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27 March, 2019
Introduction
Almost 40 years ago in July 1979, the National People's Congress enacted the Sino-Foreign Equity Joint Venture Law. This law formally opened up China to foreign investors wishing to establish a Sino-foreign Equity Joint Venture in China (EJV). This was then followed by laws providing for the establishment of wholly-foreign owned enterprises (WFOEs) in 1986 and cooperative joint ventures (CJVs) in 1988. Since then foreign-owned companies have become an intrinsic part of China's economic system.
In 2015, the PRC government published the first draft (2015 Draft) of a new law (Foreign Investment Law) to replace the specific laws regulating EJVs, WFOEs, CJVs and other foreign-invested entities (FIEs). The 2015 Draft was much more detailed than previous laws and attempted to clarify many issues that had not been previously addressed.
Some of these features proved controversial (including an attempt to reign in so-called VIE structures) and the 2015 Draft was never enacted. There was also a general concern that the law would increase, rather than reduce, the differential treatment of FIEs compared to domestically owned PRC companies.
In the midst of trade and political tensions with the United States, the PRC Government published the second draft of the Foreign Investment Law on 26 December 2018. The second draft was submitted at record speed to the National People's Congress on 8 March 2019 and was approved with only minor modifications on 15 March 2019 (Foreign Investment Law). The Foreign Investment Law will take effect on 1 January 2020.
The number of articles have been reduced from 170 in the 2015 Draft to only 42 and controversial features have been removed. The Foreign Investment Law also expressly seeks to address some of the concerns foreign businesses have raised with existing PRC regulatory environment.
Notable features
New governance provisions and 5 year's grandfathering: The specific laws applying to EJVs and CJVs will be abolished on 1 January 2020 when the Foreign Investment Law comes into effect. After that date, EJVs and CJVs have to comply with the same Company Law and Partnership Law that also regulate domestically owned companies.
The Foreign Investment Law provides for a 5 year-grandfathering period for existing EJVs and CJVs to update their shareholder agreements, articles of associations and governance practices to align with the Company Law and the Partnership Law.
This potentially gives existing EJVs and CJVs some benefit as they within the 5 years can choose when to adopt to the new and more flexible regime.
By way of example, under the existing regime, the EJVs profits must be distributed in accordance with the registered capital ratio of the shareholders. This means that a party which contributes less registered capital will also get a correspondingly smaller share of the future profits. Once this arrangement falls away, the parties can agree alternative profit sharing arrangements.
By way of further example, the highest decision making body of an EJV is the Board of Directors. Under the new regime, decisions can also be made by the shareholders in a general meeting.
Remitting profits: China imposes controls and restrictions on foreign exchange and overseas currency transfers. Delays and difficulties in receiving the necessary approvals for remitting profits and paying royalties has been a common complaint among FIEs. The Foreign Investment Law states that "[a] foreign investor's capital contribution, profits, capital gains, intellectual property rights royalties, indemnity or compensation and liquidation income etc. received in China according to law may be freely remitted from or to overseas in accordance with the law in RMB or foreign exchange." This may signal an intention by the PRC government to streamline and simplify current processes.
Protection of intellectual property: The office of the United States Trade Representative issued a s.301 report in March 2018 alleging amongst other things that FIEs were subject to unfair or forced transfer of technology and intellectual property. This sparked a heated debate about the general business climate in China and the issue has been raised by the United States in the recent trade negotiations. The Foreign Investment Law emphasises that FIEs' and their foreign owners' intellectual property shall be protected and encourages voluntary technical cooperation. It specifically prohibits PRC administrative authorities from using administrative measures to coerce an FIE into transferring technology or from divulging confidential information or trade secrets of the FIE and foreign investors.
Equal treatment for FIEs: The Foreign Investment Law expressly provides for equal treatment of FIEs and domestically-owned companies in several contexts, including:
a) Market access: With the exception of certain industries on the so-called Negative List (which lists industries in which foreign investment is either prohibited or restricted), foreign investors will be treated no less favorably than local investors from a market access perspective.
b) Supportive policies equally applicable to FIEs: Government policies that support the development in certain industries are equally applicable to foreign-invested enterprises.
c) National standard: The Standardisation Administration of China (SAC) issues mandatory and national standards for products and services. Compliance with the various standards (whether mandatory or not) can be critical to operate in the Chinese market. A frequent complaint by the foreign business community has been that certain standards have disadvantaged FIEs and that FIEs' representatives have not been allowed to fully participate in the working groups that formulate the relevant standards. The Foreign Investment Law provides that national standards shall equally apply to FIEs and FIEs shall have the right to participate in the standard making procedures in accordance with laws.
d) Government procurement: The Foreign Investment Law also provides that FIEs' domestically produced goods and services shall be treated in the same way as other domestically produced products and services in PRC government procurement.
Final Remarks
The above is merely intended to give a flavor of the Foreign Investment Law which indeed has many more interesting aspects to it. In any event, as a high-level piece of legislation, the effect of the Foreign Investment Law will turn on its implementation.
For example, the 2015 Draft included detailed and prescriptive provisions about the information which foreign investors and FIEs have to report to the PRC authorities. Some of these provisions were implemented by other PRC laws and regulations and the relevant reporting systems are already in full use (even though the 2015 Draft itself was never enacted). These specific provisions have been removed from the Foreign Investment Law which only contains a generally worded article about reporting. It is too early to say if this deletion was an editorial decision or a signal that there will be changes to reporting practices and systems.
We expect further implementing rules to be introduced before the Foreign Investment Law comes into effect on 1 January 2020. It will be particularly interesting to see if the more heated topics from the 2015 Draft like the treatment of VIEs will resurface.
For further information, please contact:
Michael Sheng, Partner, Ashurst
michael.sheng@ashurst.com
