The National People’s Congress of the PRC (the “NPC”) approved the Foreign Investment Law of the PRC (the “FIL”) at the closing meeting of the second session of the 13th NPC on March 15, 2019. FIL will come into force on January 1, 2020 (the “FIL Effective Date”). Upon taking effect, FIL will replace the three existing laws on foreign investment in China (the “Three FDI Laws”, i.e., the Law on Sino-Foreign Equity Joint Ventures (the “EJV Law”), the Law on Sino-Foreign Contractual Joint Ventures (the “CJV Law”) and the Law on Wholly Foreign Owned Enterprises) and become a fundamental law of China in the foreign investment area.
This article provides a high-level overview of FIL and analyzes the changes and challenges that investors, authorities and practitioners may need to address under the new law.
SECTION I. HIGHLIGHTS
FIL consists of 6 chapters (including General Provisions, Investment Promotion, Investment Protection, Investment Administration, Legal Liabilities and Ancillary Provisions) and 42 articles, including the following highlights:
- From Three Laws to One Unified Law
As the first unified law in the foreign investment area, FIL will replace the Three FDI Laws (Article 42). Any foreign invested enterprise (“FIE”) established after the FIL Effective Date must comply with the Company Law of the PRC (the “Company Law”) or the Partnership Enterprise Law of the PRC (as applicable), in terms of its organizational form, corporate structure and bylaws. For FIEs established before the FIL Effective Date, FIL grants a five-year transitional period, during which these FIEs may continue to retain their existing organization form, corporate structure and bylaws (Article 42).
- Scope of Foreign Investment
- Four approaches to foreign investment covered under FIL
By its terms, FIL applies to all foreign investment in the PRC. FIL provides four specific channels for conducting foreign investment in the PRC, namely: (i) forming new FIEs, (ii) investing in existing enterprises through mergers and acquisitions (“M&A”), (iii) investing in new projects and (iv) other approaches stipulated under laws, administrative regulations or promulgations of the State Council (Article 2). The broad scope of item (iv) implies that FIL is intended to apply to essentially all foreign investment activities in the PRC, and also provides flexibility for legislators and regulators to adapt and modify the law applicable to foreign investment in response to new developments and changing circumstances.
In contrast, under the current legal regime, the Three FDI Laws mainly focus on the formation of new FIEs (as well as the operations of FIEs after an entity becomes an FIE through an M&A transaction), while foreign investment through M&A is mainly governed by the Regulations on Foreign Investors’ Mergers and Acquisitions of Domestic Enterprises as promulgated by the Ministry of Commerce (“Circular 10“) and the Administrative Measures for Foreign Investors’ Strategic Investment in Listed Companies as promulgated by the Ministry of Commerce (“MOFCOM”) jointly with four other ministries and commissions (the “Administrative Measures on Strategic Investment”).
- Direct and Indirect Investment
The Three FDI Laws only contain provisions about direct investment and are silent on indirect investment. Provisions regarding indirect investment are mainly set forth in the Interim Provisions on Investment Inside China by FIEs, which only address issues in connection with investments made by FIEs but has no provisions about further investment made by FIE-invested enterprises or their subsidiaries.
In contrast, FIL explicitly specifies that foreign investment includes indirect foreign investment as well as direct foreign investment. However, there is as yet no explanation or interpretation available about what will constitute an “indirect foreign investment” (for example, whether an investment made by an FIE’s direct or indirect subsidiary would constitute an “indirect foreign investment”).
- Negative List, Information Reporting and National Security Review
Addressing two potential concerns shared by many foreign investors—namely, discriminatory market entrance policies and opaque administrative approval and regulatory regimes—FIL reiterates that China will implement high-level foreign investment liberalization and facilitation policies, establish and improve mechanisms to promote foreign investment and create a stable, transparent and predictable market environment where all competitors, both domestic and foreign alike, will be treated fairly (Article 3).
Under the Three FDI Laws, foreign investment projects are subject to case-by-case approval by the competent administrative authorities (e.g., MOFCOM and its local counterparts). Originally, any FIE could be established only after the requisite administrative approval had been obtained. Since the implementation of the restricted sectors negative list system in 2016, the case-by-case approval requirement no longer applies to many types of foreign investment projects, but to this day it is still an important structuring consideration for foreign investors.
