On March 15, 2019, China adopted the Foreign Investment Law (外商投资法), which will come into effect on January 1, 2020. The new law intends to promote foreign investment in China by offering greater transparency, a simpler regulatory and administrative regime, and equal treatment for foreign and domestic investors.

Background

An overhaul of China’s increasingly unwieldy foreign investment laws and regulations was first proposed in January 2015 to facilitate and protect foreign investments and create a more stable, transparent, and predictable investment environment. But the legislative process stalled after many revisions, and the proposal was shelved until December 2018, when the U.S./China trade conflict reignited the need to address concerns raised by foreign governments and businesses, such as IP protection, equal market access, and investment protection. A heavily revised proposal with many detailed provisions removed was then fast-tracked and adopted by the National People’s Congress less than three months later as the new Foreign Investment Law. This new law establishes the framework and direction for China’s future investment environment, but only the release of detailed implementation regulations in the coming months and years will reveal the full impact of this new law.

Replaces Existing Laws

To achieve “equal treatment” between foreign and domestic investors, the current legal regime that contains multiple restrictions and disparate treatments of foreign investments will be overhauled. The current laws governing equity joint ventures, cooperative join ventures, and wholly foreign-owned enterprises will be annulled and replaced by the new Foreign Investment Law starting next year while additional rules and regulations will be updated through the detailed implementation regulations.

The annulment of the current laws governing equity joint ventures, cooperative join ventures, and wholly foreign-owned enterprises means foreign investments will, by default, be governed by China’s Company Law (公司法) and Partnership Law (合伙企业法), which would now apply to both foreign- and domestic-invested companies alike. We expect the effects to include:

  • equity joint ventures will be allowed to distribute dividends to investors in amounts that are disproportional to their equity interests;
  • various minority investor protection provisions that are common in the U.S. will be allowed to be included in transaction documents;
  • capital contribution using equity interests in another company and share swaps relating to foreign-invested companies may become available;
  • “round-trip” acquisitions may no longer be subject to government approval;
  • “simplified” versions of transaction documents solely for government approval may no longer be needed; and
  • perhaps the equity purchase agreements, capital increase/share subscription agreements, and asset purchase agreements for the acquisition of a Chinese company by a foreign investor may no longer be required to be governed by Chinese law.

Relaxes Entry Restrictions

In addition to providing equal treatment for foreign investments, the new law also relaxes existing entry barriers by affirming the use of a negative list (负面清单) for foreign investments, so that any foreign investment in businesses not explicitly identified as being “restricted” or “prohibited” on the negative list will be treated the same as a domestic investment and not be subject to entry restriction.

The negative list was first published in June 2018 to clearly identify the industries that are restricted or prohibited to foreign investments, so that all other industries that are not identified by the negative list would be open to foreign investment without the need for additional government approval. This list has been shortened (made less restrictive) in the last nine months, with further relaxations expected under the new government policy to remove additional entry barriers for foreign investments.

Previously, the negative list was at times only used as a guideline by the administrative authorities, and approvals were still oftentimes subjective, with arbitrary restrictions in industries that are not identified by the list. Now that the new Foreign Investment Law formalizes the use of the negative list and affirms the equal status of foreign investors and domestic investors alike for investments in industries that are not identified by the negative list, we expect such restrictions to be lifted by the Chinese government.

Refrains from VIE Structure

The new law does not specifically address the treatment of the VIE structure that is commonly used in industries identified by the negative list. Instead of using an “actual control” approach with respect to VIEs that was in the 2015 draft, the final version of the Foreign Investment Law removed language related to VIE, which we believe to be a result of the difference of opinions among various governmental authorities and market players towards VIEs in China.

Offers Greater Protection and Equal Treatment

Issue

New Approach

IP Protection

Protection of the foreign investors’ IP rights includes prohibition from using administrative means to force technology transfers.

Protection of Business Secrets

Government authorities and officials are required to keep the foreign investors’ business secrets in strict confidence.

Government Covenant

Local governments are required to honor promises offered and contracts made. If any amendments to such promises and contracts are made for national interest or social interest, the foreign investors must be indemnified.

Government Expropriation

Expropriation is banned, except those required by the public interest, in which case legal procedures should be followed with fair and reasonable compensation.

Authority of Local Government

The scope of relevant local government regulations is limited, and they may not interfere with or adversely affect the regular operations of foreign-invested entities.

Feedback and Complaint Channels

Appropriate channels for foreign investors to address non-compliance with the New Law will be created.

Capital Flow Restrictions

Foreign investors may freely transfer their capital contributions, profits, capital gains, royalties, liquidation, and asset disposal proceeds in and out of China.

Government Policies and Procurement

Equal treatment for foreign-invested enterprises in accessing government developmental policies and procurement policies.

Changes Corporate Governance Structure for Equity Joint Ventures

Substantial changes in the corporate governance structure of joint ventures in China will be required under the new law. While we believe these changes will alleviate some of the existing inconsistencies caused by a mixed set of corporate governance requirements under the existing laws, the increased flexibility and wider scope may lead to relatively more challenging negotiations between joint venture partners. The new law provides for a five-year transition period for joint ventures formed under the existing laws to switch to the corporate governance structure under the existing Company Law.

Issue

Rules applicable until Dec.31, 2019

Rules applicable from Jan. 1, 2020

Highest Governing Authority

Board of directors.

Shareholders.

Board of Directors

A board with the Chairman appointed by either the foreign or domestic investor and the Vice Chairman appointed by the other.

Sole executive director is allowed; no restriction on having Chinese/foreign investor’s appointee on the board.

Management

General manager appointed by either the foreign or domestic investor and vice general manager appointed by the other.

No requirement to have domestic or foreign investor’s appointee in the management team.

Legal Representative

Must be the Chairman of the board.

Can be the Chairman of the board, an executive director, or the general manager.

Special Resolutions

Unanimous approval of the board is required for the following matters:

- amendment to articles of association

Equity Transfer

Approval by all shareholders.

No restrictions on transfer between shareholders and transfers to third parties are required be approved by at least half of other shareholders.

Establishes New Reporting and Security Review Systems

The new law promulgates two additional management systems for foreign-invested companies. The new “reporting system” (外商投资信息报告制度) aims to streamline the multiple bureaucracies in the current system while the new “national security review system” (外商投资安全审查制度) establishes a vetting process for investments that may affect China’s national security. Both of these systems are reaffirmations of existing regimes by law based on existing regulations.

Leaves Many Details to the Future

The new Foreign Investment Law is a move in the right direction to create the long-promised accessible, law-based, and business-oriented investment environment in China. But similar to most other new laws adopted in China, the important details are left to the implementation rules and how those implementation rules will be enforced. At this point in time, the old adage of “only time will tell” is an appropriate summation of the current foreign investment regime in China.