Overview on the Newly Promulgated Foreign Investment law

The plenary session of the National People’s Congress (NPC), with close to 3,000 representatives, promulgated the new Foreign Investment Law (FIL) on March 15, 2019, effective from January 1, 2020. This represents an overhaul to the current regime regulating foreign invested enterprises (FIEs) that has been in place for more than 40 years since China first opened its door for foreign investment in late 1970's.

Many commentators believe that this law was passed for facilitating the US China trade talks because China was accused of engaging in certain harmful practice including forced technology transfer and violation of intellectual property rights as well as non-tariff trade barriers, which China denies. Indeed, the fast promulgation of such an important new law in less than three months1 has created a new record in Chinese legislation history and demonstrated an obvious intent of China to ease some concerns of the US.

Forgetting any marks in the new law that are obviously to answer those US concerns, there are many exciting rules or issues to watch for in the new law itself, and most importantly the relevant implementing rules to be issued in the near future as well as necessary amendments to other existing laws down the road.

Highlights

Unifying three laws on FIEs. The FIL will replace the three existing laws on FIEs including Law on Sino-Foreign Equity Joint Ventures, Law on Sino-Foreign Cooperative Joint Ventures and Law on Wholly Foreign-owned Enterprises. The FIL provides that the organizational form and internal organs of FIEs shall be subject to the Company Law and the Partnership Law as applicable. This means that literally joint venture (JV) shall not be a legal form available in China any more, but may only exist in its original economic or business sense. Going forward, you will see the legal forms for FIEs being limited liability company (LLC), joint stock company, or partnership, and no more JVs or WFOEs (wholly foreign owned enterprises).

Definition of foreign investment and FIE. "Foreign investment" refers to the investment activity directly or indirectly conducted by a foreign natural person, enterprise or other organization (collectively a "foreign investor"), including the following:

  • Establishment of FIEs in China by a foreign investor, alone or jointly with other investors
  • Acquisition by a foreign investor of shares, equity, property share or other similar rights and interests in a Chinese enterprise
  • Investment in new projects in China by a foreign investor, alone or jointly with other investors
  • Investment in other forms as provided by laws and regulations or provisions of the State Council

"FIE" refers to an enterprise that is invested by a foreign investor, wholly or partially, the establishment of which is through registration in China pursuant to the Chinese law.

Financing. FIEs may conduct financing through public offerings of shares, corporate bonds and other methods pursuant to the law.

No forced technology transfer. China encourages to carry out technology cooperation by staying with the principle of being voluntary and following the commercial rules. The terms and conditions of technology cooperation shall be negotiated by all parties equally on the basis of fairness. The administrative authorities including their staff shall not force technology transfers. The authorities shall keep trade secret of foreign investors and FIEs in confidence and shall not divulge or illegally provide the trade secret to others.

Negative list. Foreign investors shall not invest in any area prohibited by the negative list for foreign investment, and shall satisfy the prescribed conditions to invest in areas restricted by the negative list. For investment in areas not included in the negative list, foreign investors shall be treated equally as domestic investors.

Licensing. Foreign investors shall obtain the required licenses if investing in the areas that require a license pursuant to the law. The licensing authority shall review the application of the foreign investor by applying the same conditions and procedures as domestic investors, unless the laws and regulations provided otherwise.

Foreign investment information reporting. Foreign investors or FIEs shall submit the relevant investment information to commerce authority through the enterprise registration system and the enterprise credit information publicity system. The content and scope of reporting shall be determined on the basis of necessity. The reported information that can be accessed through information sharing among the authorities shall not be asked for reporting repeatedly.

National security review and anti-trust review. The state shall establish a security review system on foreign investment if the foreign investment affects or may affect the national security. The decision of the national security review shall be final, i.e., no appeal is available. Anti-trust review may be applied pursuant to the anti-trust law if a foreign investor acquires domestic enterprises or otherwise participates in conglomeration of business operators.

Retaliation. If any country or jurisdiction has adopted discriminating measures in prohibiting or restricting Chinese investment, China may take corresponding measures to such country or jurisdiction based on the actual circumstances.