FIL replaces the case-by-case approval system with a system consisting of national treatment in conjunction with a negative list for foreign investment (Articles 4 and 28). Under this system, except as required pursuant to the negative list, the competent PRC authorities are to treat foreign investors with at least the same degree of accommodation as domestic investors receive. In practice, this system will principally involve administration of the negative list, reporting requirements for foreign investment projects and national security review procedures, with the aim of improving market access, transparency and accountability of administration over foreign investment, while at the same time balancing concerns for PRC national security.
- Negative list (Articles 4 and 28)
The negative list consists of a list of industry sectors in which foreign investments are prohibited (the “Prohibited Sectors”) and a list of industry sectors in which foreign investments are subject to restrictive conditions (the “Restricted Sectors”). In the Prohibited Sectors, foreign investors are prohibited from making investments, while in the Restricted Sectors, foreign investments must satisfy certain conditions stipulated in the negative list. In industry sectors that are neither Prohibited Sectors nor Restricted Sectors, foreign investors are to be treated at least as well as domestic investors.
- Information reporting system (Article 34)
FIEs must submit investment information to the competent authorities through the enterprise registration and public credit disclosure systems generally used for all enterprises in the PRC. FIL narrowly tailors FIE reporting requirements to a strictly need-to-know standard, and requires various administrative agencies to efficiently share information to minimize or eliminate redundant reporting burdens on FIEs.
- National security review system (Articles 6 and 35)
FIL charges foreign investors and FIEs to observe and abide by PRC law and regulation and refrain from activities that could harm PRC national security or public welfare. Foreign investment activities that may affect PRC national security will be subject to a security review system.
- Administrative measures of other governmental authorities (Articles 3, 29, 30, 32, 33 and 41)
MOFCOM is the authority in charge of the regulatory matters mentioned in section (a), (b) and (c) above. In addition to MOFCOM, FIL also clearly sets forth other government authorities’ responsibilities and powers in connection with regulating foreign investment, laying out a systematic framework for the administration of foreign investment including:
(i) foreign investment that is subject to project approval or record filing should comply with relevant project approval and record-filing requirements applicable generally under PRC law (Article 29), currently administered by the National Development and Reform Commission (“NDRC”); (ii) for any foreign investment in industries or sectors that are subject to licensing or permitting requirements, application must be made to the regulatory authorities having authority over such industries or sectors, and unless otherwise provided by law, such authorities will process such applications with respect to foreign investment in the same way they would handle a similar application from a domestic investor (Article 30); (iii) FIEs must handle tax, accounting, foreign exchange and other matters in accordance with the PRC law and regulations generally applicable to such matters, and must accept oversight and examination by PRC regulatory authorities charged under PRC law with general authority over such matters (Article 32); (iv) for any investment triggering anti-trust review requirements under the Anti-monopoly Law, application for anti-trust review must be submitted in accordance with generally applicable relevant law (Article 33), and (v) by its terms, FIL defers to any laws or regulations specially addressing foreign investment in financial industries such as banking, investment securities, insurance and financial markets such as securities exchanges and foreign exchange markets, and such specialized laws and regulations will continue to apply with priority over any conflicting provisions of FIL (Article 41).
- Protection of Intellectual Property Rights
Responding to foreign investors’ concerns about IP protection in China, FIL clearly provides that China protects the intellectual property of foreign investors and FIEs, and protects the legitimate rights and interests of intellectual property owners and relevant right holders. Any infringement upon intellectual property rights is subject to commensurate legal liability. China encourages voluntary technology cooperation in conjunction with foreign investment. The terms and conditions of technology cooperation projects are expected to be negotiated fairly between the relevant parties, and no governmental administrative authority or employee or other functionary thereof may force or compel the transfer of any technology by administrative means (Article 22).
