Adjustments to the Governance Structure of Sino-foreign Equity Joint Ventures to be noted after the Implementation of the Foreign Investment Law (Mainland China)

Teresa Huang and Joyce Wen[1]

The year 2020 is a year of significant reform for foreign investors who have already invested or plan to invest in China.  The Foreign Investment Law of the People’s Republic of China (hereinafter, the “Foreign Investment Law”) and the Regulations for the Implementation of the Foreign Investment Law of the People’s Republic of China (hereinafter, the “Implementation Regulations”) came into effect on 1 January 2020.  The Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures (hereinafter, the “EJV Law”), the Law of the People’s Republic of China on Sino-foreign Cooperative Joint Ventures (hereinafter, the “CJV Law”) and the Law of the People’s Republic of China on Foreign-funded Enterprises (hereinafter, the “FFE Law”) (hereinafter collectively, the “Three Foreign Investment Laws”) were also repealed at the same time.  The legal regime of foreign investment in China has entered a whole new era of the Foreign Investment Laws from the era of the Three Foreign Investment Laws, which resembled a troika, operated in parallel to one another, and which most people were previously familiar with.

Pursuant to the Foreign Investment Law, the provisions of the Company Law of the People’s Republic of China (hereinafter, the “Company Law”) and the Partnership Enterprise Law of the People’s Republic of China will be uniformly applied to the organizational form, organization and activity guidelines of foreign-invested enterprises.  Among the original three types of foreign-invested enterprises, the corporate governance structure of foreign-invested enterprises (including foreign joint ventures and wholly foreign-owned limited liability companies) is hardly affected by the implementation of the Foreign Investment Law, since the corporate governance structure was required by the government to comply with the provisions of the Company Law in 2006.  In addition, the number of Sino-foreign equity joint ventures in practice is much larger than that of Sino-foreign cooperative joint ventures.  Therefore, this article mainly focuses on sorting out the impact of the Foreign Investment Law and its Implementation Regulations on Sino-foreign equity joint ventures and the matters that should be noted for adjusting their governance structure.

I. Differences in the relevant provisions concerning limited liability companies under the EJV Law and the Company Law.

There are many differences between the EJV Law and the Company Law in terms of the governance rules, the operating rules, and similar matters of limited liability companies.  Important differences in the provisions can be found in the following table.

II. Matters to be noted when the existing governance rules and operating rules for Sino-foreign equity joint ventures are adjusted in accordance with the law

1. It is recommended that the existing authority of the board of directors be retained to the greatest extent possible under the articles of association. In order to comply with the provisions of the Company Law, the articles of association of a company shall be amended so that the supreme power organ is the shareholders’ meeting, and the authority of the newly established shareholders’ meeting and board of directors shall be determined in accordance with the provisions of the Company Law.  Except for the exclusive authority of the shareholders’ meeting under the Company Law, the remaining authority may be vested in the board of directors on the basis of consultation among the parties.  However, if the authority of the original board of directors can be maintained to the greatest extent possible, major adjustments to the existing governance structure of the company can be avoided as much as possible on one hand, and shareholders may be prompted to reach a consensus on amendments to the articles of association on the other hand.

2. Depending on the position of the shareholders, consideration could be given to specifying in the articles of association the veto power of particular shareholders. Major matters of the company, such as amendments to the articles of association, increase or decrease of the registered capital, corporate mergers, separation, dissolution or change to the form of the company, shall currently be approved by shareholders representing more than two thirds of the voting rights, in contrast to the requirement of unanimous consent of all the directors present in the past.  This will have a greater impact on the interest of minority shareholders who have appointed directors in the original Sino-foreign equity joint venture.  Therefore, from the perspective of protecting the interest of minority shareholders, it seems that consideration may be given to specifying in the articles of association that the above-mentioned shareholders represented by more than two-thirds of the voting rights should include a particular shareholder whose consent is required.  To wit, particular shareholders have a veto right over certain important matters.

