On 10 August 2018, the Chinese Ministry of Justice issued a Circular seeking public comments on the Implementing Regulations of the Law of the People's Republic of China on the Promotion of Private Education (Revised Draft) (Draft for Review) ("Draft").
This draft proposes a number of amendments to the prevailing version of Implementing Regulations of the Law of the People's Republic of China on the Promotion of Private Education.
The first point to make is that these are only a draft and do not yet have any legal impact. It is possible that no final draft is ever produced – something that is not uncommon in China. However, as the draft reflects an increasingly ideological approach in central government and a desire to prevent not for profit schools being controlled by for profit organisations, that is perhaps unlikely. It is also important to appreciate that this is not focused solely at foreign investors in education in China.
In short, the proposed changes are yet again trying to prevent operators in the educational sector avoiding the need to comply with existing regulations. In particular, they are seeking to re-enforce the separation of for profit and not-for profit schools in China and prevent foreign companies indirectly controlling schools in China. As a result, when they come into force, they may require Chinese partners operating schools in China under the name of a UK school to restructure themselves in order to remain in compliance with Chinese law.
Articles 5 and 12 are the most important potential changes from the point of view of UK schools planning to expand into China.
If these regulations, once they are in force, do impact upon your China partner, it may be necessary for you to engage with them about how they propose to restructure themselves. In that event, it is unlikely that the restructuring will result in any new burden for you. Although the changes may not directly or immediately impact upon you or your partner in China, you should nevertheless keep track of the developments, as they do impact upon the general market for foreign schools in China.
High Level Analysis of the Draft
The main changes and our comments are as follows:
1. Restrictions on VIE arrangement and Foreign Investment in Compulsory Education
Article 5 of the Draft provides that foreign investment enterprises (“VIEs”) established in China and social organizations with foreign actual controllers may not sponsor, participate in sponsoring or actually control privately-run schools which provide compulsory education.
The restriction on foreign "control" over private-run schools comes from the prohibition of foreign investment in compulsory education as provided under the Foreign Investment Special Administrative Measures for Access of Foreign Investments (2018 Version).
In order to "circumvent" this prohibition in China, the so-called “VIE Structure” is widely used by many overseas (particularly Hong Kong) companies.
In a VIE Structure, domestic enterprises running an education business in China are controlled by overseas companies through various commercial contracts, such as management and consultancy agreements, call option agreements, equity pledge agreements and powers of attorney.
Organisations such as Wisdom Education (06068-HK), TianLi Education (01773-HK) and YuHua Education (06169-HK) listed in Hong Kong have all adopted the VIE Structure to conduct education business involved with compulsory education policies in China.
The use of VIE Structures in the compulsory education sector has always been somewhat suspect, so this change should not be any great surprise.
If the draft leads to the prohibition being extended to schools that provide non-compulsory education (i.e. pre-school, senior high-school and universities) that would be a substantial change to the current status quo.
2. Education Groups cannot control Non-profit Private Schools
Article 12 of the Draft provides that "Education Groups" may not control non-profit private schools through merger and acquisition, franchising and contractual control.
The purpose of this provision is to avoid companies making profits from non-profit schools through an intra-group transaction.
This provision could be relevant to your partner in China. The Draft is rather vague and does not define "Education Groups". However, the State Education Bureau stated in its opinion that "Education Groups" means that there is one sponsor which operates more than one private school. It is not clear whether the definition of "Education Group" will be further extended to include any sponsor controlling, controlled by, or under common control with that party who operates more than one private school.
It is also unclear whether having the same brand, under common teaching systems, or sharing same course materials will be considered as "Education Groups".
This may result in some Chinese partners having to restructure their businesses in order to comply with the regulations. Exactly how they will have to restructure is not yet clear.
3. Public Schools may not Sponsor or Participate in Private Schools Unless Approved
Article 7 provides that:
- Public schools shall not participate or sponsor private schools;
- Public schools who wish to participate or sponsor private schools require approval by the government;
- Public schools cannot make profit for licensing its name to the private school;
- A public school who is allowed by the government to participate in or sponsor a private school shall have a separate teaching system, teaching staff, financial accounts; recruit students separately; and issue certificates separately.
We believe that item (c) means that public schools should not simply license their name to private schools, although it may license its IP (along with its school name/brand), teaching resources and management resources to the private school if it obtains applicable approval by the education bureau.
4. Affiliated Transaction is Supervised by the Government
Article 44 provides that fees, tuitions and income generated from activities by the non-profit private schools must be carried out under the bank account filed with the applicable bureau. It requires the school to build an affiliated transaction information disclosure system; publicize the affiliated transactions; and that the member of the board who has an interest in the affiliated transaction shall withdraw from voting.
Article 45 provides that the Education Bureau and Human Resources Bureau shall review and examine affiliated transactions entered into by the non-profit private schools and its affiliated parties.
In the past, many school sponsors have enjoyed the preferential policies of non-profit private schools and then transferred the profits to the schools' affiliated entity.
The Draft entitles the government to supervise and review transactions among affiliated parties of the non-profit school. It can further supervise any fees/incomes of the school by monitoring the bank account of the school filed with the applicable bureau.
5. Classification of Permit
The Draft detailed the approval authority who issues permits to schools:
- Pre-school, primary and middle school: approval by the Education Bureau in the district level;
- Universities: approval by the State Education Bureau or the Provincial level;
- Vocational/training institution: approval by the human resources bureau in the district level;
- Institutions that provide tutorial for kids which supplements or relates to the courses taken at school or relates to cultures: approval by the education bureau in the district level;
- Institutions that provide training of language, art, athletics, science for kids, and those that are improving kids' personality development and that provide culture related courses to adults: no approval is required but only need to obtain a business license.
Additionally, the Draft also regulates online teachings:
- Online degree teaching: ICP license and subject to the above approval where applicable;
- Online non-degree vocational/training institution: ICP license and file with applicable education bureau and human resources bureau in the provincial level.
It is worth noting that provision of vocational/training institutions offline requires approval but provision online only requires filing.
In practice, it is difficult to determine and leaves much room for the regulators to interpret (d) and (e). It therefore leads to uncertainty whether provision of services as described under (d) or (e) requires approval or not.
6. Preferential Policies for Non-Profit Private Schools
The Draft sets forth a set of preferential policies which may be offered to non-profit private schools:
- The government may allocate certain funds to reimburse non-profit private schools;
- The State shall lease or transfer available state assets to non-profit private schools in priority;
- The non-profit private school should enjoy the same policies as public schools, such as land-use fees and tax policies, etc.
This is merely a re-statement of existing regulations.
The draft regulation is not unexpected. It is likely to be some time before it comes into effect. Your partner in China may need to consider how the regulations will impact upon its structure in China in due course. There is nothing for you to do at the moment, but you may wish to raise a general query with your partner in China as to how they anticipate such changes may impact upon their business structure.