15 March 2019

Into A New Era: Changes and Challenges in the Foreign Investment Legal Regime of China

By: Kaiding Wang (王开定), Jian Zeng (曾坚), Bing Chen (陈兵), Xiaopeng Feng (冯晓鹏), Zhen Zhao (赵臻), Yuanyuan (Yvonne) Cheng (程圆圆), He Huang (黄荷), Mengting Huang (黄梦婷), Siying Huang (黄思颖), Linfei Hou (侯林菲), Dongjing Wei (魏冬京)

On March 15, 2019, the National People’s Congress of the PRC (the “NPC”) approved the Foreign Investment Law of the PRC (the “FIL”) at the closing meeting of the second session of the 13th NPC, which will come into force on January 1, 2020 (the “FIL Effective Date”).  FIL, upon taking effect, will replace the three existing laws on foreign investment (the “Three FDI Laws”, i.e., the Law on Sino-Foreign Equity Joint Ventures (the “EJV Law”), the Law on Sino-Foreign Contractual Joint Ventures and the Law on Wholly Foreign Owned Enterprises) (the “CJV Law”) and become a fundamental law of China in the foreign investment area, setting forth the basic legal framework in this regard. 

This article aims to provide a brief introduction of the highlights of FIL and analyze the changes and challenges that investors, authorities and practitioners may face after the new law becomes effective.

SECTION I. HIGHLIGHTS

FIL consists of 6 chapters (including General Provisions, Investment Promotion, Investment Protection, Investment Administration, Legal Liabilities and Miscellaneous) and 42 articles, including the following highlights:  

1. From Three Laws to One Unified Law 

Being the first unified law in the foreign investment area, FIL will replace the Three FDI Laws, upon taking effect (Article 42).  Any foreign invested enterprise (the “FIE”) established after FIL Effective Date shall comply with the Company Law of the PRC (the “Company Law”) or the Partnership Enterprise Law of the PRC (as applicable), in terms of its organization form, corporate structure and bylaws.  For FIEs established before FIL Effective Date, FIL grants them a five-year transitional period, during which these FIEs may continue to retain their existing organization form, corporate structure and bylaws (Article 42).  

2. Scope of Foreign Investment

(a) Four approaches of foreign investment 

FIL clearly sets forth that foreign investment may be conducted through the following four ways: (i) greenfield investment, (ii) mergers and acquisitions (“M&A”), (iii) investment in a new project and (iv) other approach stipulated under laws, administrative regulations and provisions of the State Council (Article 2).  This way, it is made clear that, in addition to the greenfield investments, foreign investments via M&A, project investment and other permitted approach shall all fall within the jurisdiction of FIL.

In contrast, under the current legal regime, while the Three FDI Laws mainly focus on greenfield investment (as well as the operations of FIEs after an entity becomes an FIE due to M&A), foreign investment through M&As is mainly governed by the Regulations on Foreign Investors' Mergers and Acquisitions of Domestic Enterprises promulgated by the Ministry of Commerce ("Circular 10") and the Administrative Measures for Foreign Investors' Strategic Investment in Listed Companies promulgated by the Ministry of Commerce (“MOFCOM”) jointly with other four ministries and commissions (the “Administrative Measures on Strategic Investment”).  

(b) Direct and Indirect Investment

The Three FDI Laws only contain provisions about direct investment and are silent on indirect investment.  Provisions regarding indirect investment are mainly set forth in the Interim Provisions on Investment Inside China by FIEs, which only address issues in connection with investments made by FIEs but have no provisions about further investment made by FIE-invested enterprises or their subsidiaries. 

FIL clearly specifies that foreign investment includes direct foreign investment and indirect foreign investment.  However, there is no further explanation about what would constitute an "indirect foreign investment" (for example, whether an investment made by an FIE’s direct subsidiary (or indirect subsidiary) would constitute an “indirect foreign investment”). 

