With the new decade on our doorstep, it is anticipated that the year 2020 will be a year in which we will continue to observe several changes to the business environment for foreign-invested enterprises in China. As highlighted in our earlier articles, the Corporate Social Credit System will be implemented. However, another major change is the implementation of the new Foreign Investment Law (FIL) on January 1st, 2020.
In recent years China has received criticism from a variety of sources regarding their treatment of foreign companies and the unfair competitive advantage of domestic enterprises in the Chinese market. Therefore, in an effort to further reform its economy and, actively promote foreign investment and to protect lawful rights and interests of foreign investors, the FIL will be implemented in 2020.
It is important for the subsidiaries of foreign-invested enterprises to have an understanding of the changes in 2020 as a result of the implementation of the new Foreign Investment Law. In this article, we discuss what the new Foreign Investment Law means for businesses and how this impacts both existing foreign-invested companies in China as well as companies seeking to enter the Chinese market.
Following China’s market reform and opening-up, the country adopted its law on equity joint ventures (JVs) in 1979, followed by the laws on wholly foreign-owned enterprises (WFOEs) and cooperative joint ventures in the 1980s. Since their implementation, these laws have provided the legal framework for foreign investors in China.
In an effort to provide more clarity and transparency, the government has been working on a new legal framework. In 2015, the Ministry of Commerce of China (MOFCOM) released a draft of the PRC Foreign Investment Law, however, plans were put on hold until end of 2018. Subsequently, in a matter of months the Chinese government, on 15 March 2019, officially passed the new Foreign Investment Law. The extraordinary speed with which the new FIL was passed cannot be fully separated from geopolitical events such as the China-US Trade War and ongoing criticism about the country’s reform.
The new Foreign Investment Law has been introduced to tackle some of the largest concerns of foreign enterprises in China. The law aims to promote equal treatment of foreign and domestic enterprises, better protection of investors rights and protection against forced technology transfers.
Overview of the new Foreign Investment Law
The new Foreign Investment Law is applicable to all foreign investment in the territory of Mainland China. Foreign investment is defined as investment activity directly or indirectly conducted by a foreign natural person, enterprise or other organization. These include the following circumstances:
A foreign investor establishes a foreign-invested enterprise within the territory of China, independently or jointly with any other investor;
A foreign investor acquires shares, equities, property shares or any other similar rights and interests of an enterprise within the territory of China;
A foreign investor makes an investment to initiate a new project within the territory of China, independently or jointly with any other investor; and
A foreign investor makes an investment in any other way stipulated by laws, administrative regulations or provisions of the State Council.
The new Foreign Investment Law includes six different chapters covering general provisions, investment promotion, protection and management, legal liability and supplementary provisions.
The law aims to promote fair competition, equal application of policies in support of enterprise development to foreign-invested enterprises and equal participation in government procurement activities.
Moreover, investment protection is improved by limiting the state’s ability to expropriate investments made by foreign investors, improved ease of remittances of funds in and out the country, stronger intellectual property rights protection and taking measures against forced technology transfers and trade secrets sharing.
It is important to note that approval of foreign investment is done according to the principle of national treatment and the negative list. This means that foreign investors are not allowed to invest in the prohibited industries as specified by the negative list and have to conform to the investment conditions for restricted industries. Foreign investment should be given equal treatment to domestic (Chinese) investment in industries which are not prohibited or restricted.
The Foreign Investment Law shall come into effect as of January 1st, 2020, and will be replacing the Laws of the People's Republic of China on Sino-Foreign Equity Joint Ventures (EJV), Sino-Foreign Cooperative Joint Ventures (CJV) and Wholly Foreign-owned Enterprises (WFOE).
Foreign-invested enterprises, which were established in accordance with the aforementioned laws before the implementation of the new Foreign Investment Law, may retain their original organizational forms and other aspects for five years upon the implementation hereof. Subsequently, foreign-invested enterprises will be subject to the Company Law, the Partnership Enterprise Law and other laws, meaning that they will be subject to the same laws as domestic enterprises.
Implications for Foreign-Invested Enterprises in China
As discussed above, companies will now have to abide by different laws. Companies looking to enter the Chinese market, will have to be established in accordance with the new Foreign Investment Law. Whereas companies currently in the establishment phase are advised to discuss the effects of this change with their advisors.
On the other hand, companies which were incorporated under the EJV, CJV or WFOE laws will have a five-year transition period to adjust to their structure in accordance with the new Foreign Investment Law. Below we discuss specifically how the implementation of the Foreign Investment Law impacts WFOEs and Joint Ventures.
Wholly Foreign-Owned Entities (WFOEs)
Because the existing WFOE law is already largely in line with the Company Law, there will be a limited impact for existing WFOEs. We have elaborated on the impact for WFOEs below:
Under the new Foreign Investment Law, WFOEs will no longer be limited to being a limited liability company organizational form, but will also be able to establish a joint-stock company under the Company Law.
Moreover, under the WFOE law, foreign-invested enterprises are required to allocate at least 10% of the after-tax profit amount to a reserve fund and employee bonus and welfare funds, up until the total of 50% of the registered capital. Under the Company Law companies shall allocate 10% of their after-tax profits to their statutory common reserve. However, they are not required to contribute to the employee bonus and welfare funds, where this is up to the discretion of the shareholders.
Lastly, in case of a liquidation, the liquidation committee no longer has to include the legal representative, but will be formed according to the decision of the shareholders or be determined via the general meeting of shareholders.
Joint Ventures (JVs)
On the other hand, the impact of the new Foreign-Investment Law will be larger for Joint Ventures. Among others, existing Joint Ventures should consider the following:
According to EJV and CJV law the board of directors is the highest authority, which shall decide all major issues concerning the joint venture. Under the Company Law, the board of shareholders is the highest authority.
Moreover, under Company Law amendments of the articles of association of the company (including among others an increase or reduction of the registered capital and merger, division, dissolution or change of corporate form) will be adopted by majority vote (two thirds) of the shareholders, whereas under the current JV laws this requires unanimous agreement of the members of the Board of Directors.
As a consequence of the above, the Joint Venture agreements of existing JVs will have to be renegotiated. Even though the law provides an implementation period of 5 years, foreign investors should focus on this issue as soon as possible, as renegotiations tend to be complex and time consuming.
Whether the objectives set out for the new Foreign Investment Law will be met, remains to be seen. Even though the new FIL has been well received by the international business community, skepticism remains about its wording and definitions as well as its further implementation locally.
The U.S.-China Business Council highlighted that the draft of the Foreign Investment Law does not address how foreign companies can gain fair competition with domestic players, the language is unlikely to be enough to allow equal participation by foreign companies and the lack of specification of what kind of trade secret disclosures will be prohibited and what terms such as “national interest” and “social public interests” exactly entail. Moreover, the European Chamber of Commerce in China views the new law as “surprisingly accommodating” to concerns they had. However, they do note that the laws and regulation in China are by-and-large very good, but that the implementation differs across regions and different levels and hence whether the law will have the desired impact will depend on the implementation in practice.
Although the full impact of the New Foreign Investment Law and its further implementation remain to be seen, foreign investors will have to abide by its regulations as of January 1, 2020. Even though there will be a transition period of 5 years, we advise companies to initiate the required adjustments sooner rather than later.
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