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The Foreign Investment Law | March 2019

By eusme | Article      24.03.2019     Tags:

On March 15th, the National People’s Congress announced the Chinese Foreign Investment Law, a regulation that will come into effect on 1st January 2020. 

Below is a brief introduction of the Law for an easier understanding for EU SMEs.

I. Contents

The new Foreign Investment Law includes 42 clauses and 6 chapters: General    Provisions, Investment Promotion, Investment Protection, Investment Management, Legal Liability and Supplementary Provisions.

The law reiterates principles already affirmed and piloted in Shanghai FTZ since 2015: “pre-establishment national treatment” and a “negative list” for foreign investments.

In fact, many provisions are made under the idea of promoting foreign investments. Equal application of policies supporting enterprises, participation in standards formulation and government procurement activities, reliable public services supporting foreign investments, the ability for local governments to develop foreign investment promotion, facilitation policies and measures within their authority. All these are indeed included in the FIL.

In regards of the investment protection, the following aspects are covered: the general principle of non-expropriation[1]; the free remittance of legitimate funds in and out of China; the implementation of intellectual property rights (“IPR”) protection with non-mandatory requirements for foreign investors on  technology transfer; confidentiality obligations from administrative authorities;  compliance of local legislation with national laws; obligation for local government to fulfill policy commitment and contract made toward and with foreign enterprises; and finally the establishment of a complaint mechanism.

Besides the mention of the negative list for foreign investment access, the Chapter 5 “Investment Management” also provides applicable laws related to forms and structures of organizations, review of concentration before merging operations; review over national security issues; and a foreign investment information reporting system.
 

II. Issues to be noted

The issuance and implementation of the Foreign Investment Law marks the establishment of a new framework for the foreign investment administration system in China. The first draft of the law was released for comments in early 2015, and the Chinese Central Government has worked on it for several years. After the first review made in December 2018, the legislative authority speeded up the reviewing process that took less than 3 months. The final version is quite general, though it covers many important issues for foreign investors such as IPR protection, free remittance of funds, government procurement, standardization, financing, expropriation and requisition, commitment by local governmental authorities etc.  It has been said that this law was approved in this session of the National People’s Congress as an olive branch to the United-States.  True or not, many provisions deserve further clarification for a clear implementation. Here is a list of a few points to which EU SME investors should be paying attention.

 

1.  Investor identity

The Chinese Constitution states that foreign organizations and individuals can invest in China using various forms of economic cooperation with Chinese enterprises and other economic organizations in accordance with Chinese laws. 

Some Chinese individuals can be shareholders of newly established FIEs in some areas, which is an exception to the above provision of the Chinese Constitution.  The new Foreign Investment Law does not state clearly if this practice would be legally allowed as a general principle; therefore, there is still something that needs to be clarified.

According to the Foreign Investment Law, “foreign investors” refers to foreign natural persons, enterprises or other organizations.  It is not clear if foreign non-economic organizations as part of foreign organizations can be considered as foreign investors.   

 

2. Foreign investment

In regards of foreign investments, there are still some questions that need to be answered for a better implementation of the law. To name a few:

  • How to understand indirect investment as provided in the law?
  • Will the negative list apply to investment indirectly made by any foreign investors, or will it apply only to indirect investment controlled by foreign investors?
  • What will be the criteria to consider who is the controlling one?
  • What does “investment in newly built projects” as a mode of foreign investment refers to?
  • How will the foreign investment administration system like information reporting and national security review apply to this mode of foreign investment?

 

3. Mandatory application of governing law

According to the Chinese Contract Law, Chinese law should be applied to joint venture contracts. This provision was first provided in the implementation regulations of the laws governing Sino-foreign joint ventures, and then accepted by the Chinese Contract Law. Since contractual provisions may be interpreted differently under different legal systems and thus affect the parties’ rights and obligations, foreign investors, including EU SME investors, are advised to pay attention to a possible modification of the governing law on such matter.

 

4.  Organization form and structure of FIEs

With this Foreign Investment Law implemented, Chinese-Foreign Equity Joint Ventures Law, Wholly Foreign-Owned Enterprises Law, Chinese-Foreign Contractual Joint Ventures Law will all be abolished, and the Chinese Company Law and the Chinese Partnership Enterprises Law will apply uniformly to both FIEs and domestically invested enterprises in terms of organization form, structure and operating rules.

However, difference exists between the Chinese Company Law and the original three regulations, such as: highest authority organ in the enterprise; decision making mechanism; profit distribution; distribution of residual property; equity transfer etc.  Before the end of the 5-year transitional period, already existing Sino-foreign joint ventures will need to revise their contracts and articles of association to comply with the Chinese Company Law.  Some may trigger the negotiation between shareholders on corporate governance to reflect their current interest allocation under the Foreign Investment Law.

It is still not clear whether it is possible for foreign investors who will set up FIEs with legal personality before 1st January 2020 to draft agreements and articles of associations in accordance with the Chinese Company Law instead of still effective laws on wholly foreign-owned enterprises and joint ventures. In this way, the foreign investors may avoid the complication of revising the chartered documents later when the Foreign Investment Law comes into effect, but the confirmation of a relevant authority is needed for this.

 

5. Effectiveness of affiliated regulations

Besides the current three laws on FIEs, there are many affiliated rules and regulations issued by various governmental authorities which are still effective. Which regulations will remain effective and which will be abolished or changed?  The governmental authorities need to make clear decisions on that, and the outcome will surely affect FIEs.

 

6. Investment from Hong Kong, Macau and Taiwan

This issue is not mentioned in the Foreign Investment Law.  After the closure of the session, the Prime Minister Li Keqiang expressed publicly that administration on investment from Hong Kong, Macau, and Taiwan can refer to administration on foreign investment as provided in this law. Still, specific written provisions are required to justify this decision from legal perspective.

 

7. Variable Interest Entity (VIE) structure

Compared to the draft issued in 2015 and available for public inspection and comments, the approved final version of the Foreign Investment Law has removed clauses on actual controllers and VIE structure.  In such situation, the legality of a VIE structure, and its supervision, both remain in the grey area. Nonetheless, the fallback provision about foreign investment stipulates “the foreign investment in other way stipulated under laws, administrative regulations or provisions of the State Council” and consequently gives space for governmental authorities to decide how to deal with this issue in the future.

 

8.National Security Review

National security review is officially provided in the Foreign Investment Law to apply over foreign investments across the country. Both green land investment and investment through M&A, if they may affect the state security could affected. However, no detailed provisions are made about the scope of review, the competent authorities, documents required, timeline and procedure, factors affecting the review result or even violation consequences etc.  Since the result is final and binding and that no administrative reconsideration or litigation would be allowed, foreign investors - including EU SME investors - should keep a close eye on this.

As a basic law governing foreign investment in China, the general provisions above leave uncertainties as well as space for lobbying.  The EU SME Centre will keep a close eye on it and we will update EU SMEs in the future of any development.

In the end, we would like to remind EU SME investors that the principle of reciprocity is provided in the “Supplementary Provisions” in the current Law, which gives Chinese government flexible space in the future implementation. Foreign investors’ interest may be affected if their home country takes any measures towards Chinese investors which is seen as discriminatory from the Chinese government.

 

EU SMEs can find a Chinese version of the Foreign Investment Law at http://www.chinalaw.gov.cn/Department/content/2019-03/18/592_230773.html for a read.

 

 



[1] Investments are not subject to governmental expropriation

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