3. Negative List, Information Reporting and Security Review

In connection with two of the foreign investors’ major concerns – market entrance and un-transparent administrative approval system – FIL reinstates that China implements policies with high-level investment liberalization and convenience, establishes and improves a foreign investment promotion mechanism, and creates a stable, transparent and predictable market environment featuring fair competition (Article 3). 

Under the Three FDI Laws, foreign investment projects are subject to “case-by-case approval” by the competent administration authorities (i.e., MOFCOM and its competent local counterparts).  An FIE can be established only after the requisite administrative approval has been obtained.  (Note: after the implementation of the negative list system in 2016, the “case-by-case approval” requirement no longer applies to many types of foreign investment projects).  

FIL officially abolishes the "case-by-case approval" system and establishes a the administration system of national treatment plus negative list for foreign investment (Articles 4 and 28) which mainly consists of the negative list administration, the foreign investment projects reporting  and the national  security review, aiming to improve the transparency of administration over foreign investment  and ensure that FIEs can participate in market competition on an equal basis.

(a) Negative list (Articles 4 and 28)

FIL provides that, with respect of foreign investment administration, China adopts a system of national treatment plus negative list.  The negative list will be issued by, or released upon approval by, the State Council.  The negative list consists of a list of industry sectors in which foreign investments are prohibited (the “Prohibited Sectors”) and a list of industry sectors in which foreign investments are restricted (the “Restricted Sectors”).  In the Prohibited Sectors, foreign investors areprohibited from making investments, while in the Restricted Sectors, foreign investments must satisfy with conditions stipulated in the negative list.  In the industry sectors that are neither Prohibited Sectors nor Restricted Sectors, foreign investment and domestic investment will be treated equally.

(b) Information reporting system (Article 34)

The State establishes a foreign investment information reporting system. Foreign investors or FIEs shall submit investment information to the competent authorities through the system of enterprises registration and the disclosure of enterprise credibility information to public. 

(c) Security review system (Article 35)

According to Article 35 of FIL, the State establishes a security review system to conduct security review over foreign investment projects that affects or may affect national security. 

(d) Administration measures of other governmental authorities (Articles 3, 29, 30, 32, 33 and 41) 

It is worth noting that MOFCOM is the authority in charge of the regulatory matters mentioned in section (a), (b) and (c) above.  In addition to MOFCOM, FIL also clearly set forth other government authority’s responsibilities and authorities in connection with foreign investment, which lays a systematic framework for the administration of foreign investment: 

(i) for any investments that are subject to project approval or record-filing, the investors shall comply with the project approval or record-filing requirement (Article 29; currently the authority in charge of project approval and record-filing is the National Development and Report Commission (“NDRC”)); (ii) for any investments that are subject to license and permit requirement, the investors shall apply with the relevant industrial regulatory authorities to obtain the requisite licenses and permits (Article 30); (iii) FIEs shall handle its tax, accounting, foreign exchange and other matters with the relevant regulatory authorities (Article 32); (iv) for any investment triggering an anti-trust review under the Anti-monopoly Law, the investors shall apply for an anti-trust review accordingly and (v) when making investments in financial industry such as banking, securities and insurance and the financial markets such as securities exchange and foreign exchange market, regulations in those industries and markets shall apply (Article 41). 

4. Protection of Intellectual Property Rights 

In responding to foreign investors’ concerns about IP protection in China, FIL clearly sets forth that China protects the intellectual property of foreign investors and FIEs, and protects the legitimate rights and interests of the intellectual property owners and the relevant right holders; any infringement upon intellectual property rights is subject to legal liabilities.  The State encourages voluntary technology cooperation in accordance with commercial rules in the process of foreign investment. The terms and conditions of technology cooperation shall be negotiated and determined between the relevant parties under the principle of fairness, and no administrative organ or functionary thereof may force the transfer of any technology by administrative means (Article 22). 

