Our last newsletter, the PRC Law on Prevention and Control of Soil Contamination—One Year after Implementation—focused on the key issues of the newly implemented statutes, the emerging trend of environmental enforcement and the impacts on business. In this newsletter we would like to report on the initiatives to tackle the strengthening environmental enforcement and feasible practices to mitigate risks.

I. Introduction

Since China declared a “war on pollution” in 2014, environmental protection has become a top priority executed by stringent legislation, enforcement and centralized campaigns. Such emerging change has mixed effects on businesses. On the one hand, companies which have already adopted advanced pollution controls will have an edge over their competitors due to the more leveled playing field. On the other hand, the rapid statutory changes and intensified enforcement also increase the exposures of companies to unpredictable inspections and potential legal liabilities. Over the last two years, we have noted increasing environmental cases as well as increasing environmental compliance service demands. Right now, the second round of nationwide inspection is ongoing and will continue for another two years. Given the above, strategies on how to deal with the current situation are advisable.

II. Newly Established Companies

1. Selection of Site

Traditionally, companies chose their investment locations based on convenience of transportation and the preferential policies that local governments are able to give, e.g., preferential land use right granting fees and subsidies. Nowadays, environment related aspects should also be taken into consideration, especially for heavy-polluting industries.

In terms of physical location, some areas are generally under stricter environmental scrutiny, like Beijing-Tianjin-Hebei Region, Yangtze River Delta Region and Pearl River Delta Region. Based on practical experience, factories operating outside of industrial parks, unqualified industrial park or small industrial parks are also under stricter scrutiny. In this regard, for industrial business, in particular heavy-polluting industries, it is advisable to locate in industrial parks as opposed to random places. Further, from pollutant discharge perspective, it is advisable to gather detailed information about the approved pollutant discharge capacity of the potential location and the potential neighbors. The reason is that even if a company has a valid pollutant discharge license, it still can be ordered to shut down, if the aggregated pollutant discharge in a certain area exceeds the threshold or there are some heavy polluters in the vicinity.

Another major risk companies may face is relocation. Over the last two years, more companies were ordered to relocate for various reasons like control of volatile organic compounds, protection of Yangtze River Delta Hub, incompatible environmental compliance due to change of planning, etc. Although all of these relocated companies have been duly compensated by the government, the uncertainty caused by relocation disrupts business and the long-term strategies of companies. Therefore, when selecting sites, companies shall take time to analyze whether the long-term planning of the local district or industrial zone fits their business plans and whether change of planning is likely to happen in the near future. The local planning usually can be found on the local governments’ website. Change of planning, e.g., change the industrial use land to commercial use land, may toughen the overall environmental requirements in the area or cause suspension in environmental impact assessment approval procedures, and cause additional human and monetary costs for relocation.

2. Additional Aspects to Due Diligence

For the reasons stated above, district or industrial zone planning shall be included in due diligence, if possible. Usually, the local planning of the next few years is publicly available. If not, investors may require local governments to provide them with detailed planning of the district where the potential site is located.

In M&A projects, checking of administrative penalties is a standard part of due diligence. Upon implementation of the Law of the PRC on Prevention and Control of Soil Contamination in 2019, additional checks should be run on whether the target is under major administrative supervision or the land owned by the target is listed as construction land subject to soil contamination risk management and restoration. According to the Law of the PRC on Prevention and Control of Soil Contamination, enterprises under major supervision are subject to stricter administrative managements, requirements and responsibilities. Land listed as construction land subject to risk management and restoration cannot be utilized for other purposes (like production) but for soil contamination risk control and restoration only. Acquisition of such target or land use rights will expose investors to substantial risks.

Further, according to the Law of the PRC on Prevention and Control of Soil Contamination, the owner of the land use right shall carry out the soil contamination risk control and remediation where the party liable cannot be identified. Before such provision, the owner of land use right would only be liable where it was the actual polluter. Now, the scope of soil contamination liability of the owner of land use right has been broadened. Given the fact that adverse effect of soil contamination is subtle and gradually escalates over time, by the time pollution becomes obvious, the situation is often hard to reverse, and the damages are often substantial. Therefore, it is advisable to conduct a soil assessment before acquiring land use right to draw a clear-cut line between the past and future liabilities. The same rule applies when a company decides to close down to relocate.

III. Existing Companies

1. Self-assessment of Environmental Compliance

(1) Update of Environmental Compliance List

From a legal perspective, because of the rapid change of law, it is essential to keep environmental compliance standard up to date. Regardless of the actual structure of companies, having a dedicated manager/department supervising environmental compliance can help to track policy changes and respond promptly. Further, internal assessments should be made upon change or updates of laws to see whether additional measures should be adopted to meet the heightened benchmark of statutory requirements. Alternatively, companies may entrust third-party resources, like environmental management consultants or law firms, to do such assessments on a regular basis.

