On 15 March 2019, the National People’s Congress of the People's Republic of China (the “PRC”) promulgated the PRC Foreign Investment Law (the “FIL”). The FIL will come into effect on 1 January 2020.
The FIL has altogether six chapters, i.e. general provisions, investment protection, investment promotion, investment management, legal liability and supplementary provisions, with in total 42 articles. The key issues of the FIL are national treatment of foreign investment and the negative list for foreign investment. The FIL also focuses on the promotion and protection of foreign investment and provides general principles of a foreign investment management system such as an information reporting system and a security review system.
To give you an overview of the FIL, we summarize its main content and highlights as below:
1. Replacement of the FIE Laws (defined as below)
According to Article 42 of the FIL, it will replace the existing special laws and regulations on foreign-invested enterprises (“FIEs”), i.e. especially, the PRC Sino-foreign Equity Joint Ventures Law, the PRC Wholly Foreign-owned Enterprises Law and the PRC Sino-foreign Cooperative Joint Ventures Law and their respective Implementing Rules (collectively the “FIE Laws”). After entry into effect of the FIL, the FIE Laws shall simultaneously be abolished, and the FIL shall become the main legal basis for foreign investments in the PRC. Existing FIEs shall then have a grace period of five years during which they may retain their original organizational form before they must adapt to the new legal requirements.
In addition, according to Article 31 of the FIL, the organization form, institutional framework and standard of conduct of a foreign-invested enterprise shall be subject to the provisions of the PRC Company Law, the PRC Partnership Enterprise Law, and other laws.
Therefore, the organization form, institutional framework and standard of conduct of the existing FIEs, which are not consistent with the PRC Company Law or the PRC Partnership Law, shall be changed respectively within five years after the FIL comes into effect. This will have considerable impact on FIEs, especially Sino-foreign Equity Joint Ventures (“EJVs”) and Sino-foreign Cooperative Joint Ventures (“CJVs”). For example, for CJVs, which are not legal persons, the organization form shall be changed into a partnership or a company. For all the EJVs and CJVs in the form of a limited liability company, the Articles of Association shall be amended to be in accordance with the PRC Company Law, which will bring many corporate changes, e.g. the highest authority shall be changed from the board of directors into the shareholders’ meeting.
2. Pre-establishment National Treatment and Negative List Administrative System
Article 4 of the FIL provides that the State shall implement a Pre-establishment National Treatment and Negative List Administrative System for foreign investment. The State shall give national treatment to foreign investments which do not fall into the negative list.
According to Article 28 of the FIL, a foreign investor shall not invest in any sectors in which foreign investment is forbidden by the negative list. A foreign investor shall meet the investment conditions stipulated under the negative list for any sector restricted by the negative list. For sectors which are not mentioned in the negative list, management shall be conducted under the principle of consistency of domestic and foreign investment.
The negative list approach is not new. It has already been implemented since October 2016. The currently valid Negative List was published on 28 June 2018 and only includes 48 items. At present, a 2019 version of the Negative List is under preparation and is expected to further shorten the number of industry sectors, in which foreign investment is prohibited or restricted.
FIEs in the future also enjoy the same treatment as domestic enterprises. Article 9 of the FIL provides that all national policies on supporting the development of enterprises shall equally apply to FIEs in accordance with the law. This is the first time that it is confirmed by statutory PRC law that FIEs shall receive the same treatment as domestic companies.
3. Promotion and Protection of Foreign Investment
Chapter two and three of the FIL deal with the promotion and protection of foreign investment.
a) Local Policies and Local Governments’ Commitment
According to Article 18 of the FIL, local People's Governments at county level or above may, in accordance with the provisions in laws, administrative regulations or local regulations, formulate policies on promotion and facilitation of foreign investment within their respective statutory authorities.
In addition, Article 25 of the FIL states that local People's Governments at all levels and their relevant departments shall keep policy commitments lawfully made to foreign investors and FIEs and perform all contracts entered into according to the law. If any policy commitment or contract needs to be changed due to national interests or public interests, the statutory authority and procedures shall be followed, and the foreign investor or foreign-invested enterprise concerned shall be compensated for losses incurred thereby according to the law.
In the process of attracting foreign investment, many local governments currently offer and agree to some preferential treatments, such as reductions of rents etc. However, some of these preferential treatments are beyond the actual authority of the local governments and when the local governments do not comply with such preferential treatment as offered and agreed to by the local governments, it is practically impossible for FIEs to claim for respective performance or compensation. According to Article 18 of the FIL, it may become possible for local governments at or above county level in the future to legally implement respective investment promotion policies and to validly and bindingly agree to preferential treatments which would then result in corresponding legal rights and claims of the relevant FIEs. As an enhancement, Article 25 of the FIL also emphasizes that the government shall protect foreign investment by keeping policy commitments lawfully made to foreign investors and FIEs and performing all contracts entered into according to the law.
b) Participation in Standardization Work and Fair Competition in Government Procurement
Article 15 of the FIL stipulates that the State shall guarantee that FIEs can equally participate in setting standards in accordance with the law, and enhance information disclosure and social supervision on standard setting. The compulsory standards formulated by the State shall equally apply to FIEs.
According to Article 16 of the FIL, the State shall guarantee that FIEs can participate in government procurement activities through fair competition. Products produced and services provided by FIEs within the territory of the PRC shall be equally treated under government procurement.
Similar requirements have already been mentioned in the Circular on Several Measures concerning the Expansion of Opening-up and the Active Use of Foreign Capital promulgated by the State Council On 1 December 2017. This circular requires that a fair competition environment shall be further created. It is proposed to promote the fair participation of domestic and foreign-invested enterprises in the PRC's standardization work, promote the fair participation of domestic and foreign-invested enterprises in government procurement bidding, and support FIEs to expand financing channels. The FIL now expressly reflects the above requirements.