5. Protection of Legitimate Rights and Interests

In connection with foreign investors’ concerns about non-national (less favorable) treatment, FIL clearly protects the legitimate rights and interests of foreign investors and FIEs in China, including: 

(a) The State's various policies in support of enterprise development shall apply equally to FIEs in accordance with applicable law (Article 9); 

(b) The State protects the FIEs’ right to equally participate in the standards formulation procedure; and the compulsory standards set by the State shall equally apply to FIEs (Article 15); 

(c) The State protects the FIEs' right to participate in government procurement activities through fair competition; and the products produced and services provided by FIEs within the territory of China shall be equally treated in government procurement according to law (Article 16); 

(d) Similar to domestic companies, FIEs may conduct financing via public offering, issuance of corporate bonds or other securities, and other approaches in accordance with applicable law (Article 17);

(e) Foreign investors may freely remit into or out of China, in Renminbi or any other foreign currency, their contributions, profits, capital gains, income from asset proposal, intellectual property royalties, lawfully acquired compensation, indemnity or liquidation income and the like (Article 21);

(f) The administrative organ and its functionaries shall keep confidential the trade secrets of FIEs they become aware of in the course of performing their duties, and shall not divulge or illegally provide such secrets to others (Article 23); 

(g) In formulating normative documents concerning foreign investment, the people's governments at all levels and their departments concerned shall not impair FIEs' legitimate rights and interests or increase their obligations (Article 24); 

(h) Local people's governments at all levels and their departments concerned shall honor the policy commitments lawfully made to foreign investors and FIEs and perform all contracts concluded according to the present Law.  If any policy commitment or contract needs to be changed due to national interests or public interests, changes can be made only within their statutory authority and relevant procedures shall be followed. In addition, the foreign investors or foreign-funded enterprises concerned shall be properly compensated according to the present Law for the losses incurred as result of such change. (see Article 25). 

SECTION II. CHANGES AND CHALLENGES

On one hand, FIL will bring significant changes to the foreign investment legal regime and lead the foreign investment into a new era; on the other hand, FIL only sets out the general principles on foreign investment, and many implementation details are pending further clarification by the State Council, MOFCOM and other relevant authorities.  We set forth below some analysis and suggestions on the changes, as well as challenges the investors, regulatory authorities, law practitioners and other relevant parties may face, after FIL comes into effect. 

1. More detailed measures are needed for the implementation of the negative list system, the information reporting system and the security review system. 

China began to implement a negative list system for the administration of foreign investment since 2016, the latest amendment to the Three FDI Laws.  On June 28, 2018, the National Development and Reform Commission (“NDRC”) and MOFCOM jointly released the Special Administrative Measures for Foreign Investment Access (Negative List) (2018 version) (the “Negative List 2018 Version”), which established the negative list system for the administration of foreign investment.

Under the negative list system, for foreign investment in the industry sectors within the negative list, the “case-by-case approval” system continues to apply, while in sectors that do not fall within the negative list, foreign investments are given equal treatment to domestic Chinese investments, save for record-filing requirements pursuant to the Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises. 

After the FIL Effective Date, the Three FDI Laws will be invalid and consequently the “case-by-case approval” system will be of no legal basis.  Therefore, it is expected that the State Council and/or MOFCOM may issue new regulations on the management of those foreign investment projects in industry sectors  within the negative list.

Furthermore, FIL does not contain provisions on record-filing of foreign investments in industry sectors outside the negative list.  Hence, it is expected that MOFCOM would issue more detailed measures or guidelines in order to implement the foreign investment information reporting system.  The implementation rules may be drafted based on the existing Provisional Measures on Administration of Filing which is expected to be repealed after the new rules being promulgated.

The existing regulations relating to national security review are the Notice on Establishing a Security Review System for Foreign Investors' Mergers and Acquisitions of Domestic Enterprises released by the General Office of the State Council in 2011 and the Regulations on Implementing the Security Review System for Foreign Investors' Mergers and Acquisitions of Domestic Enterprises released by MOFCOM.  

