Debby Yu
To boost the confidence of foreign investors in their investment in China, the 13th National People’s Congress of China promulgated on March 15, 2019 the Foreign Investment Law of the People’s Republic of China (hereinafter, the “Foreign Investment Law” or the “Law”), which will come into force on January 1, 2020, when the “three foreign investment laws,” which have been implemented for over 30 years (namely, the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures, the Law of the People’s Republic of China on Wholly Foreign-owned Enterprises, and the Law of the People’s Republic of China on Sino-Foreign Cooperative Joint Ventures), will be repealed and the Foreign Investment Law will take their place as the fundamental law that regulates foreign investment in China. However, the Foreign Investment Law merely serves as a regulatory framework. To implement this law, the Ministry of Justice released the Implementation Regulations for the Foreign Investment Law of the People’s Republic of China (Draft for Solicitation of Public Opinions)[1] on November 1, 2019 (hereinafter, the “Draft”) to serve as accommodating administrative regulations for the Foreign Investment Law. This change of law will have an impact on foreign businesses investing in China. It is advisable for foreign investors to understand the situation and think about potential coping measures as soon as possible. In this essay, the Foreign Investment Law and the Draft are initially summarized along with relevant explanation in order to be helpful.
Highlights of the Foreign Investment Law The Foreign Investment Law consists of six chapters (the “General Provisions,” “Investment Promotion,” “Investment Protection,” “Investment Administration,” “Legal Liabilities” and “Supplemental Provisions”) and has a total of 42 articles. The Foreign Investment Law is highlighted below:
1. The so-called “foreign investment” means the direct or indirect investment within the territories of China, including new establishment of foreign-invested enterprises, acquisition of equity in enterprises within the territories of China (i.e., mergers and acquisitions), new construction projects and other manners of investment (Article 2 of the Investment).
2. Pre-establishment national treatment and the negative listing administrative system will be implemented, and the original administrative model involving case-by-case approvals will be abolished. As a result, national treatment will be afforded to foreign investments outside of the negative list, which will specifically point out the areas where foreign investment is prohibited and restricted (Article 4 of the Law).
3. With respect to investment promotion, foreign-invested enterprises (hereinafter, the “FIEs”) will be allowed to equally enjoy all kinds of state policies that support the development of enterprises; the opinions and recommendations of the FIEs should be heard when laws and regulations relating to foreign investment are being formulated; the FIEs’ fair participation in government procurement should be guaranteed; the FIEs should be allowed to conduct financing via public offering of stocks or corporate bonds; and local governments will be allowed to formulate investment promotion and facilitation policy measures to attract foreign investment (Articles 9, 10, 16, 17 and 18 of the Law).
4. With respect to investment protection, unless it is otherwise specifically stipulated by law with the payment of fair compensation, foreign investors’ investment will not be subject to expropriation; a foreign investor’s capital contribution, profits, capital gains, and proceeds from the disposal of assets in China may be inward and outward remitted freely; strict legal liabilities will be pursued in order to protect intellectual property rights; technical cooperation should be negotiated on an equal footing under the principle of fairness and technology transfers shall not be compelled by administrative means; administrative agencies and their staff shall not disclose trade secrets; all levels of local people’s governments and relevant departments are required to fulfill their policy commitments to the FIEs and perform all kinds of contracts, or compensation shall be provided; and complaint mechanisms will be set up where the FIEs may apply for assistance with a mediation solution or bring administrative actions (Articles 20, 21, 22, 23, 25 and 26 of the Law).
5. With respect to investment administration, foreign investors shall not invest in areas prohibited from investment, foreign investors seeking to invest in areas with investment restrictions are required to meet the negative list conditions, and areas outside the negative list shall be subject to administration conducted under the principle of equal treatment to domestic and foreign-invested enterprises; the organizational format and organizational body of foreign invested enterprises should be governed by laws such as the Company Law and the Partnership Enterprise Law of China; the acquisition of Chinese domestic enterprises or participation in management concentration in other manners by the FIEs should be subject to government review in accordance with the Anti-monopoly Law; an information reporting system will be established where investment information should be submitted and delivered via a designated registration and public disclosure system; and a safety review system should be set up, and the decision on the safety review should be final (Articles 28, 31, 33, 34 and 35 of the Law).
6. With respect to legal liabilities, legal liabilities should be specifically imposed on the staff of administrative agencies for behavior such as abuse of their authority, favoritism and irregularities or disclosure of trade secrets. Not only will administrative punishment be imposed pursuant to law, but also criminal liabilities may even be pursued (Article 39 of the Law).