Aside from regular checks, bringing in third-party inspectors for formulating an audit report may help as well. By doing so, violations can be identified before official inspections so that risks can be mitigated beforehand. Or, third-party inspectors can be brought in for verifying the official results tested in governmental inspections where prima facie case shows, or there is probable cause to believe that the official result has errors.

From a technical perspective in environmental cases, industry association and expert seminars can add value. Industry associations are regularly entrusted to draft environmental standards. Thus, they can often provide detailed insight to compliant best practice. Experts in industry associations are often entrusted by ministries to draft technical regulations and to sit on the panel of providing expert opinion in environmental cases. For issues which are not clearly stipulated under technical regulations their interpretations are of great value.

(2) Staff Training to Handle Inspection

To handle environmental inspections, companies may educate their frontline staff, e.g., from security guards at the plant entrance to operation supervisors, on how to answer frequently asked environmental questions and direct inspectors to the right resources in the company. Environmental permits and operational records shall be well organized and accessible to the entire operations team to deal with inspections without prior notice.

Companies can collect the same samples at the same time or right after the official inspection to preserve evidence and do their own tests. In case of discrepancies between the official results and the companies’ own results, such samples and test results can be used as physical and documentary evidence in administrative legal actions to support the companies’ argument where environmental violations are found.

Frontline staff should also be trained on how to deal with on-site inspection records. In the event that environmental violations are found, inspectors will make official on-site inspection records stating the details of the inspections, facts of violations, related evidence and applicable laws. Such records are required to be signed by the responsible persons on site. The on-site responsible persons should go through the records thoroughly and ask for correcting any untrue, incomplete or misleading facts, and statements in such records before signing. Since such records will be the basis for the subsequent administrative decisions, missing this opportunity to set the record straight may lead to unrecoverable damages.

2. Proactive Communication with Regulators

In practice, when a new regulation is promulgated, local authorities often provide companies with inadequate notice periods. In addition, for fear of being held liable under the current centralized environmental inspection campaign, many authorities have opted to take a “wait and see” or “one case one review” approach which further prolongs the period to obtain approvals or even suspends granting any approvals.

In order to keep up with the changes of law and implementing policies from authority perspective, it is advisable to have effective communication channels with local regulators on a regular basis. Especially, where an abrupt change of policy occurs, such approach can help companies to identify risks in current operations and make corresponding plans. We noted productive results in practice from meetings with authorities in this regard. On the other hand, companies may use this channel to express their concerns and suggestions from business side. Lately, Chinese governments at various levels reinstate the importance to create, fair, transparent and predictable business environment. Abrupt police changes and inadequate lead time certainly contradict the creation of a mature business environment. The voice of reason should be heard by regulators so as to improve the administrative measures.

Compared to significant reformation of environmental protection legislation in the recent years, regulating of implementing rules are behind schedule. For complicated issues without clear guidelines, for precaution, it is advisable to send written inquiries to authorities for their instructions and approvals. This approach also applies when authorities give verbal orders and requirements. Authorities use these non-written methods to avoid their liabilities, However, passive acceptance will not help companies to avoid risks. Only written communications with authorities can later be used to prove due cares taken by companies and to argue for the doctrine of legitimate expectation in subsequent administrative proceedings, if any.

3. Administrative Hearing, Reconsideration and Litigation

Data show environmental inspections and penalties are at a historical high in China. In practice, the supply of technical environmental professionals does not match the demand which results in inexperienced inspectors and inexpert inspection results. As China’s environmental enforcement regime matures and for protecting the legitimate interest of business, companies should consider taking legal actions to challenge unjustified administrative decisions where falsely accused.

Before making administrative decisions, authorities should notify companies of the facts of violations, legal basis, proofs and their rights to make their statements or arguments. In cases where companies are ordered to stop production, suspension or revocation of permit or are imposed fines or seizure of property over RMB 50,000, authorities must inform companies of their rights of administrative hearing.

Authorities usually issue administrative decisions and orders to rectify violations alongside with the administrative penalties. Administrative hearing, reconsideration or litigation does not suspend the implementation of the aforementioned orders to rectify. Companies must rectify accordingly within the designated time period. Otherwise such continuous status of violation may trigger consecutive daily fines. In practice, consecutive daily fines are not rare and prone to end up with huge amounts.

According to PRC administrative laws, where certain administrative decisions infringe the lawful rights or interests of companies, they are entitled to administrative reconsideration or administrative litigation to challenge the administrative decisions. Based on our practical experience, in environmental contamination cases, environmental damage litigation or public interest litigation often entails administrative fines and order to rectify. Acquiescence to false allegations in administrative decision may be used against companies subsequently in judicial proceedings. Therefore, companies should weigh the options cautiously and make the decision, within the statute of limitations, on whether to proceed with legal actions or not.