May 2, 2017

A new Shanghai local rule came into effect on April 10, 2017 and will be effective until March 31, 2022.  It is one of the most important Shanghai local rules governing its booming real estate market.

It has introduced a new set of requirements on acquiring, developing, holding and disposal of real estate projects in Shanghai, which will have large impact on both domestic and foreign real estate developers and investors, who currently have or are going to make investments in Shanghai.

Going forward, real estate developers will more often see mandatory terms on the long-term holding of commercial and office buildings directly incorporated in land grant contracts, including the minimum term and percentage that they should hold real properties before future disposal.  While it is not uncommon to see similar requirements on public auction notices recently, the new rule has set up a mechanism among various governmental departments requiring the land bureau to work with other governmental authorities to determine whether land grant contracts should have such long-term holding clause and how such clause should be drafted on a case-by-case basis before putting up public auction notices.  Land grant contracts with a long-term holding clause will become the norm in Shanghai.

When it comes to disposal of office and commercial buildings via asset sales, the new rule prohibits unit-by-unit asset sales and developers are required to sell at least one whole floor each time.  The rationale behind seems clear: first, it intends to dissuade small investors from entering the office and commercial buildings market.  Another reason may be that unit-by-unit asset sales are likely to decrease the likelihood of successful positioning, marketing and operation of office and commercial buildings since it is much more difficult to align the interests of and reach consensus among different individual buyers/owners.

Consistent with the increasing public awareness of environmental protection, the new rule puts more weight on environmental protection both before and after land grant.  Soil sampling (including groundwater sampling) is required to be completed by “relevant department(s)” before each land grant and if the land is found to be polluted, it should be cleaned up before land granting and proper documents concerning the pollution and the clean-up plan should be appended to the land grant contract.  It means that land pollution and clean-up history will be disclosed to developers before land grant.  This will be particularly useful for industrial land buyers because they can get comfort from such disclosure that the government has cleaned up the damaged land and such disclosure may, if it is technically detailed enough, serve as the baseline for evaluating possible future pollutions caused by industrial activities.  On the other hand, developers must clean up the land at their own expenses if it is polluted after granting and may even lose the land without any compensation from the government if it is severely polluted after it is granted and the government decides to take it back.  

Notably, the new rule may put an end to certain forms of equity sale transaction structures that are commonly seen in the market nowadays.  It expressly prohibits any change of capital contribution ratio, shareholding structure or ultimate controller of a developer before the developer has paid up the land grant premium, obtained the land use right certificate, the construction project planning permit and the construction work permit, and has spent 25% of the total investment amount.  Obviously, Shanghai government expects developers to make long-term investment in the city as opposed to merely aiming at harvesting short-term property appreciation value.  Even if a developer has met such requirements, it should send a written notice to the land bureau before proceeding with any equity sale.  Before the new rule, many property sales were done by adopting the so-called “offshore transaction structure”.  It is essentially a sale of the shares of the offshore holding company which in turn directly or indirectly holds the PRC project company that holds the target real property.  This structure has many advantages therefore is readily the first option chosen by foreign sellers and buyers.

The new rule also contains other practical measures to reinforce such “early-exit ban”.  It authorizes the real estate registration authority to put on record the capital contribution ratio and shareholding structure of developers when the latter apply to register their land use right or their title to the premises built upon granted lands.  Moreover, real estate registration authority is prohibited from issuing title certificates to developers for premises that they are obligated to hold for themselves for a long term pursuant to the land grant contracts.