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28 December, 2019
Foreign-invested Enterprises Under Same Corporate Governance Regime as Chinese Companies
On 15 March 2019, the National People’s Congress of China adopted the new Foreign Investment Law (the “Law”). It aimed to unify and streamline the framework of foreign investment in China, and build a market environment with stability, transparency, predictability and fair competition. The Law will take effect on 1 January 2020.
How will the Law impact on foreigners doing business in China? This article will present how foreign investment was regulated before the Law was passed and illustrate selected highlights of the Law.
Foreign Investment Regulation Prior to the Law
Prior to the Law, there was no unified law to regulate foreign investment in China. Foreign investment was mainly governed by the Sino-foreign Equity Joint Ventures Law, Wholly Foreign-owned Enterprise Law and Sino-foreign Cooperative Joint Ventures Law (collectively the “Initial Foreign Investment Laws”).
The Sino-foreign Equity Joint Ventures Law was applicable if foreign investors partnered with Chinese investors to conduct business by establishing a limited liability company. The Wholly Foreign-owned Enterprise Law regulated the entities wholly owned by foreign investors. The Sino-foreign Cooperative Joint Ventures Law applied to the situation where foreign investors cooperated with Chinese investors in any form (e.g. by way of contract or partnership).
The Initial Foreign Investment Laws established a pre-approval approach for China to regulate foreign investment. Each foreign investment project shall be approved by relevant Chinese authorities before launching in China. In practice, there were mainly two steps for foreign investors to set up their business in China:
- Submit an application to the Central Ministry of Commerce and/or its offices on provincial or municipal level (the “Reviewing Authorities”), with relevant documents including the joint venture contract, articles of association, etc.; and
- If approved, the Reviewing Authorities will then issue a certificate of approval to the investors. Only with such certificate can the investors apply for establishment of enterprise with the Administration of Industry and Commerce (similar to the Companies Registry in Hong Kong).
The Directory of Industries of Foreign Investment served as the basic guidance for Chinese authorities to determine whether a foreign investment project may be approved. It classified four types of industries: encouraged, permitted, restricted and prohibited.
In addition, the Sino-foreign Equity Joint Ventures Law and Sino-foreign Cooperative Joint Ventures Law also regulated the organisational form and governance structure for foreign investment, which are different from PRC Company Law. In particular:
|
Initial Foreign Investment Laws |
PRC Company Law |
|
| Highest decision-making authority | Directors | Shareholders |
| Legal representative | Chairman of directors | Chairman of directors, executive director or senior manager |
| Board of directors | The board must be established. Both Chinese and foreign investors have the right to appoint directors. | Can have only one executive director and not necessary to establish the board. |
| Voting mechanism | The resolution on certain issues shall be unanimously approved by the directors who are present at the meeting. | Major matters such as amendment of the articles of association, increasing or reducing registered capital, etc. shall be subject to approval of two-thirds of the shareholders. |
| Profit-sharing | Profits shall be distributed according to the proportion of parties’ registered capital or according to the contract. | Unless otherwise agreed by all shareholders, profits shall be distributed in accordance with the paid capital. |
| Share transfer | Shall be unanimously agreed by other shareholders. | Unless otherwise provided in the articles of association, shall be agreed by more than half of the other shareholders. |
From the above table, it could be concluded that compared with PRC Company Law, the Initial Foreign Investment Laws imposed more stringent requirements on governance structure.
However, after 1 January 2020, the Initial Foreign Investment Laws will cease effect and such stringent requirements will also be lifted. Corporate governance in PRC Company Law will apply to foreign-invested enterprises.
The Law will replace the fragmented foreign investment regime with a unified and comprehensive foreign investment system. The following is a discussion about the notable highlights of the Law.
Highlights of the Law
Overarching Principle on Foreign Investment Regulation
National treatment is one of the key emphases of the Law. It places foreign investors on equal footing with domestic investors in the Chinese market and gives them equal protection. For instance, the Law expressly provides that government procurement procedures will allow foreign-invested enterprises to participate on equal basis with domestic enterprises. Foreign-invested enterprises can also equally enjoy policies that support and promote the business of domestic enterprises.