3. It is recommended that the shareholders with the right to nominate directors and the number of directors to be nominated by each shareholder be specified in the articles of association in order to ensure, to the greatest extent possible, that the composition of the board of directors is consistent with the outcome of the original consultation among the shareholders. Pursuant to the relevant provisions of the EJV Law, the shareholders of a Sino-foreign equity joint venture may directly appoint directors of the company as long as there is a consensus, and may also allocate the number of directors not in proportion to their capital contributions.  In practice, therefore, the shareholders of a Sino-foreign equity joint venture, even with a relatively small shareholding, can achieve full control over the board of directors of the company.  For example, when an overseas private equity fund (PE) injects capital into a domestic company, even if the registered proportion of capital so contributed is low, the PE will usually ask for a certain proportion of board seats during negotiations due to the substantial amount of the actual investment.  Under the Company Law, the directors of a company are elected by the shareholders’ meeting and there is no specific provision concerning the allocation of directorships.  Therefore, it is proposed to amend the articles of association to specifically stipulate the shareholders who have the right to nominate directors and the number of directors to be nominated by each shareholder in order to ensure, to the maximum extent possible, that the candidates nominated by each shareholder can be elected directors of the company in the shareholders’ meeting so as to ensure the original allocation of directorships.

4. Whether natural person shareholders of the Chinese nationality are to be introduced may be considered based on the circumstances.  During the era of the Three Foreign Investment Laws, the EJV Law and the CJV Law did not allow domestic natural persons to enter into equity or cooperative joint ventures with foreign investors.  After the Foreign Investment Law and the Implementation Regulations are implemented, the investment entities on the Chinese side specifically include Chinese natural persons.  Therefore, enterprises may consider whether to introduce Chinese natural person shareholders according to their own circumstances.

5. The articles of association may be optionally amended by the enterprises according to their own business development Article 46 of the Implementation Regulations stipulates that after the organizational form and structure of existing foreign-invested enterprises are adjusted in accordance with law, the methods of transfer of equity or interest, distribution of proceeds and distribution of surplus property stipulated in the contract between the former equity or cooperative joint venture parties may continue to be in force in accordance with the contract.  Therefore, with respect to equity transfer, profit distribution, surplus property distribution, a Sino-foreign equity joint venture can consider whether the original form needs to be modified from a commercial perspective.

6. Attention should be paid to the deadline under the transition period. The Foreign Investment Law and its Implementation Regulations provide that during January 1, 2020 through December 31, 2024, a foreign-invested enterprise may adjust its organizational form and organization in accordance with the provisions of laws such as the Company Law and the Partnership Enterprise Law of the People’s Republic of China and register changes in accordance with law, or it may continue to retain its original organizational form and organization.  Beginning with January 1, 2025, for existing foreign-invested enterprises that have not adjusted their organizational form, organization, etc. and changed their registration in accordance with law, the market supervision and management department will not process their applications for other registration matters, and the relevant circumstances will be made public.  Therefore, it is still recommended that enterprises should be prepared and engage in consultation and negotiation as soon as possible.

The Foreign Investment Law has reshaped the legal regime of foreign investment, and according to the above proposal, the change in the governance rules for Sino-foreign equity joint ventures will certainly lead to a new round of negotiations between Chinese and foreign shareholders.  And in the course of such negotiation, the most important thing for individual shareholders is to first weigh and clarify their own position, i.e., whether they are majority shareholders holding the majority of shares or minority shareholders with a relative small shareholding.  Both parties will have different bargaining power and different positions on changes to the governance rules based on their shareholding status.  To avoid the weakening or deprivation of the original powers/rights, it is recommended that the relevant enterprises and their cooperation partners should be prepared and negotiate as early as possible to maximize the protection of their own rights and interests.

[1] The authors are lawyers at  Shanghai  Lee, Tsai & Partners.  However, the contents of this article merely reflect personal opinions and do not represent the position of this law firm.