7. With respect to the supplemental provisions, discriminatory measures are specifically prohibited. To wit, if any country or area adopts discriminatory prohibitions, restrictions or similar measures against investment from China, corresponding measures may be adopted with respect to such country or area based on actual circumstances. After the three foreign investment laws are repealed, foreign-invested enterprises which have been established may continue with their original corporate organizational format within five years after the effective date of the Law (Articles 40 and 42 of the Law).
Highlights of the Draft To ensure effective implementation of the Foreign Investment Law, the Ministry of Justice drafted the Implementation Regulations of the Foreign Investment Law of the People’s Republic of China (Draft for Solicitation of Public Opinions) (hereinafter, the “Draft”) in conjunction with the authorities such as the Ministry of Commerce and the National Development and Reform Commission and provided relevant explanation.[2] The following highlights are provided in comparison with the contents of the above Foreign Investment Law as follows:
1. Foreign investors may invest within the territories of China on their own or with other investors including “Chinese natural persons” (Article 3 of the Draft).
In judicial practice, issues pertaining to the application of law may arise after the nationality of an investor is changed. Currently, as more and more citizens of China have emigrated overseas and lost their Chinese nationality due to their acquisition of foreign nationality, the issue of whether the Foreign Investment Law applies, after they acquire foreign nationality, to enterprises which have been invested within the territories of China by China’s citizens before their Chinese nationality is changed is not mentioned in the Draft. Likewise, for natural persons who obtain the Chinese nationality by relinquishing their foreign nationality, the issue of whether the Foreign Investment Law still applies, after they obtain the Chinese nationality, to enterprises invested by them within the territories of China before they obtain the Chinese nationality is also not mentioned in the Draft.[3] Some also believe that the Foreign Investment Law bases the determination of a foreign investor on the place of establishment and registration of the foreign enterprise without exception.[4]
2. The so-called newly constructed projects invested within the territories of China refer to investment in the construction of specific projects within the territories of China by foreign investors without establishing foreign-invested enterprises and without acquiring shares, equity, property shares or other similar equity of enterprises within the territories of China (Article 4 of the Draft).
The Draft provides an explanation about the new construction investment projects under Article 2, Paragraph 2, Subparagraph 3 of the Foreign Investment Law. Therefore, it seems that new construction projects are limited to investment projects under contractual relations. However, commentators believe that since there is no specific relevant provision, this may raise the concern about a lack of legal basis in practice.[5] In addition, if there is no clear regulation concerning the specific layer of indirect investment in enterprises invested by the FIEs and investment conducted by all levels of the FIEs’ subsidiaries, the FIEs may evade the negative list control in this fashion. Recently, there have been heated discussions about piercing review and regulation. Some believe the concept that reinvestment in the territories of China by foreign-invested enterprises should be included in foreign investment should be universally governed by regulatory requirements here.[6] As for whether investment by the FIEs in the structure of a VIE agreement is consistent with the fundamental provisions concerning other types of investment, the Draft is silent about this aspect.
3. With respect to investment promotion, it is required that the formulation of laws, regulations, rules, and normative documents concerning foreign investment should be preconditioned by the solicitation of opinions from foreign-invested enterprises and foreign chambers of commerce and should not be relied on as the basis of foreign investment administration without being promulgated pursuant to law. In addition, a catalogue of industries encouraged for foreign investment should be formulated to encourage and guide investment in specific industries, domains and areas by foreign investors and foreign-invested enterprises; foreign investors are encouraged to expand their investment within the territories of China by using their investment gains generated from the territories of China; the FIEs shall participate in standards setting tasks on an equal footing, be equally governed by compulsory standards, and equally participate in government procurement activities; and foreign investment guides should be formulated (Articles 10, 13, 14, 15, 16, 17 and 21 of the Draft).
4. With respect to investment protection, a punitive compensation system for infringement upon intellectual property rights will be established; normative documents involving foreign investment should be subject to legality review and fair competition examination; policy commitments should be provided in writing; all levels of local people’s governments and relevant departments shall not change their policy commitments or contractual stipulations unless for the sake of national interest and social or public interest and shall not breach or rescind any agreement on the ground of delineating or adjusting administrative zones, change of government, adjustment of agencies or functions or replacement of relevant responsible persons; and a guide for lodging complaints should be formulated, and the components of the complaint mechanism, the leading unit, main responsibilities, work rules, complaint channels and the complaint guide should be announced to the society (Articles 24, 27, 28, 29 and 31 of the Draft).
