Vietnam: Decree 38

1. Introduction

Background

On 15 April 2003, the Government issued a long-awaited decree on the conversion of foreign-invested companies into shareholding companies.[1] By way of background, foreign-invested companies in Vietnam, be they 100% wholly foreign-owned or joint ventures, are not companies divided by shares. Instead, the equity in a foreign-invested company is held by way of legal capital, the holders of which are identified in the Investment Licence of the company. This has various implications, among other things:

• Since any change to the Investment Licence requires approval from the relevant licensing authority, any change in the investors in the company will require an application to be made to the licensing authority for an amendment to that Investment Licence. This makes the exit from foreign-invested companies in Vietnam rather more difficult than it would be from companies set up in almost any other jurisdiction.
• It also makes it difficult to raise money for the purposes of expanding the business through the sale of an interest in the company.

Under Decree 38, foreign investors can convert currently existing foreign-invested companies into joint stock companies, which are companies divided by shares.

The avowed aim of Decree 38 is:

• to improve the operational effectiveness of foreign-invested companies;
• to mobilize capital from domestic and foreign investors;
• to diversify the forms of investment, improving and making more attractive the investment environment; and
• to increase the number of companies which are able to list on the Vietnamese securities market.

Implementing regulations

It is important to bear in mind that the Decree 38 is drafted in very general terms, and will require the passage of implementing regulations detailing the manner in which conversion will take place before it is clear exactly how it will work in practice. No such regulations have yet been drafted. From informal discussions we have had with officials of various governmental agencies, we understand that:

• among others, the Ministry of Planning and Investment (MPI), the State Bank and the Ministry of Finance will be involved in the drafting of the regulations;
• the Ministry of Finance is expected to issue separate implementing regulations concerning financial aspects of Decree 38;
• the Department of Management of EPZs and IZs under the MPI will be in charge of the conversion (this is somewhat surprising, as the Department of Foreign Investment or the Legal and Investment Department are the agencies one would expect to be in charge of such issues);
• it is not clear in what form the implementing regulations would be issued, as a circular or as official correspondence, nor is it clear when such regulations are likely to be passed (although we are given to believe it is imminent).

What type of companies can apply?

The conversion option is available to both joint venture companies and wholly foreign-owned companies.

Only a limited number of foreign-invested companies will be selected by the MPI for conversion over the next 12 months. Each of which will be subject to Prime Ministerial approval. Companies which will be eligible for conversion are those which:

• have fully paid their legal capital contributions as provided in the Investment Licence;
• are in the industrial, agricultural or service sectors;
• have "officially" operated for at least 3 years, the last year of which was profitable; and
• have made an application to the MPI for conversion.

The MPI is instructed to report back to the Government within two years on the progress of the converted companies.

We understand that, to date, some 21 foreign-invested companies have applied for conversion. According to one source at the MPI, companies have until July this year to make the application.

According to Decree 38, the MPI has 30 days from the date it receives the application documents[2] to submit its opinions and those of the other relevant ministries to the Prime Minister for approval.

What form will conversion take?

Although it is still unclear precisely how the conversion will work from a legal point of view, the regulations provide that conversion will take place in one of the following ways:

• by converting the legal capital contributions of the investors into shares and maintaining their holdings at the same level; or
• by assigning a part of the investment capital to new shareholders; or
• by issuing additional shares to raise additional investment capital.

The basis of the conversion will be the total asset value of the foreign-invested company as recorded in the audited accounts.

In relation to land use rights contributed by the Vietnamese partner to a joint venture, such rights will be valued in accordance with the value set out in the Investment Licence.

How will the shareholding company be governed?

According to Decree 38, shareholding companies will be governed by the Foreign Investment Law as well as the Enterprise Law. This could give rise to some challenges, since there could be areas where the legislation conflicts. We are given to understand that the intention of the draftsman was that shareholding companies would be entitled to the protections and incentives under the Foreign Investment Law, while management would be regulated in accordance with the Enterprise Law. However, it is not clear which legislation is intended to regulate such things as foreign exchange and import-export.

Who can purchase shares in a shareholding company?

Persons who are eligible to purchase shares in a shareholding company include: foreign investors, foreign-invested companies and domestic investors.

There must be at least 3 shareholders, one of which must be the foreign founding shareholder which must maintain at least a 30% interest in the company throughout the life of the company. There is no restriction on the maximum number of shareholders.

Transfer of shares

The transfer of shares is restricted. Apart from the maintenance by the founding shareholder of a 30% interest in the company throughout the life of the company, all transfers of shares by foreign investors to Vietnamese nationals must be approved by the MPI. The transfer of shares between foreign investors does not appear to require approval.

The proceeds from the sale of shares by foreign founding shareholders to Vietnamese investors must be re-invested in Vietnam, unless approval is obtained from the relevant authorities to transfer such proceeds abroad.