Observations and Comments

More clarification or implementing rules needed. The FIL has only 42 articles, 6 chapters. Many provisions are very generic without specifying detailed operational guidance. Such brevity of the FIL has left many issues to be addressed in implementing rules or by amending certain existing rules in the next, for example:

  • Would there be any minimal foreign shareholding requirement for a company to be classified as FIE?
  • Would the VIE structure be regulated as indirect foreign investment?
  • What is considered the investment in new projects?
  • What would the other forms of foreign investment?
  • How to classify the Chinese subsidiary of an FIE (domestic re-investment)?
  • If a Chinese individual sets up and owns a Chinese company, but later the Chinese individual immigrates and becomes a foreign passport holder, would the underlying Chinese company become an FIE, which is allowed to make outbound dividend distribution?
  • Would the foreign investment reporting to the commerce authority replace the current recordal of FIEs with the commerce authority when such FIEs are not covered by the negative list?
  • Will the investors from Hong Kong, Macau and Taiwan be also treated as foreign investors?
  • Can the investors to an FIE choose to have the foreign law, instead of PRC law, govern the shareholder agreement for setting up a joint venture or a share purchase agreement for acquiring a Chinese company?
  • Would it still require an approval of the Ministry of Commerce if a Chinese controlled foreign company is to acquire its related PRC company?

Progress on no forced technology transfer. Indeed, we have seen solid progress that China is making to implement the FIL even if it has not yet formally taken effect until 2020. A very recent example is about the rule of no forced technology transfer. The State Council has just amended the Technology Import and Export Regulations. The amendments deleted certain controversial provisions from the Regulations, for example, the result of improving the imported technology within the validity period of the technology import contract shall belong to the party that makes such improvement (i.e., licensee); the technology import contract cannot contain certain restrictive provisions (such as, restricting the licensee from improving the licensed technology; restricting the licensee from obtaining similar or competing technology from other sources, etc.). Also, the State Council has amended the Implementing Regulations of Law on Sino-Foreign Equity Joint Venture Enterprises, deleting the provisions that imposed a cap of 10 year validity for a technology transfer agreement and provided that the licensee has the right to continue using the licensed technology after the expiration of the technology transfer agreement.

More flexibilities available to foreign investors. Because the FIEs will be organized fully under the Company Law (or Partnership Law if applicable), it is possible that a foreign investor may partner with a Chinese individual to directly set up an LLC. This has greatly expanded the foreign investors' choices of business partners if ever needed. Also, Company Law has provided that the profit distribution is not necessarily following the shareholding ratio if the Articles of Association provide otherwise. Hence, a foreign investor may negotiate with the Chinese investor for flexible ways on profit distribution. This could provide a lot of planning room for foreign investors.

Application of law in gap and in transition period. First, the FIL provides that the FIEs established before 2020 pursuant to the repealed three laws on FIEs can continue retaining their original organizational form. This means that the repealed laws may still be applicable for 5 years after 2020 in order to govern the organizational form of the existing FIEs. Therefore, during such 5 year transition period, the investors will have the choice to accelerate the application of the FIL and hence the Company Law by amending their organizational form pursuant to the Company Law. But the new FIEs that will be established between now and the end of 2019 will face a dilemma. That is, if the new FIE is established under the old laws on FIEs to be repealed, shortly after when it is 2020, the FIE would need to amend its organizational form again pursuant to the FIL and hence the Company Law. This can cause additional cost to the FIE. But obviously the new FIE would not have the choice of applying the FIL now since the FIL has not taken effect until 2020. Hopefully there will be clarification on how to handle the new FIEs to be set up in this gap period.

Overall, the FIL appears to be very favorable to foreign investors, yet, the key is to make sure that the FIL has been actually implemented in practice as being drafted for landing those favors to the foreign investors. From now on, we expect there will be a lot of new implementing rules to be formulated, or certain existing rules be amended. We will monitor the development and share our update with you from time to time.