Legal Capital – Implied Impact on Foreign Investment in Service Sector

This discussion addresses the implied impact of the norm of legal capital to foreign investment in business services in Vietnam. 

In service sector, the foreign investment is subject to the Schedule of Specific Commitments in Services made upon Vietnam’s accession to the World Trade Organization (“Service Schedule”) and the relevant domestic law. Legal capital is prescribed by the Service Schedule as a barricade to limit the foreign participation into the market of service business. The Service Schedule provides neither definition nor specific amount of legal capital. Then the domestic law should be referred to. Legal capital means the minimum amount of charter capital required by law for the establishment of a company. This requirement is applied to some business services only. The said international treaty and local legislation cause certain restrictions in terms of foreign equity ownership in a joint venture between foreign and local investors.

Basically, the limitation of the foreign contribution in a joint venture’s equity capital is subject to the legal capital required by the relevant law. For an example, a joint venture desires to be a mobile network provider with transmission capacity. For this joint venture, the Law on Telecommunication initially requires it to attain a legal capital of US$500,000. The Service Schedule prohibits the foreign capital contribution in this kind of service to exceed 49% or US$245,000. In any circumstances, this 49% of the legal capital shall not be changed.

Impliedly, the foreign investors’ ownership will be diluted if the charter capital is larger than the legal capital. Such dilution guarantees the compliance of the joint venture with the Service Schedule. If the charter capital in the above example is US$1 billion, the foreign investors’ ownership in the joint venture shall not exceed 24.5% of the total amount of the charter capital or US$245,000. 24.5% of the charter capital satisfies the limitation of 49% of the legal capital.

This restriction will probably concern both foreign and local investors in a prospective and existing joint venture. Local investors may not entice foreign investors to willingly invest generous amount to a prospective joint venture or raise the equity capital in an existing one. Foreign investors probably do not want their ownership to be diluted when the local investors unilaterally contribute the raised equity capital. To protect their ownership, the foreign investors should have a voting mechanism to sufficiently reject a capital increment proposal. Such voting mechanism can be agreed in the article of association of the joint venture. The sufficiency of a voting mechanism is contingent on the voting rights between the foreign and local investors. For example, if the foreign investors own 49% of voting rights, the joint venture may structure that increasing the charter capital requires the approval of the shareholders owning at least 52% voting rights.