A previous draft of FIL released by MOFCOM in 2015 soliciting public comments (the “2015 Draft”) had one chapter stipulating the national security review system, with an attempt to set up a relatively comprehensive regime on the national security review system.  Since there is only one clause (i.e. Article 35) as a principle provision to address the security review issue in FIL, the specific content of the security review system remains to be stipulated by the State Council.

2. “Indirect Investment” and implementation of negative list.

The Three FDI Laws only regulate the first-layer investment activity by foreign investors in China.  The Interim Provisions on Investment Inside China by FIEs only regulates the second-layer foreign investment in China (i.e., the investment activities conducted by FIEs.  There are no existing regulations regulating the down-stream foreign investments (i.e. the investment activities carried out by the enterprises invested by FIEs and their subsidiaries).

Article 2 of FIL defines foreign investment to include both “direct” investment and “indirect” investment by foreign investors.  However, there are no further explanation on "indirect investment".  

What constitutes of “indirect investment” is important with respect to the implementation of the negative list.  One of the objects of foreign investment regulation is to prevent foreign investors from evading negative list administration through various indirect investment methods. Therefore, whether China will adopts the “penetration principle”, to which level the “penetration principal” will be used, whether “control” will be used as a standard, whether it is limited to the fields specified in the negative list, and the administration methods (licensing or filing) etc. are all pending the relevant authorities’ further clarification.

3. VIE Structure continues to be in the grey area.  

The VIE structure, also known as "contractual arrangements", is commonly used by foreign investors to invest in China in industry sectors where foreign investments are prohibited or restricted, and also used as means for Chinese domestic companies to achieve an offshore financing or listing.  The 2015 Draft attempted to cover the VIE structure as a form of foreign investment.  However, FIL does not contain content regarding the VIE structure issue.  Nevertheless, when enumerating forms of foreign investments, Article 2 of FIL includes a catch-call clause: “other forms of investment stipulated in laws, administrative regulations or by the State Council”, which leaves room for regulating the VIE Structure as a form of foreign investment in the future.

4. Governing law 

Pursuant to the Implementation Regulations on the Sino-foreign Equity Joint Venture Law (the “EJV Regulations”) and the Implementation Regulations on the Sino-foreign Contractual Joint Venture Law (the “CJV Regulations”), the formation, validity, interpretation, execution and dispute resolution of the equity joint venture contracts and contractual joint venture contracts must be governed by the laws of the PRC.  Circular 10 also stipulates that, in connection with an acquisition of domestic company by foreign investor(s) defined thereunder, the equity purchase agreement, the capital increase agreement and the asset purchase agreement must be governed by the laws of the PRC.  The above-mentioned governing law requirement was embedded into the Contract Law in 1999 and upgraded from a regulation-level legal requirement to a law-level legal requirement.  Article 126 of the Contract Law provides that the Sino-foreign equity joint venture contracts, Sino-foreign contractual joint venture contracts and contracts for Sino-foreign cooperative exploration and exploitation of natural resources, which are to be performed within the territory of the PRC, shall be governed by the law of the PRC.  

Nevertheless, the concepts of “Sino-foreign equity joint venture contracts” and “Sino-foreign contractual joint venture contracts” used in Article 126 of the Contract Law were derived from the Three FDI Laws and the above-mentioned EJV Regulations and CJV Regulations.  Upon FIL taking effect, the above-mentioned EJV Regulations and CJV Regulations are expected to be repealed at the same time as the Three FDI Laws are repealed.  Therefore, the terms of “Sino-foreign equity joint venture contracts” and “Sino-foreign contractual joint venture contracts” will lose their legal basis.  It is expected that the Contract Law will be amended accordingly to address the governing law issue, though it is not clear whether the investors (including foreign investors) will be given the flexibility to choose the governing law of their investment agreement. 

Similarly, once the Three FDI Laws repeal, the relevant provisions in Circular 10 regarding the equity purchase agreement, the capital increase agreement and the asset purchase agreement shall be governed by the laws of the PRC may also need to be amended.