- Protection of Legitimate Rights and Interests
Responsive to foreign investors’ concerns that they may be subjected to discriminatory restrictions or otherwise treated less favorably than domestic PRC enterprises, FIL explicitly provides that:
- The State’s various policies in support of enterprise development will be applied equally to FIEs and domestic enterprises in accordance with generally applicable relevant law (Article 9);
- The State protects FIEs’ rights to equally participate in the formulation, dissemination and monitoring of national standards; and compulsory standards set by the State will apply equally to both domestic enterprises and FIEs alike (Article 15);
- The State protects FIEs’ right to participate in government procurement activities through fair competition. Products produced and services provided by FIEs within the territory of China will be treated equally in government procurement in accordance with applicable law (Article 16);
- FIEs may seek financing in the China via public offering of shares, issuance of corporate bonds or other securities, and other means permitted under generally applicable relevant law (Article 17);
- Foreign investors may exercise discretion in accordance with applicable law to remit into or out of China, in Renminbi or any other currency, their contributions, profits, capital gains, income from disposition of assets, intellectual property royalties, lawfully acquired compensation, indemnification proceeds, proceeds of liquidation and the like (Article 21);
- Administrative agencies and their employees and other functionaries must keep confidential any trade secrets of FIEs they become aware of in the course of performing their duties, and must not divulge or illegally provide such secrets to others (Article 23);
- In formulating normative documents concerning foreign investment, the people’s governments at all levels must not impair FIEs’ legitimate rights and interests or increase their obligations (Article 24);
- Local people’s governments at all levels should honor policy commitments lawfully made to foreign investors and FIEs and perform all contracts concluded with foreign investors in accordance with applicable law. If any policy commitment or contract needs to be changed due to national or public interests, changes should be made only within the scope of statutory authority and applicable procedures should be properly followed. In addition, the foreign investors or FIEs concerned should be compensated fairly in accordance with applicable law for losses incurred as result of such changes. (Article 25).
SECTION II. CHANGES AND CHALLENGES
On one hand, FIL will bring significant changes to the legal regime for foreign investment and open the way for a new era of foreign investment in China. On the other hand, FIL only sets out general principles, and the State Council, MOFCOM and other relevant authorities will need to provide further clarification with respect to many implementation details before January 1 of next year. We set forth below some analysis and suggestions on the changes, as well as challenges that investors, regulatory authorities, law practitioners and other concerned parties may face in the 9 months leading up to the FIL Effective Date, and even after FIL comes into effect.
- More detailed measures are needed for the implementation of the negative list system, the information reporting system and the national security review system.
Negative list: China has implemented a negative list system for the administration of foreign investment since 2016, nearly concurrent with the latest amendment to the Three FDI Laws. On June 28, 2018, the NDRC and MOFCOM jointly released the Special Administrative Measures for Foreign Investment Access (Negative List) (2018 version), which established the currently effective negative list system for the administration of foreign investment.
Under the current negative list system, the case-by-case approval system continues to apply to sectors included on the list, while in sectors not included on the list, foreign investment is given equal treatment with domestic Chinese investment, save for record-filing requirements pursuant to the Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises.
On the FIL Effective Date, the Three FDI Laws will be repealed and consequently the case-by-case approval system will end. Therefore, we expect the State Council and/or MOFCOM may issue new regulations on the administration of foreign investment projects in sectors included on the negative list.
Information reporting: FIL does not contain provisions on record filing of foreign investments in industry sectors outside the negative list. Hence, we expect that MOFCOM will issue more detailed measures or guidelines in order to implement the foreign investment information reporting system. The implementation rules may be drafted based on the existing Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises, which is expected to be repealed after the new rules are promulgated.
National security review: The existing regulations relating to national security review are the Notice on Establishing a Security Review System for Foreign Investors’ Mergers and Acquisitions of Domestic Enterprises, released by the General Office of the State Council in 2011, the Regulations on Implementing the Security Review System for Foreign Investors’ Mergers and Acquisitions of Domestic Enterprises, released by MOFCOM in 2011 and the Measures for the Pilot Program of National Security Review of Foreign Investment in Pilot Free Trade Zones released by the State Council in 2015.
