（Author: Jennifer Jiang, Chief Attorney of Bilingual Lawyers)

Variable interest entity (VIE) is originally a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity in which the investor holds a controlling interest that is not based on the majority of voting rights. In China, VIE is not uncommonly used in foreign investment area as a circumvention structure to invest in restricted or prohibited industries, especially known in Internet industries.

In general, the basic structure is comprised of a China domestic company, some offshore holding companies (i.e., in Cayman, BVI, HK) and a China wholly foreign-owned enterprise (WFOE). Critically, the WFOE controls the domestic company by a system of agreements, such as equity option, equity pledge, voting proxy, consulting and service, technical license and loan agreements; so that profits of the China domestic company can be transferred to the WFOE, then the holding companies; thus VIE is also called conduit.

As a circumvention structure, VIE structure will be vulnerable if the China authorities impose greater restrictions. However, in order to attract foreign investment, China authorities have been inclined to acquiesce in its use.

In practice, the risks of VIE structure are mainly associated with breach of contract arrangements. Alipay case is one of the widely known cases in which the offshore holding companies lost control over the domestic companies. In 2011, Jack Ma, the founder of Alipay, successfully severed the VIE structure between Alibaba Group and Alipay.  

To reduce and avoid the above risks, the VIE related agreements need to be carefully designed and their implementations need to be constantly monitored.