21 February, 2019
BACKGROUND AND GENERAL PROVISIONS OF THE DRAFT
The National People’s Congress disseminated the latest draft Law on foreign investment (the «Bill») on 27 December 2018 in order to collect final comments from the public between now and 24 February 2019.
The final text should be adopted at the National People’s Congress session of March 2019.
The Bill notably recalls the principles of the protection of foreign investments, the application of domestic treatment to foreign-owned enterprises and equality of access to public procurement contracts. These general principles do not modify the obligations of the administrative authorities and local authorities in such matters.
THE MAIN PROVISION OF THE BILL: THE REPEAL OF THE LAW ON JOINT VENTURES AND THE IMPLICATIONS THEREOF
As with its original version from 2015, the main provision of the Bill is the repeal of the Law on wholly foreign-owned enterprises («WFOE») as well as two Laws on Chinese-foreign joint ventures (Joint Ventures in Equity and Contractual Joint Ventures, together referred to as «JV»).
The fact that this repeal has been maintained in the Bill from the outset would seem to con firm that it will remain final text.
The repeal of the Laws on JVs is the focal point of this Bill. From now on, the application of the general law regime to JVs will remove the constraint of the right of veto enjoyed by the minority party (either Chinese or foreign). This flexibility provides foreign companies with the opportunity to control a JV if they hold 2/3 of the share capital.
This means that the following decisions, which had been subject to unanimity under the Law on Joint Ventures, may now be taken at a 2/3 majority:
-
the amendment of the articles of association;
-
a share capital increase or decrease; and
-
the merger, demerger, dissolution or change of legal structure of the JV.
For already-established JVs in which the foreign company holds 2/3 of the share capital, it is possible to open negotiations with the Chinese party to place decisions requiring unanimity under the 2/3 majority regime.
Clearly, it is to be expected that the Chinese party will not be willing to abandon its right of veto, or at least not without compensation. Nonetheless, negotiations on this matter may be launched.
OTHER IMPLICATIONS OF THE REPEAL OF THE LAWS ON JVS
Compliance of the legal structure will require competence to be transferred to the new «Shareholders’ Meeting» which must be introduced into the agreement and articles of association of JVs (as WFOEs have already been subject to the Law on Companies since 2006, this aspect is not relevant to them).
It will be necessary to examine the other implications of inclusion within the scope of general company law regime. For example, the Chief Executive Officer of a JV (and no longer the Chairman of the JV, as was mandatory) will now be entitled to be the legal representative as is already the case for WFOEs and, more generally, for limited liability companies.
The Bill provides that companies currently governed by these laws may maintain their legal structures for a further 5 years after the entry into force of the Law on Foreign Investment.
Consequently, it may be understood that the authorities are giving WFOEs and JVs a period of 5 years in which to comply with general law regulations, which mainly consist of the Law on Companies.
NONETHELESS, THE ALIGNMENT OF JVS AND WFOES WITH THE GENERAL LAW REGIME IS STILL LIMITED
There is, therefore, good reason to be satis ed with the repeal of the Laws on JVs and WFOEs.
Nonetheless, it would be desirable for the alignment of foreign-owned enterprises with the general law regime applicable to Chinese-owned enterprises, to be accompanied by the alignment of the rules on capital and investment, which is not currently provided in this Bill.
Foreign-owned enterprises (JVs and WFOEs) must currently be heavily capitalised in order to obtain loans (loans in foreign currency, loans secured in foreign currency, loans in RMB taken out with banking institutions located outside China). The Chinese authorities impose a ratio according to which the amount of the loan available will depend on the amount of paid-up share capital.
Such ratio is not applied to Chinese-owned enterprises.
Similarly, local investments by foreign-owned enterprises are restricted. If they do not have the status of holding companies (which requires major prior investment that is most often unavailable), they may not apply their capital for local investments for which only pro ts may be used.
This is a major constraint since it means that foreign companies wishing to invest locally and do not have sufficient income to do so, are obliged to form a new WFOE (or JV) for every investment they wish to make.
This regime severely encumbers the procedures for foreign investment in China. It leads to fixed costs that continue to reduce the attractiveness of China in favour of Hong Kong or Singapore.
THE IMPORTANCE OF THE FORTHCOMING REGULATIONS
The regulations passed in application of this Law might indicate the extent of the legislative authority’s determination. Will the legislative authority take matters to their full logical conclusion in respect of applying the general law regime to all companies irrespective of the nationality of their ownership?
For further information, please contact:
Lisbeth Lanvers-Shah, Partner, DS Avocats
lanversshah@dsavocats.com