A previous draft of FIL released by MOFCOM in 2015 soliciting public comments (the “2015 Draft”) had one chapter which attempted to set up a relatively comprehensive regime for the national security review system. Since Article 35 of FIL contains the only reference addressing national security review, the State Council may promulgate implementing provisions for the national security review system.
- “Indirect Investment” and implementation of negative list.
The Three FDI Laws only regulate the first layer of investment activity by foreign investors in China, and the Interim Provisions on Investment Inside China by FIEs only regulates the second layer of foreign investment (i.e., investment activities conducted by EJVs, CJVs or wholly foreign owned enterprises). There are no existing regulations regarding down-stream foreign investments (i.e. investment activities carried out by subsidiaries of EJVs, CJVs or wholly foreign owned enterprises).
Article 2 of FIL defines foreign investment to include both “direct” investment and “indirect” investment by foreign investors. However, FIL contains no further explanation of what constitutes “indirect investment”.
The characterization of “indirect investment” is important with respect to the implementation of the negative list. One of the objectives of foreign investment regulation is to prevent foreign investors from entering restricted sectors through various indirect investment methods. Therefore, whether China will adopt some form of a “penetration principle” whereby a certain component of foreign ownership would trigger foreign investment regulations, restrictions and prohibitions, even if such foreign ownership is indirect and diluted, or whether control will be used as the operative standard; what level of penetration or control may be deemed material, whether indirect investment regulations will be limited to the sectors included on the negative list, and the applicable administrative methods (such as licensing or filing) are all pending further clarification from the relevant authorities.
- VIE structure continues to be a grey area.
VIE structures based on contractual arrangements are commonly used by foreign investors to invest in China in industry sectors where direct foreign investment is prohibited or restricted, and are also used by Chinese domestic companies as a means to obtain offshore financing or listings on stock exchanges. The 2015 Draft attempted to regulate VIE structures as a form of foreign investment. However, FIL does not explicitly address the VIE structure issue. Nevertheless, when enumerating forms of foreign investments, Article 2 of FIL includes a catch-all clause sweeping in “other forms of investment stipulated in laws, administrative regulations or by the State Council,” which appears to provide sufficient flexibility for regulating VIE structures as a form of foreign investment subject to FIL.
- Governing law
Pursuant to the Implementation Regulations on the Sino-Foreign Equity Joint Venture Law (the “EJV Regulations”) and the Implementation Regulations on the Sino-Foreign Contractual Joint Venture Law (the “CJV Regulations”), the formation, validity, interpretation, execution and resolution of disputes with respect to equity joint venture contracts and contractual joint venture contracts must be governed by the laws of the PRC. Circular 10 also stipulates that, in connection with an acquisition of domestic companies by foreign investors (as defined therein), equity purchase agreements, capital increase agreements and asset purchase agreements must be governed by the laws of the PRC. The above-mentioned governing law requirement was embedded into the Contract Law in 1999 and upgraded from a regulation-level to a statute-level legal requirement. Article 126 of the Contract Law provides that Sino-foreign equity joint venture contracts, Sino-foreign contractual joint venture contracts and contracts for Sino-foreign cooperative exploration and exploitation of natural resources which are to be performed within the territory of the PRC shall all be governed by the law of the PRC.
However, the concepts of “Sino-foreign equity joint venture contracts” and “Sino-foreign contractual joint venture contracts” used in Article 126 of the Contract Law were derived from the Three FDI Laws and the EJV Regulations and CJV Regulations. The EJV Regulations and CJV Regulations are expected to be repealed at the same time as the Three FDI Laws are repealed when FIL takes effect. Therefore, the terms of “Sino-foreign equity joint venture contracts” and “Sino-foreign contractual joint venture contracts” will lose their legal basis. It is expected that the Contract Law will be amended accordingly to address the governing law issue, though it is not clear whether investors (including foreign investors) will be given the flexibility to choose the governing law of their investment agreements.
Similarly, once the Three FDI Laws are repealed, the relevant provisions in Circular 10 requiring that equity purchase agreements, capital increase agreements and asset purchase agreements be governed by the laws of the PRC may also need to be amended.
