Consequences of the new Chinese Foreign Investment Law

The New Foreign Investment Law of the People’s Republic of China (PRC) (the “Foreign Investment Law”) was made effective on January 1st, 2020.
Such law has been a long time coming, ever since the Ministry of Commerce (MOFCOM) in 2015 released a draft of the PRC Foreign Investment Law, in an effort to provide more clarity and transparency.
However, plans for promulgation were put on hold until March 15th 2019, when the PRC government officially passed the new law; a measure which must be analyzed in a context of an ongoing trade-war between the PRC and the US, as well as constant criticism about the country’s reform of its laws to render it more “investment friendly” and more equalitarian between foreign and domestic companies.

Overview of the new Foreign Investment Law

The new Foreign Investment Law is applicable to all foreign investments in the territory of the PRC. Foreign investment is defined as an investment activity directly or indirectly conducted by a foreign natural person, enterprise or other organization. These include the following situations:

1. A foreign investor establishes a foreign-invested enterprise within the territory of the PRC, independently or jointly with any other investor.
2. A foreign investor acquires shares, equities, property shares or any other similar rights and interests of an enterprise within the territory of the PRC.
3. A foreign investor makes an investment to initiate a new project within the territory of the PRC, independently or jointly with any other investor; and
4. A foreign investor makes an investment in any other way stipulated by laws, administrative regulations or provisions of the State Council.

Main Objectives of the law

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.

Also, in what concerns the process of incorporation of new foreign invested companies, such approval 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 said list and must conform to the investment conditions for restricted industries.
Still within this topic, foreign investment should be given equal treatment to domestic investment in industries which are not prohibited or restricted.

Having come into force on January 1st, 2020 the law 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 these 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.

What are the Implications for Foreign-Invested Enterprises in the PRC?

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.

In addition to this, 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 you may find the impact of this new law on foreign invested companies in the PRC:

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:
1. Under the new Foreign Investment Law, WFOEs will no longer be limited to be a limited liability company organizational form, but will also be able to establish a joint-stock company under the Company Law.
2. 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.
3. Lastly, in case of a liquidation, the liquidation committee no longer has to include the legal representative. Instead, it will be formed in accordance with the decision of the shareholders or be determined via the general meeting of shareholders.

Joint Ventures (JVs)

As for existing Joint Ventures, the impact will be the following:
1. In terms of corporate governance, the new highest authority within Joint Ventures is now changed from the Board of Directors to the Board of Shareholders. Something which will allow shareholders to take over the power of decision-making and avoid difficulties to validate legal documents, due to Director(s) refusal of signature, something that unfortunately still occurs a lot.
2. 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.
3. Because 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.

Conclusion

It is still to early to see if the objectives set out for the new Foreign Investment Law will be met. However, in general, this new law has been well received by the international business community at large.
With two months since its entry into force, we at ORBIS will monitor closely what impact will the law have on foreign investors and their companies.
Do not hesitate to contact us if you need any assistance on these matters at contact@orbis-alliance.com