Place: Insights / Perspectives / Detail
China's New Foreign Investment Law and its Impacts on FIEs
2019-04-15David Fu

On March 15, 2019, the PRC National People’s Congress promulgated the People's Republic of China (“PRC” or “China”) Foreign Investment Law (the “Foreign Investment Law”), which will become effective as of January 1, 2020.  Upon its implementation, the Foreign Investment Law will supersede and replace the existing PRC Sino-foreign Equity Joint Venture Law (the “EJV Law”), PRC Sino-foreign Cooperative Enterprise Law (the “CJV Law”) and PRC Wholly-foreign Owned Enterprise Law (collectively, the “FIE Laws”), which have been governing foreign investment in China for several decades. 

 

This article addresses (i) the key highlights of the Foreign Investment Law, (ii) a summary of significant changes to the FIE Laws raised by the Foreign Investment Law and (iii) an analysis of potential impacts of the Foreign Investment Law on the existing foreign-invested enterprises (“FIEs”) in China, including the Sino-foreign equity joint ventures (“EJVs”), the Sino-foreign cooperative joint ventures (“CJVs”) and the wholly-foreign owned enterprises (“WFOEs”).

 

 
 
 

Key Highlights of the Foreign Investment Law

 
 
 

 

The Foreign Investment Law applies to investment activities conducted directly or indirectly within the territory of China by foreign natural persons, enterprises or other organizations (collectively, the “Foreign Investors”), including the following:

 

  • establishing an FIE in China, either alone or together with any other investor;

     

  • acquiring shares, equity interests, property shares or any other similar rights and interests of an enterprise in China;

     

  • investing in a new project in China, either alone or together with any other investor; and

     

  • investing in any other way as provided by applicable laws or regulations or rules of the State Council.

 

When the Foreign Investment Law becomes effective, the organization form and structure of a newly established FIE will conform to and comply with the PRC Company Law (the “Company Law”) or the PRC Partnership Enterprise Law, as the case may be.  An FIE already established prior to the implementation of the Foreign Investment Law may retain its current organization form and structure for a maximum period of five (5) years following the effective date of the Foreign Investment Law (the “Five-year Grace Period”).  Accordingly, all of the existing FIEs will have the Five-year Grace Period to modify and change its current organization form and structure to comply with the relevant provisions of the Company Law.  

 

The supervision and regulation of “investment in domestic enterprises through contracts, trusts and other agreements by Foreign Investors” (especially foreign investment structured through a variable interest entity or “VIE”) have been removed from the final version of the Foreign Investment Law.  However, we cannot rule out the possibility that “foreign investment through contractual control” may fall into the scope of foreign investment subject to the regulation of the Foreign Investment Law under the “catch-all” clause as discussed above.  It remains to be seen how the Foreign Investment Law and its forthcoming implementation rules would regulate the VIE investments.

 

The Foreign Investment Law has set out general principles in terms of promotion and protection of foreign investment.  National treatment has been introduced by reinforcing China's implementation of the Special Administrative Measures (Negative List) for Foreign Investment Access (2018) (the “Negative List”), which sets forth a list of industries for which the foreign investment is either “prohibited” or “restricted”.  If the foreign investment falls into the scope of the Negative List, it shall be subject to certain restrictions and government approval requirements under the Negative List.  If the foreign investment does not fall into the scope of the Negative List, the treatment to such foreign investment shall be no less favorable than that granted to domestic investors and their investments.  In addition to the Negative List management system, other modernized systems such as information reporting system have been also adopted.  Meanwhile, the existing regulations applicable to mergers and acquisitions by Foreign Investors such as the merger control review and national security review systems remain to be applicable.

 

Furthermore, protective measures such as compensation for expropriation, protection of IP rights and trade secrets, as well as establishment of complaints mechanism have been introduced to protect the legitimate rights and interests of Foreign Investors.

 

 
 
 

Significant Changes to FIE Laws

 
 
 

 

Upon the implementation of the Foreign Investment Law, the FIE Laws will be abolished.  Accordingly, the organization form and structure of all existing FIEs are required to conform to and comply with the Company Law, subject to the Five-year Grace Period.  As a result, an existing FIE will have to face certain significant legal changes and challenges such as the following:

 

1.  Corporate Governance:

 

Under the existing FIE Laws, an EJV/CJV currently does not have a shareholders’ meeting.  The board of directors of an EJV (or the board of directors or joint management committee of a CJV) is the highest authority of the company.  The powers of the board of directors include the review and approval of all major matters of the company, such as amendment of the articles of association, termination and dissolution of the company, increase or reduction of the company’s registered capital, and merger or division of the company (collectively, the “Major Matters”), which are subject to unanimous approval by all directors present at a duly convened board meeting.