- Profits may be distributed NOT in proportion to the shareholders’ respective capital contributions; in a liquidation process, however, the remaining assets must be distributed in proportion to the shareholders’ equity-holding percentages
Under current law, the Sino-Foreign Equity Joint Venture Law requires that the investors of an equity joint venture (“EJV”) must share profits and bear risks and losses in proportion to their respective contribution to the registered capital of the EJV. In contrast, the Sino-Foreign Contractual Joint Venture Law allows the Chinese and foreign investors to allocate the profits of the contractual joint venture (“CJV”) according to commercially negotiated contractual provisions. As a result, in practice, if the parties wish to share profits NOT in proportion to their respective contribution to the registered capital, usually they must choose to set up a CJV rather than an EJV.
Article 31 of FIL provides that, upon the repeal of the Three FDI Laws, the operations of FIEs should comply with the Company Law. Pursuant to the Company Law, a limited liability company may distribute profits to shareholders NOT in proportion to their respective equity-holding percentages in the company, if the distribution plan has been unanimously agreed among all shareholders. Therefore, it is expected that investors in EJVs may have more flexibility in dividend distributions in the future.
Under current law, the legal provisions regarding allocation of a company’s remaining assets to its shareholders after the completion of the company’s liquidation process vary between types of enterprise. The EJV Regulations allow the shareholders to separately negotiate the allocation of the remaining property. The CJV Law allows the remaining assets to be allocated in accordance with the agreement between shareholders. Pursuant to the Company Law, however, the company’s remaining assets must be distributed in proportion to the shareholders’ respective contribution to the registered capital of the company.
After the repeal of the Three FDI Laws and the expiration of the five-year transitional period, FIEs will be required to revise their articles of association to comply with the Company Law. After the expiration of the 5-year transitional period, a distribution of remaining assets not in proportion to the shareholders’ respective capital contributions may be challenged by relevant authorities when the foreign investor attempts to remit the liquidation proceeds of the remaining assets out of China.
- No further approval required for amendments to joint venture contracts and articles of association.
Under the Three FDI Laws as originally promulgated, joint venture contracts and articles of association of all EJVs and CJVs, as well as any amendments thereto, were subject to approval by MOFCOM or its competent local counterparts. On September 3, 2016, the State Council amended the Three FDI Laws to expressly provide that, for any investments that are not subject to specific foreign investment market access restrictions, MOFCOM would no longer review and approve joint venture contracts and articles of association. However, MOFCOM approval is still required with respect to EJVs and CJVs operating in restricted industries.
FIL does not include concepts of “equity joint venture contracts” and “contractual joint venture contracts”, nor does it contain any provisions subjecting joint venture contracts and their articles of association to approval by any governmental authorities. Hence, the case-by-case approval system will officially come to an end, and regulatory authorities will no longer interfere with the specific contents of joint venture contracts and articles of association of foreign enterprises, regardless of what industries they may be active in.
- Unanimous consent of equity transfer and “deemed consent”
Pursuant to the EJV Regulations and CJV Regulations, an investor in an EJV or a CJV must obtain consent from all other investors in order to transfer all or part of its equity or other rights to a third party.
Equity transfers of purely domestically funded companies are governed under Article 71 of the Company Law. Instead of a unanimous consent from all other shareholders, Article 71 of the Company Law only requires the transferring shareholder to obtain consent of more than 50% of the other shareholders. Article 71 also provides that a shareholder who neither grants its consent to the transfer nor agrees to purchase the transferred equity will be deemed to consent to such transfer.
Historically, there was a debate about whether the “deemed consent” provision under the Company Law should also apply to FIEs. In order to avoid disputes, some FIEs even expressly provided in their joint venture contracts and articles of association that the “deemed consent” provision would not apply. However, the Supreme People’s Court confirmed in Provisions on Several Issues Concerning the Trial of Dispute Cases related to Foreign-invested Enterprises (I) that the “deemed consent” provision under the Company Law also applies to foreign-invested enterprises.
Upon repeal of the Three FDI Laws, it is not clear whether the Supreme People’s Court’s judicial interpretation will continue to be valid. Nevertheless, pursuant to Article 31 of FIL, all operations of FIEs will be governed by the Company Law, which we understand to also include equity transfers.