In addition, for fair participation of FIEs in government procurement, the PRC is now in the process of acceding to the Agreement on Government Procurement, which is a multilateral agreement within the framework of the WTO with the fundamental aim of mutually opening government procurement markets among its parties. The Agreement on Government Procurement further establishes rules requiring that open, fair and transparent conditions of competition be ensured in government procurement.
c) Protection of Intellectual Property
The FIL emphasizes the protection of intellectual property including trade secrets of foreign investors and FIEs.
According to Article 22 of the FIL, the State shall protect the intellectual property rights of foreign investors and FIEs, protect the legitimate rights and interests of holders of intellectual property rights and the relevant right holders. In case of any infringement of intellectual property right, legal liability shall be investigated strictly in accordance with the law. During the process of foreign investment, the State shall encourage technology cooperation on the basis of free will and business rules. Conditions for technology cooperation shall be determined by all investment parties upon negotiation under the principle of equity. No administrative department or its staff member shall force the transfer of technologies by administrative means.
Forced technology transfer is a problem that many foreign investors and foreign governments focused on in the recent months. The PRC has stated in Article 7 of the WTO Accession Protocol that in the PRC technology transfer shall not be the pre-condition of approval of foreign investment. At the same time, the PRC has made similar commitments in relevant international agreements. This time, it is further expressly stipulated in the FIL that administrative departments and their staff members are prohibited from forcibly transferring technology.
For the protection of trade secrets, according to Article 23 of the FIL, administrative departments and their staff members shall keep confidential any trade secret of foreign investor or foreign-invested enterprise they are aware of during the performance of their duties, and shall not divulge or illegally provide to others the secret. Otherwise, the relevant staff member of an administrative department shall bear the legal liabilities stipulated in Article 39, i.e. a penalty will be imposed, even worse, he/she will be held criminally liable.
4. Management of Foreign Investment
In Chapter Four of the FIL, some management systems of foreign investment are introduced.
a) Foreign Investment Information Reporting System
According to Article 34 of the FIL, the State shall establish a foreign investment information report system. A foreign investor or foreign-invested enterprise shall submit investment information to the competent Authority of Commerce through the enterprise registration system and the enterprise credit information publicity system. The contents and scope of foreign investment information to be reported shall be determined under the principles of necessity. The investment information able to be obtained by interdepartmental information sharing shall not be required to be submitted again.
The FIL only includes one article regarding the Foreign Investment Information Reporting System. We expect that after enactment of the FIL, detailed regulations regarding this system will be issued.
The information reporting system covers a wide range of content and is expected to include initial reports, alteration reports and periodic reports. The initial reports and alteration reports may partially replace the current filing system for establishment and changes for FIEs, and the periodic report is similar to the current joint annual reporting system for FIEs. Reporting matters may be more streamlined than in the current filing information. The FIL stipulates that the contents and scope of information report shall be determined under the principles of necessity.
If any FIE violates such obligation of reporting information, the legal liabilities shall be borne according to Article 37. Firstly the competent Authority of Commerce shall order it to make corrections within a prescribed time limit; if such corrections are not made in time, a penalty of not less than RMB100,000 yet not more than RMB 500,000 shall be imposed.
b) Foreign Investment National Security Review System
Article 35 of the FIL sets out that the State shall establish a safety review system for foreign investment, under which the safety review shall be conducted for foreign investment influencing or probably influencing the state security. A decision on safety review made according to the law shall be final.
Under the current regulations, M&A projects as well as investments in free trade zones related to certain security-related industries, such as military, national defense as well as certain key agricultural products, energy, resources and infrastructures, are subject to national security review. The FIL only includes one article regarding the Foreign Investment National Security Review System. According to the wording of the FIL, any foreign investment “influencing or probably influencing the state security” shall be subject to national security review in the future. As a consequence, also greenfield investments outside of free trade zones and investment projects in industries not covered by the current security review regulations may be required to go through national security review in the future. If really implemented, this would be a step back compared to the current situation. We expect that after the FIL comes into effect, detailed regulations regarding such system will be issued, which will hopefully bring further clarity.
According to Article 40 of the FIL, where any country or region takes any discriminatory prohibitive, restrictive or other similar measure against the People's Republic of China in terms of investment, the People's Republic of China may take corresponding measures against the said country or region in light of the actual conditions.
Although such provision is, generally, in line with international practices, it appears quite remarkable that this is expressly stated in the FIL. The reason for including such a provision into the FIL may well be seen in the recent PRC-US trade war and the PRC’s intention to emphasize its strength and importance in the current global economy and, thus, to make clear that the PRC will strictly act in line of a tit-for-tat strategy and not accept any treatment which the PRC government considers as unfair.
In the past months, foreign investors and foreign governments increasingly asked the Chinese government for national treatment of foreign investment enterprises and open market access of foreign investors. Also, a lot of criticism in the areas of intellectual property protection and licensing have been voiced. It seems that these lobbying activities have paid off, since the FIL addresses them all one by one and promises national treatment, investment safety and further market liberalization.
Nearly all stipulations of the FIL are an improvement compared to the current FIE Laws. However, the reform of the foreign investment regulatory system is a long-term project and the FIL only contains rather general principles on foreign investment in the PRC and the provisions are relatively general, short and vague. It is expected that after the FIL comes into effect, implementation rules and other ancillary regulations will be issued accordingly and that these implementation rules and ancillary regulations will provide the decisive details and show the real impact of the FIL on the PRC foreign investment regime. Eventually, only these implementation rules and the actual implementation practice of the FIL will show whether it will indeed bring major improvements for foreign investors in the PRC or not.