We mentioned earlier that the MPI is instructed to report back to the Government within two years on the progress of the converted companies. In discussions with officials of the MPI, it was made clear to us that they felt that at the reporting stage it was likely that the restrictions on the transfer of shares would be reviewed and, hopefully, lifted.

Management

It is stated in Decree 38 that foreign shareholders will be entitled to engage in management of a shareholding company. Management itself is to be undertaken in accordance with the provisions of the Enterprise Law.

The main differences between management under the Foreign Investment Law and that under the Enterprise Law is that,under the Foreign Investment Law management is by the Board of Management and Directors, while under the Enterprise Law, shareholding companies are managed by the General Meeting of Shareholders, the Board of Management, Directors and an Inspection Committee.

Can a shareholding company list on the stock market?

Shareholding companies will be permitted to list on the Vietnamese stock market and on foreign stock markets. However, in the case of foreign listings approval will be required from the "relevant authorities". It is not clear in this case which is the "relevant authority". It could be the Prime Minister, the MPI or the State Securities Commission.

2. Application procedures

Although it is unlikely that either the Joint Venture Agreement or the Charter of a foreign-owned company would prohibit its conversion into a shareholding company, unanimous approval is required from the members of the Board of Management as the conversion will result in a change to the Charter.

In order to convert into a shareholding company, the following procedures must be carried out:

1. The foreign-owned company will need to convene a meeting of the members of the Board of Management to discuss and approve the conversion;
2. An application for conversion should be submitted to the MPI comprising of the following:

   a. Application for conversion signed by the General Director;

   b. Plan on conversion;

   c. Report on the operations of the foreign-owned company prior to conversion;[3]

   d. Draft Charter of the shareholding company; and

   e. Resolutions of the Board of Management of the foreign-owned company approving the plan on conversion.

   The Conversion Plan appears to be the most important document. Decree 38 suggest this document should cover the following areas:[4]

   • targets and requirements of conversion;
   • proposed scale and form of conversion;
   • proposed timing for conversion, including the issuance of shares and venue for the sale of shares (if any);
   • employment plan and preferential treatment for employees (if any);
   • proposed listing of the shares on the domestic or foreign stock markets; and
   • results of the evaluation of the company.

   It may also be appropriate to include other issues in the Conversion Plan which we would be happy to advice on in due course.

   Given that the conversion of foreign-invested companies into shareholding companies is novel in Vietnam, and the authorities will be inexperienced in such matters, it will be important to couch the application in the most appropriate way, and to have informal discussions with the authorities prior to formal submission. Again, we would be pleased to advice on this aspect in due course.

3. 3. The shareholding company will be required to carry out post-licensing procedures after the issuance of the Amended Investment Licence, such as public announcements.

Other issues

1. There are a number of areas in the Charter of the foreign-owned company which may require amendment for the purposes of the conversion to a shareholding company. The Law on Enterprises will regulate shareholding companies, inter alia, in relation to (i) the rights and obligations of the shareholders; (ii) the offer, transfer, purchase, and redemption of shares; and (iii) the management of the shareholding company,[5] and these issues should be taken into account in the revised Charter.
2. Depending on the nature of the shareholding, it may be necessary for a shareholders agreement to be entered into. This may be based on the current joint venture agreement. Such agreement should be carefully drafted so as to effectively regulate the rights and obligations of current and future investors/shareholders.
3. If it is intended that the shareholding company will list on the stock market, it is vital that all company documents are in order. In our experience, the nature of the regulatory environment in Vietnam is such that it is difficult to comply with all formalities in a manner which is acceptable to foreign stock exchanges. We will be happy to advise in more detail on this aspect in due course.

3. What are the benefits of conversion?

1. The ability to list on the Vietnamese and foreign stock markets, providing the opportunity to mobilise capital from domestic and foreign sources.
2. The ability to transfer shares to new investors without the need to go through the cumbersome process of seeking approval from the licensing authority and obtaining an amendment to the investment licence.
3. It provides foreign and domestic investors with an exit strategy (subject to the 30% rule for founding shareholders).
4. It appears (although it is not entirely clear) that the term of operation of the shareholding company will not be limited to a maximum of 70 years as it is under the Foreign Investment Law.
5. The principle of unanimity on certain board decisions set out in the Foreign Investment Law will not apply.
6. Stock option plans could be offered to local employees rather than the phantom schemes which are all that can be offered under the present law.
7. Any preferential treatment to which foreign-invested companies are currently entitled would continue to apply to the shareholding company.

[1] Decree 38/2003/ND-CP of the Government dated 15 April 2003 on the conversion of foreign invested companies into shareholding companies (Decree 38).

[2] Article 22 of Decree 38.

[3] Although Decree 38 is not clear, it is likely that the report must be prepared for the period from the date of establishment (i.e. 6 April 1994) to date.

[4] Article 21 of Decree 38.

[5] Article 19 of Decree 38.