- Round-trip investments
Pursuant to Circular 10, so-called “round-trip investments,” in which a Chinese domestic company or natural person transfers ownership in an affiliated Chinese company to an offshore company that is also owned or controlled by the transferor, are subject to approval by MOFCOM. To avoid the uncertainty of MOFCOM approval results, investors have made great efforts to structure their transaction in ways that do not trigger a round-trip investment approval requirement. So far as we know, no round-trip investment application has been filed since Circular 10 came into effect in September 2006.
Under FIL, only foreign investments in sectors included on the negative list are subject to approval by MOFCOM or its competent local counterpart. Supervision of round-trip investments and administration of the negative list are fundamentally different regulatory mandates. Hence, the legal basis that subjects round-trip investments to MOFCOM approval will be lost upon FIL’s implementation, especially if Circular 10 is repealed together with the Three FDI Laws. However, new regulations may be issued to reinstate MOFCOM’s authority to review and approve round-trip investments.
- Capital contribution in form of equity and share swaps
Under the Three FDI Laws, investors are only allowed to make capital contributions in the forms of cash, tangible property, intellectual property rights and other property rights. Equity that an investor holds in another entity is not one of the permitted forms of capital contribution. Hence, for many years until the Company Law was amended in 2005, foreign investors could not establish FIEs by making contributions of equity. This long-standing limitation materially increased the complication and cost of foreign investors’ corporate restructuring transactions in the PRC, and successful cases of foreign investment acquisitions structured as share swaps were also rare.
After the amendment of the Company Law in 2005, investors were allowed to make capital contributions of non-monetary properties that could be valued and transferred in accordance with applicable law, including equity interests. However, both the Administrative Provisions on Registration of Registered Capital of Companies and the Interim Provisions of Ministry of Commerce on Capital Contribution in the Form of Equity of Foreign Investment Enterprises only allow investors to make capital contribution of equity they hold in enterprises in China—but not equity interests or shares of enterprises outside China.
Circular 10, which was issued in 2006, further allows foreign investors to use the shares or equity interest of an overseas listed company or an overseas special-purpose vehicle as payment method to acquire shares or equity of domestic companies in China.
Recently, in July of 2018, MOFCOM issued a draft Amendment to the Administrative Measures on Strategic Investment, soliciting public comments. The draft provided that, subject to certain conditions, foreign investors may also strategically invest in a Chinese listed company by transferring equity they hold in overseas companies or by issuing new shares as means of payment.
With the repeal of the Three FDI Laws, there are no legal restrictions preventing foreign investors from making capital contribution in equity or conducting acquisition by means of share swaps. However, Circular 10 and the Administrative Provisions on Registration of Registered Capital of Companies are still the currently effective regulations. Whether cross-border share swaps will be liberalized is still unclear and pending clarification by the relevant authorities.
- Can Chinese natural persons establish FIEs with foreign investors?
The EJV Law and the CJV Law only allow foreign investors to set up EJVs and CJVs with Chinese companies, enterprises or other economic organizations, while Chinese natural persons are not allowed to establish new EJVs and CJVs with the foreign investors.
To facilitate foreign investors’ acquisitions of domestic enterprises established by Chinese natural persons, Circular 10 allows Chinese natural persons who are the shareholders of the target companies to remain as shareholders of the target company after the completion of the acquisition, even though upon completion of the transaction the target company has been converted from a domestic company into an FIE.
FIL does not clearly address this issue. Article 2 of FIL refers to “other investors”. However, FIL neither sets out the scope of “other investors”, nor does it exclude Chinese natural persons from the scope of “other investors”. It is unclear whether this should be interpreted permissively to imply that Chinese natural persons can also cooperate with foreign investors to establish new FIEs.
In accordance with Article 18 of the Constitution of the People’s Republic of China (Amended 2018), foreign investors are permitted to invest in Chinese enterprises and to enter into various forms of economic co-operation with other economic organizations. However, this provision does not mention Chinese natural persons either. Therefore, whether Chinese natural persons can establish new FIEs with foreign investors remains unclear.