Scope of Application
The Law extends its application to various types of foreign investment. According to article 2 of the Law, the Law will apply to foreign investors (whether natural persons, enterprises or organisations from foreign countries) when they conduct the following types of foreign investment activities:
- Establishment of a foreign-invested enterprise in China, independently or jointly with any other investor;
- Acquisition of shares, equities, property or any other similar rights and interests of an enterprise in China;
- Investment in a new project in China, independently or jointly with any other investor; or
- Investment in any other way as may be stipulated by laws, administrative regulations or provisions of the State Council (“catch-all provision”).
Pre-establishment National Treatment and Negative List
The Law establishes a nationwide “pre-establishment national treatment and negative list” management system for foreign investment. During the investment access stage, foreign investment that is not included in the Foreign Investors Special Administrative Measures (the “Negative List”) will be treated no less favourably than domestic investment. In other words, industries outside the Negative List can be freely invested by foreigners, and the government’s pre-approval approach will not be applied to such projects. Foreign investors will only be required to register their investments with relevant authorities.
The Law regards the Negative List as its important supplement. The Negative List, in fact, is not new either. Prior to the passage of the Law, the National Development and Reform Commission and the Ministry of Commerce jointly issued the Negative List on 28 June 2018, which contained restrictions or prohibitions on foreign investment in certain industries. It replaced the Directory of Industries of Foreign Investment used earlier for guidance purpose.
On 30 June 2019, the Negative List was revised and took effect on 30 July 2019. It opens up the market further and allows foreign investors to run more sectors in the form of majority share-controlling or wholly-owned business. For example, the service sector will see greater opening-up in the sectors of transport, infrastructure, culture and value-added telecommunications. Fewer restrictions can also be seen in agriculture, mining and manufacturing industries.
Abandonment of the Initial Foreign Investment Laws
As stated above, the Law will replace the Initial Foreign Investment Laws to establish a unified regulatory approach to foreign investment. Thereafter, the PRC Company Law and PRC Partnership Enterprise Law will equally apply to foreign-invested enterprises. In this case, a newly established foreign-invested enterprise can be registered as a limited liability company or partnership enterprise, without distinguishing as a wholly foreign-owned enterprise, sino-foreign joint venture or sino-foreign cooperation. If foreign investors elect to register a limited liability company, the corporate governance rules under the PRC Company Law will apply.
Other Investment Protection Provisions
Other than the market access threshold as stated above, the Law also expressly provides rules to protect the interests of foreign-invested enterprises in China, in particular:
No expropriation
No expropriation of foreign-owned assets other than under exceptional circumstances and for public interests;
Exchange control
Free transfer of Renminbi or foreign currency into and out of China, for returns of capital, profits, capital gains, royalty payments, and other lawfully obtained compensation;
Requirement on local governments
Local governments are required to honour contractual and other commitments lawfully made. They shall not enact rules that may impair the legitimate rights and interests of foreign-invested enterprises, increase their obligations, or illegally interfere with or affect the normal production and operation activities of foreign-invested enterprises; and
Intellectual property protection
Foreign investors’ intellectual property rights in China are protected. Government agencies cannot “force” a foreign investor to commit to a technology transfer into China.
Hong Kong, Macau and Taiwanese Investments
The Law on its face does not apply to Hong Kong, Macau, or Taiwanese investments (“H/M/T Investments”). H/M/T investments are not characterised as foreign investments but as special domestic investments. However, H/M/T investments could be regulated with reference to the rules in the Law.
Insights
The Law marks a far-reaching reform in China’s foreign investment system by lowering the market entry threshold and improving the business environment for foreign-invested enterprises. Given that the Law only sets out basic and general rules, subsequent specific rules and regulations will need to be promulgated by the State Council to fully implement the Law. It is believed that the Law and its accompanying rules will create a friendlier and more efficient market for foreign investors in China.