The National Development and Reform Commission and the Ministry of Commerce promulgated on June 30, 2019 the Catalogue for Industries for Encouraging Foreign Investment (2019 Version), which went into effect on July 30, 2019.[7]
5. With respect to investment administration, the voting right percentages enjoyed by foreign investors under the partnership agreement on a foreign-invested partnership set up in the negative list areas for foreign investment shall meet the restrictive provision on shareholding under the negative list; investment in the territories of China by wholly-owned enterprises set up outside of China by natural persons, legal persons or other organizations may be free from the restriction on the relevant special regulatory measures under the negative list for foreign investment; the review mechanism for areas restricted from foreign investment in the negative list for foreign investors stipulates that market regulatory and administrative departments are required to examine if the foreign investment meets restrictive requirements such as shareholding and high-level managerial officers under the negative list; if the review has been conducted by the relevant department pursuant to law when relevant formalities are handled, no repetitive review will be conducted; and the principle that the burden on foreign investors and foreign-invested enterprises should be reduced as much as possible is established with respect to the reporting of foreign investment information (Articles 34, 35, 38 and 40 of the Draft).
Since the launch of the pilot of the “negative list for market access” in 2016, the length of the negative list has sharply shortened from 190 items to 48 items. Moreover, Premier Li Keqian remarked that market access for finance, culture, energy, telecommunications, education, medicine and cloud computing would be further liberalized by June 2019. Obviously, the Chinese government is very proactive in carrying out such measure.[8] On June 30, 2019, the National Development and Reform Commission and the Ministry of Commerce promulgated the Special Administrative Measures for the Access of Foreign Investment (Negative List) (2019 Version) and the Special Administrative Measures for the Access of Foreign Investment to Pilot Free Trade Zones (Negative List) (2019 Version), which went into effect on July 30, 2019.[9] The provisions of the former were reduced from the previous 48 articles to 40 articles, while the provisions of the latter were compressed from the original 45 articles to 37 articles. The eased or removed foreign investment restrictions primarily pertain to seven areas, including transportation, infrastructure, culture, value-added telecommunications, agriculture, mining and manufacturing.[10]
6. With respect to the arrangements for the transitional period, the Draft specifically provides that in case of inconsistency between the organizational format and organizational body of existing foreign-invested enterprises and the mandatory requirements under laws such as the Company Law and the Partnership Enterprise Law, the state encourages completion of the change formalities pursuant to law within five years after the effective date of the Foreign Investment Law. In case of failure to complete the change formalities within such period pursuant to law, the change formalities shall be completed pursuant to law within six months after January 1, 2025; and failure to do so within such period will cause the corporate registration agencies not to process other registration matters of such enterprise with the relevant circumstances publicly disclosed in the enterprise information disclosure system. The existing methods for sharing profits and distributing residual property which are contractually agreed among joint venture and cooperating parties to foreign-invested enterprises may be continuously followed pursuant to their agreements within the term of the joint venture or cooperation (Articles 42 and 43 of the Draft).
In this regard, certain provisions in joint venture agreements and articles of association involving the FIEs are mandatory provisions under the Company Law. For instance, with respect to the establishment of shareholders’ meetings, the FIEs are required to revise joint venture/cooperation agreements and articles of association and to set up shareholders’ meetings within the transitional period. The contents of the adjustments should include provisions[11] concerning additional authority of the shareholders’ meetings and voting methods and adjustment to the authority of the board of directors and voting methods with such adjustments and registration completed pursuant to the Law within the 5-year transitional period. The Draft also provides an additional grace period of six months, and violations will be publicly disclosed in the system in case of failure to comply.
7. With respect to the application of law to investment from Taiwan, this Law does not specifically stipulate if investment from Hong Kong, Macau or Taiwan will be included, resulting in considerable speculation. However, the Draft has specifically provided that the Law on the Protection of Investments by Taiwan Compatriots and its implementation regulations shall apply to investments in mainland China by Taiwan investors, and matters not stipulated shall be dealt with in reference to the Foreign Investment Law and the Implementation Regulations (Article 44 of the Draft).