One question relating to Chinese natural persons is whether the investments of a Chinese natural person who subsequently acquires foreign citizenship will become foreign investments because of the change in citizenship, and consequently subject to FIL. The 2015 Draft answered this question in the affirmative. However, the final published version of FIL does not include explicit provisions on this question. A literal reading of FIL suggests that the answer to the aforesaid question should be “yes,” because when a Chinese natural person acquires foreign citizenship they will no longer be a citizen of the PRC, but rather will become a “foreign natural person,” which is one of the types of foreign investor enumerated in Article 2 of FIL.
Another question relating to Chinese natural persons is whether an investment into China by an offshore entity that is controlled by a Chinese natural person constitutes a foreign investment. The 2015 Draft deemed such investment to be an investment by Chinese investors; but FIL adopts the “incorporation place” principle—whether an investment constitutes a foreign investment will generally be determined based on the place of incorporation (or nationality, in case of a natural person) of the investor.
- “Investment in new projects” needs further clarification.
In addition to new FIE investments and M&A investments, the scope of foreign investment stipulated in Article 2 of FIL includes “investment in new projects.” Further clarification is needed to answer the following questions: whether “investment in a new project” refers to an investment project that foreign investors carried out through contractual arrangement (such as natural resources exploration and exploitation concession agreement, infrastructure construction and operation concession agreement, etc.) and how to apply the foreign investment administration system (such as information reporting system, national security review system, etc.) to such new projects in practice.
- Five-year transitional period
FIL grants a five-year transitional period after the FIL Effective Date in which FIEs established pursuant to the Three FDI Laws prior to the effectiveness of FIL may keep their original organizational forms. However, it is not clear whether the joint venture contracts and articles of association of the existing FIEs will continue to be effective and enforceable during the transitional period, since the Three FDI Laws will be repealed upon the FIL Effective Date.
This question is relatively complicated and requires a clause-by-clause analysis. For example, some clauses in the joint venture contracts and articles of association will automatically become invalid due to the repeal of the Three FDI Laws, such as the unique terms in the Three FDI Laws that the joint venture contracts would come into effect only after the competent authority’s approval. These terms will not lead to disputes even without revision. However, other terms, such as the voting mechanism of the board of directors, may need to be negotiated between the parties when the joint venture contract is amended. Some provisions are mandatorily required under the Company Law, so a revision will be necessary; for example, FIEs will need to establish a shareholder meeting in compliance with the Company Law. Therefore, it will be necessary to amend the joint venture contract and articles of association to establish a shareholder meeting during the transitional period. Provisions that are not mandatorily required pursuant to the Company Law may be left to the discretion of shareholders, with no need to amend during the transitional period, even when there is inconsistency with the Company Law.
It is also unclear whether FIEs and the parties to joint ventures will need to revise existing joint venture contracts and articles of association during the five-year transitional period and go through the relevant approval and filing procedures. There is possibility that the parties may not reach an agreement with respect to some clauses. The consequences if the transitional period expires while the parties have not yet reached agreement, or have not gone through the relevant approval or filing procedures, are unclear. FIL does not have provisions to address these issues, which leaves uncertainty for the future. For example, after the expiration of the five-year transitional period, there may be circumstances where the registration authority refuses to handle the relevant change filing on the ground that the company’s articles of association do not comply with the provisions of the Company Law. In addition, a shareholder may claim that certain terms of the agreement are invalid on the basis that the equity interest transfer method as stipulated in the joint venture contracts and article of association does not comply with the provisions of the Company Law. In such circumstance, it is still unclear how a court or arbitration tribunal might apply the law.
- Amendment of joint venture contracts and articles of association, establishment of shareholder meetings, and the adjustment of the rules of the board of directors
For EJVs and CJVs in the form of limited liability companies, one significant feature in the corporate governance is that the board of directors is the highest authority which determines all major matters of the enterprise. Both the EJV Regulations and CJV Regulations have set forth a list of matters subject to the unanimous resolutions of the board of directors.