5. Profits may be distributed NOT in proportion to the shareholders’ respective of capital contribution; in a liquidation process, however, the remaining assets must be distributed in proportion to the shareholders’ equity-holding percentage 

In the current legal regime, the Sino-foreign Equity Joint Venture Law requires that the investors of an equity joint venture (“EJV”) shall share profits and bear risks and losses in proportion to their respective contribution to the registered capital of the EJV.  In contrast, the Sino-foreign Contractual Joint Venture Law allows the Chinese and foreign investors to allocate the profits of the contractual joint venture (“CJV”) according to contractual provisions.  As a result, in practice, if the parties wish to share profits NOT in proportion to their respective contribution to the registered capital, usually they can only choose to set up a CJV rather than an EJV.

Article 31 of FIL provides that, upon the repeal of the Three FDI Laws, the operations of the FIEs shall comply with the Company Law.  According to the Company Law, a limited liability company may distribute profits to shareholders NOT in proportion to their respective equity-holding percentage in the company, if the distribution plan has been unanimously agreed among all shareholders.  In this connection, it is expected that the investors of EJVs may have more flexibility in dividend distribution in the future.

Under the current legal regime, the legal provisions regarding allocation of a company’s remaining assets to its shareholders after the completion of the company’s liquidation process are different.  The EJV Regulations allow the shareholders to negotiate separately the allocation of the remaining property.  The CJV Law allows the remaining assets to be allocated in accordance with the agreement between shareholders.  In the Company Law, however, the company’s remaining assets shall be distributed in proportion to the shareholders’ respective contribution to the registered capital of the company.  

After the repeal of the Three FDI Laws and the expiration of the five-year transitional  period, the FIEs are required to revise their AOA to comply with the Company Law provisions.  At that time, a distribution of remaining assets not in proportion to the shareholders’ respective capital contribution may face difficulties when remitting the remaining assets (in cash) out of China.

6. No further approval required for amendments to joint venture contracts and articles of association.

Under the Three FDI Laws, the EJV Regulations and CJV Regulations, the joint venture contracts and articles of association of EJVs and CJVs, as well as any amendments thereto, are subject to approval by MOFCOM or its competent local counterparts.  On September 3, 2016, the State Council amended the Three FDI Laws and expressly provided that, for any investments that are not subject to specific foreign investment entrance management, MOFCOM would no longer review and approve the joint venture contracts and articles of association.

FIL does not include concepts of “equity joint venture contracts” and “contractual joint venture contracts”, nor does it contain any provisions subject the joint venture contracts and the articles of association to approval by any governmental authorities.  Hence, the “case-by-case approval” system will officially come to an end.  The regulatory authorities will no longer interfere with the specific contents of the joint venture contracts and the articles of association.

7. Unanimous consent of equity transfer and “deemed consent”

Pursuant to the EJV Regulations and CJV Regulations, an investor of an EJV or a CJV must obtain consent from all other investors in order to transfer all or part of its equity/rights to a third party.

Equity transfers of purely domestically funded companies are governed under Article 71 of the Company Law.  Instead of a unanimous consent from all other shareholders, Article 71 of the Company Law only require the transferring shareholder to obtain consent of more than 50% of the other shareholders.  Article 71 also sets forth that a shareholder who neither grants its consent to the transfer nor agrees to purchase the transferred equity will be deemed to consent to such transfer.  

Historically, there was a debate about whether the “deemed consent” provision under the Company Law should also apply to FIEs.  In order to avoid disputes, some FIEs even expressly provided in their joint venture contracts and articles of association that the “deemed consent” provision shall not apply.  However, the Supreme People’s Court confirmed in the Provisions on Several Issues Concerning the Trial of Disputes Cases related to Foreign-invested Enterprises (I) that the “deemed consent” provision under the Company Law also apply to foreign-invested enterprises.  

Upon repeal of the Three FDI Laws, it is not clear whether the Supreme People’s Court’s judicial interpretation will continue to be valid.  Nevertheless, pursuant to Article 31 of FIL, all operations of FIEs will be governed by the Company Law, which we understand also include equity transfer.  