This Law has relatively less impact on Taiwanese investors adopting the business model of sole proprietorship and more impact on Taiwanese investors adopting the corporate format of Sino-foreign equity joint ventures and Sino-foreign cooperative joint ventures, which will be required under the new law to adjust their organizational format and organizational body. Take Sino-foreign equity joint ventures for example. Their supreme power organ will be the shareholders’ meeting rather than the board of directors. In addition, with respect to Sino-foreign cooperative joint ventures, non-legal-person cooperative joint ventures should be transformed into limited companies or foreign-invested partnerships. The supreme power organ of a Sino-foreign cooperative joint venture will no longer be the board of directors or joint management committee and will be governed exclusively by relevant provisions of the Company Law or the Partnership Enterprise Law.
According to the Survey on the Operating Status of Overseas Invested Enterprises conducted by the Investment Commission during 2008~2014, the major model of business operation in mainland China as employed by Taiwanese consists of sole proprietorship, which accounts for around 80%, and equity joint venture or cooperative joint venture, which accounts for 20%. Therefore, within five years after the effective date of the Foreign Investment Law, 20% of the Taiwanese enterprises will need to change their organizational format and organizational body in accordance with the Company Law and the Partnership Enterprise Law.[12]
8. Relevant regulations, namely the Implementation Regulations for the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures, the Interim Provisions on the Duration of Joint Operation of Sino-foreign Equity Joint Ventures, the Implementation Regulation for the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures and the Implementation Regulation for the Law of the People’s Republic of China on the Sino-foreign Cooperative Joint Ventures will be repealed at the same time (Article 45 of the Draft).
Conclusions On December 26, 2018, the National People’s Congress released the Foreign Investment Law (Draft), which was shortly adopted on March 15, 2019 with its effective date on January 1 of the following year. The rapid adoption of the Foreign Investment Law in a few months is generally interpreted as a response to the China-US trade war to reduce the US’s pressure on China and to demonstrate China’s liberalization resolution by expanding the scale of liberalization and specifically restricting administrative agencies from interfering with the FIEs’ compulsory technology transfers. However, although the draft Foreign Investment Law of 2015 is different from the Law only by one Chinese character in its Chinese name, still the contents are greatly reduced from the 170 articles of the 2015 version to 42 articles[13] with the accommodating measures yet to be formulated.
There have been relevant accommodating measures for certain articles such as articles relating to the negative list, specifically pointing out that a competent authority’s deliberate delay of application approval should be prevented and stipulating that competent authorities shall not disclose any trade secret of the FIEs and that the use of administrative means to compel technology transfers is prohibited. Such measures are recognized by commentators. However, anti-discriminatory provisions allow China to retaliate against countries that take discriminative measures against China’s enterprises. This will create a factor of uncertainty in the relations between China and the FIEs. As for the safety review mechanism and the implementation of the information reporting system, there has been no specific regulation. As a result, the FIEs may be concerned that this may result in unnecessary political risks and information security risks for enterprises.[14]
Currently, the Implementation Regulations are released in the form of a solicitation of public opinions, and the solicitation of public opinions will stop on December 1. The official version of the Implementation Regulations will be promulgated in near future so that they may go into effect concurrently with the Foreign Investment Law on January 1, 2020. The subsequent legislative progress is worthy of our close attention with an observation of relevant judicial practices in order to provide compliance reference for the foreign businesses seeking to invest in mainland China.
[1] http://www.moj.gov.cn/news/content/2019-11/01/zlk_3235065.html
[2] http://www.moj.gov.cn/news/content/2019-11/01/zlk_3235066.html
[3] Jun He Law Offices, Brief Commentaries on the Implementation Regulations for the Foreign Investment Law (Draft for Solicitation of Public Opinions), November 2, 2019
[4] King & Wood Mallesons, Entering the Era of the Foreign Investment Law – Practical Changes and Challenges for the Foreign Investment Law, March 5, 2019.
[5] Same as Note 3.
[6] Jun He Law Offices, Testing the Temperature of Water Subtly – Prelude for VIE Regulation? November 3, 2019
[7] http://www.ndrc.gov.cn/zcfb/zcfbl/201906/t20190628_940276.html
[8] Kuo-chen Wang, Potential Impact of the Foreign Investment Law of Mainland China, China Economic Research Institute, May 2019, P70
[9] http://www.ndrc.gov.cn/zcfb/zcfbl/201906/t20190628_940274.html
http://www.ndrc.gov.cn/zcfb/zcfbl/201906/t20190628_940275.html
[10] http://www.xinhuanet.com/fortune/2019-06/30/c_1124690509.htm
[11] Same as Note 4
[12] Hui-hsin Yen, Potential Impact of the New Foreign Investment Law of Mainland China on Taiwanese Businesses, Straits Exchange Foundation
[13] Same as Note 11
[14] Same as Note 7