With the repeal of the Three FDI Laws, these provisions will become obsolete. Thereafter, pursuant to the Company Law, for any FIE in the form of a limited liability company, the shareholder meeting will be the highest authority, and the shareholder meeting and the board of directors will divide their responsibilities and authorities in accordance with the Company Law. The amendment of the company’s articles of association, increase or decrease of the registered capital, and the merger, division, dissolution or change of the company’s form will no longer be matters subject to unanimous resolutions of the board of directors, but will be subject to affirmative vote of shareholders representing no less than two-thirds of the total voting power participating in a shareholders meeting. In addition, the Three FDI Laws and the Company Law also have inconsistencies regarding the number of board members, terms of office, the quorum required for board meetings, and appointment of directors, and the Company Law provisions will govern after FIL comes into effect.
Due to the substantive differences between the Three FDI Laws and the Company Law in respect of corporate governance, it is foreseeable that investors will start a new round of negotiations on corporate governance and related business terms in conjunction with amending the joint venture contracts and articles of associations of their EJVs and CJVs in accordance with the Company Law.
- The transitional period between the release day and effective day
As discussed in Sections 12 and 13 above, existing FIEs will need to amend joint venture contracts and articles of association in anticipation of the phase-out of the Three FDI Laws. FIL will come into force on January 1, 2020. During the period from March 15, 2019 through January 1, 2020 (the “Pre-Effective Transitional Period”), foreign investment will continue to be subject to the Three FDI Laws. However, existing EJVs and CJVs may wish to amend their joint venture contracts and articles of association as soon as possible, so that they are not caught unprepared on January 1 of next year. Whether FIL and the Company Law could directly apply to such amendments made during the Pre-Effective Transitional Period is a question pending clarification by the regulatory authorities.
- Investment by Hong Kong, Macao and Taiwan investors
Under the current foreign investment legal regime, investment by Hong Kong, Macao and Taiwan investors are administrated with reference to the relevant provisions of the Three FDI Laws.
However, Hong Kong, Macao and Taiwan investors do not fall within the scope of “foreign investors” under FIL, and FIL does not contain provisions about investment from Hong Kong, Macao and Taiwan. Whether investments from Hong Kong, Macao and Taiwan will be administered with reference to the provisions of FIL is pending clarification by the State Council and MOFCOM.
- Sorting out and adjusting existing foreign investment laws and regulations and special policies
FIL clearly specifies that the Three FDI Laws will be repealed upon FIL taking effect. However, it is silent about the validity of other administrative regulations, departmental rules and normative documents (the “Existing Foreign Investment Regulations“) which were formulated based on the Three FDI Laws. New or revised regulations and repeal of obsolete Existing Foreign Investment Regulations in the areas of development and reform, industry and commerce, foreign exchange and finance and taxation should all be top priorities.
In addition, various rules, measures and policies have been issued to regulate various aspects of FIEs’ operations, including: (i) re-investment by FIEs inside China; (ii) total investment, registered capital and foreign debt limits for FIEs; (iii) foreign-invested investment companies and foreign-invested start-up enterprises; and (iv) merger and acquisition under Circular 10 and the Administrative Measures on Strategic Investment, among others. Further clarification is needed to sort out and revise these measures and policies to conform to FIL.
SECTION III. Conclusion
The reform of the foreign investment administration regime is a project of great systematic significance. Now that FIL has been formally enacted, we recommend that foreign investors should pay close attention to the relevant provisions of FIL and the upcoming implementation regulations and measures, and monitor further revision and amendment of the Existing Foreign Investment Regulations. Existing FIEs should adjust their charter documents, organizational forms, corporate structures and other matters in a timely manner accordingly. We look forward to assisting our foreign investor clients actively seize the greater investment opportunities that will soon be possible in China under this new, more equitable legal framework.
Authors: Kaiding Wang (王开定), Jian Zeng (曾坚), Bing Chen (陈兵), Xiaopeng Feng (冯晓鹏), Zhen Zhao (赵臻), Yuanyuan (Yvonne) Cheng (程圆圆), He Huang (黄荷), Mengting Huang (黄梦婷), Siying Huang (黄思颖), Linfei Hou (侯林菲), Dongjing Wei (魏冬京)