
- No foreign curriculum allowed!
- No foreign ownership, control or even participation!
- No entrance examinations allowed!
Though the above are all somewhat accurate descriptions of what the new revised regulations state, they should not be surprising as they are very much in line with the evolutionary arc of China’s private school laws. This is because there is another party that has a vested interest in how private schools operate in China and that party’s goals are much more important than any foreign or Chinese investor’s concerns.
At the birth of the People’s Republic of China in 1949, all 2,200 existing private schools become property of the newly formed state, the same as with factories and other key parts of the Chinese economy. However, there still existed interest in and demand for private education. Within the first couple of decades, the Chinese government propagated regulations that provided a basic regulatory framework for how a private school could be established. These regulations provided that interested parties, called sponsors and not owners, would be permitted to establish private schools. A private school thus established had to be a non-profit entity, even though a survey at that time showed that 95% of the school “sponsors” did expect to profit from the school. Perhaps sensing this, the initial regulations also allowed the non-owner sponsor to receive a “reasonable rate of return,” but by entirely unspecified methods.
Now that it was lawful to do so, private schools sprang into being to meet market demand. The prohibition on private school ownership and the non-profit requirement triggered the emergence of grey income strategies by many private school sponsors. Sponsors became very creative and operated on the edge or outside the bounds of any existing laws to ensure they profited from their private school ventures. Sponsors created one or multiple for-profit companies that provided (for a fee) all the services the school would require. Sponsors often were the private school’s landlords so they could profit from charging above market rents Foreign investors, educators and schools were sought and brought in to bring funding, prestige, branding, and talent to these new private schools. Public school buildings and land were often used in part or in whole for these private school enterprises. Offshore VIEs were set up and then used to access foreign financial markets and to stash profits far from Chinese tax authorities.
China’s ambiguous private school laws impacted two groups with very different goals: investors and the China Communist Party (CCP). Our China lawyers see this all the time when helping our clients invest in restricted sectors in China, and so we have learned what is required to navigate the regulations in a way that will make these deals profitable in both the short and the long term for foreign investors.
Investing in a Chinese private school is very different from investing in a manufacturing entity. A joint-venture Chinese factory might easily produce products and profits for ten or more years, and if the relevant Chinese laws are modified in a way that makes foreign investor profits no longer possible, the foreign investor can usually depart having accomplished a decent amount of their profit goals. A private school is meant to be around for 50-100 years or more, and any financial rewards take much longer to realize. A change in laws making a school unlawful to operate after only ten years usually hurts these types of investors with longer-term operating goals. China’s lack of certainty in its private education regulations was foreign investment and growth in this sector.
The CCP knew it had to get control of private education in China so as to be able to keep control its citizens education choices. And yet at the same time, the CCP also understood private education’s contributions to China’s economic and social progress.
All of this resulted in a series of attempts to revise China’s private education laws. In 2002 the Private School Law 《民办教育促进法》was passed and in 2013, a first Amendment to the Private School Law was passed, and in 2015 a second Amendment. By 2016, a third Amendment was passed to guide exactly how private schools in China should be both established and operated. This Third Amendment provided for the following:
- Private schools could set tuition prices with less government oversight.
- Private schools could be split into non-profit and for-profit entities:
- Compulsory age children (6-16) must attend a non-profit entity.
- Non-compulsory age children could attend a for-profit entity.
- These for-profit units would be subject to corporate law, which provides for:
- Clear ownership of assets by investors.
- The ability to go public directly, with no need for VIEs.
- The ability for investors to receive dividends legally.
- The “reasonable rate of return” requirement was removed.
This created challenges for established private schools, many of which had been operating in ways that were now unlawful. Investors liked the new opportunity to own part of a private school, but these for-profit schools would lose some of the tax-favorable policies and permissions that had previously been a major factor in their profitability.
China’s private school laws were going to serve the purposes of the CCP, which was — above all else — to control the education of its citizen children, specifically during the compulsory education years.
This latest revision continues along this evolutionary arc and is completely in line with the CCP’s goals:
- The local CCP committee will be involved with the administration of the school so as to ensure it follows CCP dictates and strengthens the students’ education in core socialist values.
- Foreigners and foreign-controlled organizations are excluded from establishing, participating in, or being in actual control of a private school that educates compulsory age children.
- Foreigners are not allowed on the board of a private school that educates compulsory age children.
- Foreign curricula are banned in private schools that educate compulsory age children.
Bottom line: Every industry in China is regulated with the ultimate objective of serving the goals of the Chinese Communist Party, even those that have escaped its scrutiny for stretches of time. As our China lawyers so often say, “just because something has been allowed to exist or operate in China for years means nothing if that activity conflicts with the CCP’s goal of remaining in power.” We have a very savvy client in a very restricted Chinese industry who keeps a laminated card in his pocket listing out the key elements of China’s current Five Year Plan and he says he consults it 3-5 times a week. So yeah, it does matter.
If you are considering or are already operating in a restricted industry in China, it is imperative you understand the CCP’s goals and you operate within Chinese law. Education is a restricted industry in China because it is so impactful on Chinese society. Foreign involvement and investment in this sector must be done with care and within the current and projected evolutionary arc of future private school regulations.