 

Under the Foreign Investment Law, subject to the Five-year Grace Period, an FIE is required to have a shareholders’ meeting as the highest authority of the company in accordance with the Company Law.  The powers of the shareholders’ meeting include the review and approval of all major matters of the company such as the Major Matters, which are subject to the approval by shareholders representing more than two-thirds of the company’s voting rights.  As a result, those Major Matters which previously require unanimous approval of all directors present at a duly convened board meeting under the FIE Laws will now only require super-majority approval by shareholders (representing more than two-thirds of the company's voting rights) under the Company Law.  Accordingly, if a Foreign Investor has less than one third of the equity interests in an EJV/CJV, such Foreign Investor would no longer enjoy the veto right with respect to the Major Matters which it used to enjoy under the FIE Laws.

 

2.  Transfer of Equity Interests:

 

Under the existing FIE Laws, if one party to an EJV/CJV intends to assign its equity interest to a third party, the transferring party is required to obtain the consent from the other party.  In the case of an EJV, the non-transferring party also has the right of first refusal to purchase such equity interest to be transferred.

 

Under the Foreign Investment Law, an FIE is required to comply with the relevant provisions regarding the equity transfer under the Company Law.  A shareholder proposing to transfer its equity interests to a non-shareholder is required to obtain the consent of more than half of the other shareholders.  If more than half of the other shareholders do not consent to the proposed transfer, the non-consenting shareholders are required to purchase such equity interests, failing which they will be deemed to have consented to the proposed transfer.

 

3.  Distribution of Profits:

 

Under the existing FIE Laws, an EJV is required to pay the profits to its shareholders in proportion to their respective contributions to the registered capital of the company.

 

Under the Foreign Investment Law, the shareholders of an FIE may, in accordance with the relevant provisions of the Company Law, reach an agreement on a percentage and method for the payment of profits which may vary from their respective contributions to the registered capital of the company.

 

4.  Allocation of After-tax Fund:

 

Under the existing FIE Laws, an EJV/CJV may contribute to the reserve fund, the employee bonus and welfare fund and the enterprise development fund in accordance with the percentage decided and approved by the board of directors.  

 

Under the Foreign Investment Law, an FIE will be required to contribute 10% of the after-tax profit to its statutory surplus reserve in accordance with the Company Law until the aggregate sum of the statutory surplus reserve reaches more than 50% of its registered capital.

 

 
 
 

Implications to Foreign Investors

 
 
 

 

Based on the above analysis, upon the implementation of the Foreign Investment Law, within the permitted Five-year Grace Period, each of the existing FIEs (including EJVs, CJVs and WFOEs) established prior to the Foreign Investment Law will be required to amend its organization form and structure in compliance with the Company Law.  For an existing EJV/CJV, a Foreign Investor will need to consider starting to negotiate with its Chinese joint venture partner in a timely manner to (i) make revisions to the existing joint venture contract (or cooperation agreement) and articles of association of the relevant EJV/CJV; and (ii) submit the amendments to competent governmental authorities for approval or filing, as the case may be.  The revisions would include, at a minimum, adding or amending the relevant provisions regarding the corporate governance of the company, such as the shareholders' meeting and the board of directors.  

 

The mismatch between the original corporate governance terms of a joint venture established prior to the Foreign Investment Law and the corporate governance provisions under the PRC Company Law will certainly become the subject of intensive negotiation between a Foreign Investor and its Chinese joint venture partner over the next few years prior to the expiry of the Five-year Grace Period.  This would potentially reopen the negotiation over corporate governance terms and other related terms for the joint venture.  Foreign Investors will be well advised to get prepared before they discuss with their joint venture partners any intended revisions to the corporate governance terms and operating rules of the joint ventures.

 

For an existing WFOE, a Foreign Investor will also need to review the current articles of association of the WFOE to determine if any revisions are necessary to fully comply with the corporate governance provisions under the Company Law.

 

Furthermore, matters previously required under EJV Law or CJV Law to be stipulated in the joint venture contract or cooperation agreement, such as the purchase of raw materials, the sale and distribution of products, the introduction of technology and the use of land, are no longer required to be specified in the joint venture contract or cooperation agreement under the Foreign Investment Law.  Accordingly, in connection with the amendments to the joint venture contract (or cooperation agreement) and articles of association of the relevant EJV/CJV, a Foreign Investor may also consider whether to make revisions to the relevant provisions regarding the above matters.

 

 
 
 

Conclusion

 
 
 

 

Upon its implementation, the Foreign Investment Law will replace and unify the FIE Laws to regulate foreign investment and FIEs in China.  We expect that as the Foreign Investment Law becomes effective as of January 1, 2020, relevant implementation regulations will be promulgated accordingly to provide further clarity and guidance for Foreign Investors and FIEs to comply with the new law.

 

 

 

David Fu
Partner
david.fu@glo.com.cn