China’s new Foreign Investment Law is a major regulatory overhaul of foreign investment law in China. Effective 1 January 2020, the new law will repeal the existing joint venture (“JV“) laws and the wholly foreign owned entities (“WFOE”) law, and largely bring foreign investment under the same regime as governs domestic companies. However, in terms of practice, the new law consolidates incremental changes that have been underway for years and, to some extent, is a case of law catching up with practice.
The Foreign Investment Law has also been passed amidst intensive trade talks with the US. These trade talks are, to varying degrees, reflected in the broad statements of principle included in the new law. And with much of the new law being statements of principle, implementing rules will be required before the new law becomes effective and practical.
National Negative List System
The new Foreign Investment Law provides pre-establishment national treatment for foreign investors, subject to a “Negative List”. That is, provided the investment is not prohibited or restricted, foreign investors will be treated no less favorably than domestic Chinese investors for the purpose of investment in China.
The new law confirms existing practice that requires permitted investments to be filed for record with the Ministry of Commerce (“MOFCOM”). Filing for record can be completed online for foreign investment projects that are not restricted or regulated under the National Negative List.
After the MOFCOM filing, the foreign investor must file formal application documents with the Chinese corporate registration authority (being the State Administration for Market Regulation (“SAMR”), previously the State Administration for Industry and Commerce) for issuance of the new company’s business license (equivalent to a certificate of incorporation). It must then complete follow up registrations with the tax agency, banks and other regulatory authorities (e.g., environment bureau for manufacturing entities). Unless there are plans to simplify these processes, substantial time and effort will likely still be required to establish a new foreign-invested company in China.
The new Foreign Investment Law requires information disclosure to MOFCOM, and imposes penalties for foreign investors and foreign invested entities (“FIEs”) that fail to duly disclose. For violations that are not rectified promptly, an administrative fine between RMB100,000 to RMB500,000 can be imposed. In addition, such violation will be recorded in the FIE’s Chinese Social Credit System record.
The current MOFCOM registration system already requires foreign investors to disclose detailed information. For example, each foreign investor must disclose its ultimate controller and any subsequent change of its ultimate controller.
Corporate Structure and Management
The new Foreign Investment Law does not contain any provisions on the corporate or organizational structure of FIEs. This means that all FIEs will need to comply with the PRC Company Law, PRC Partnership Law and other such laws in the same way as purely domestic Chinese entities.
Inconsistencies currently exist among the various FIE laws and the Company Law. These inconsistencies reflect the fact that the existing FIE laws are simply too old, the earliest one having been first issued in 1979. For instance, the Equity JV law states that the board of directors is the highest authority of the JV and that directors should have a term of 4 years. The PRC Company Law, however, states that the shareholders are the highest authority of the company, and directors only have a term of 3 years.
Existing FIEs will have a five-year grace period to adjusting their corporate organization to the new regime. Based on past experience, this will mean that whenever an existing FIE makes any change that requires a corporate filing with SAMR (e.g., a change of directors), then it will be required to make further changes to fully comply with the PRC Company Law (or other applicable law).
Investment Protection Principles
The new Foreign Investment Law is not very detailed; rather, it mainly sets out various general principles. This in part reflects the fact that, once effective, the details will be governed by existing laws such as the PRC Company Law. Investment protection principles set out in the new law include:
No government expropriations. This general principle, however, does not prevent expropriation on the grounds of “social and public interests”, with “fair and reasonable” compensation and under “due process”.
Protection of intellectual property. Specifically, government authorities are prohibited from using administrative means to require the involuntary transfer of a foreign investor’s intellectual property.
FIEs in China may, so long as due procedure has been followed, freely repatriate funds from various sources, including profits, capital investment, funds from assets disposals, intellectual property license fees, legal compensation, and funds remaining after liquidation.
Government officials must keep confidential all information collected during foreign investment registrations.
Free association. FIEs in China can freely organize and join chambers of commerce and other associations in accordance with applicable laws and regulations.
National Security Review
The Foreign Investment Law states that a National Security Review System will be established, and that the State will review “any foreign investment that endangers or might endanger national security”. The review decision so made will be final and not appealable. Until implementing rules are issued, it is difficult to know how the National Security Review System will be operated, though we expect that it will reflect the existing national security review mechanism for foreign-invested M&A activity.
The new Foreign Investment Law aims to create a more level playing field in which foreign and domestic companies are treated equally, subject to the “Negative List”. In particular, the formal repeal of laws that focused on pre-establishment requirements is good news for foreign investors. Significantly, the new Foreign Investment Law reflects a change in the mentality of Chinese regulators toward treating foreign investment the same as Chinese investment. We anticipate seeing more such changes once detailed implementation rules are issued.