8. Round-trip acquisition

Pursuant to Circular 10, round-trip investments are subject to the approval by MOFCOM.  To avoid the uncertainty of MOFCOM approval results, investors made great efforts to structure their transaction in ways not to trigger a round-trip investment approval.  So far as we know, no round-trip investment application was filed ever since Circular 10 came into effect in September 2006.

Under FIL, only foreign investments falling within the negative list are subject to approval by MOFCOM or its competent local counterpart.  The administration on round-trip investment and the administration on investments falling within the negative list are different, by nature.  Hence, the legal basis that subject round-trip acquisitions to MOFCOM approvals will be lost upon FIL’s implementation, in particular, if Circular 10 will repealed together with the Three FDI Laws.  To continue MOFCOM’s authority to review and approve round-trip acquisitions, the relevant authorities may need to publish new regulations. 

9. Capital contribution in form of equity and share swap

Under the Three FDI Laws, investors are only allowed to make capital contributions in forms of cash, in kind, intellectual property right and other property rights.  “Equity” that the investor holds in another entity is not one of the permitted forms of capital contribution.  Hence, for a long period of time, foreign investors could not establish foreign-funded enterprises by making contributions in equity, and successful acquisition cases in form of share swap are also very limited.

After the amendment of the Company Law in 2005, investors are allowed to make capital contributions by using non-monetary properties that can be valuated and transferred in accordance with the law, such as equity.  However, both of the Administrative Provisions on Registration of Registered Capital of Companies and the Interim Provisions of Ministry of Commerce on Capital Contribution in the Form of Equity of Foreign Investment Enterprises only allow investors to make capital contribution by using equity they hold in enterprises in China (not equity or shares of enterprises outside China).

Circular 10 further allows foreign investors to use the shares or equity interest of an overseas listed company or an overseas special-purpose vehicle as payment method to acquire shares or equity of domestic companies in China.  

In 2018, MOFCOM publized a draft Amendment to the Administrative Measures on Strategic Investment, soliciting public comments.  The draft also provided that, subject to certain conditions, foreign investors may strategically invest in a Chinese listed company by using the equity they hold in overseas companies or by using new shares to the Chinese company as means of payment.

With the repeal of the Three FDI Laws, there are no legal restrictions preventing foreign investors from making capital contribution in equity or conducting acquisition by means of share swap.  However, Circular 10 and the Administrative Provisions on Registration of Registered Capital of Companies are still the current valid regulations.  Whether the cross-border share swaps will be liberalized is still unclear and to be clarified by the relevant authorities.

10. Can Chinese natural persons establish FIEs with foreign investors?

The EJV Law and the CJV Law only allow foreign investors to set up EJVs and CJVs with Chinese companies, enterprises or other economic organizations, while Chinese natural persons are not allowed to establish new EJVs and CJVs with the foreign investors.

To facilitate the foreign investors’ acquisitions of domestic enterprises established by Chinese natural persons, Circular 10 allows Chinese natural persons who are the shareholders of the target companies to remain as shareholders of the target company after the completion of the acquisition, although upon completion the target company has been converted from a domestic company into an FIE.

FIL does not clearly address this issue.  Article 2 of FIL mentions “other investors”.  However, FIL neither sets out the scope of “other investors”, nor does it excludes Chinese natural person from the scope of “other investors”.  It is unclear whether this should be interpreted in the direction that Chinese natural persons can also cooperate with foreign investors to establish new FIEs.

According to Article 18 of the Constitution of the People's Republic of China (Amended 2018), the State permits foreign investors to invest in Chinese enterprises and to enter into various forms of economic co-operation with other economic organizations.  However, this provision does not mention Chinese natural persons either.  Therefore, whether Chinese natural persons can establish new FIEs with foreign investors remains unclear.

One question related to Chinese natural persons is that if a Chinese natural person subsequently acquires foreign citizenship, whether his/her investment in China will become FIEs and consequently be subject to FIL.  The 2015 Draft gave a “yes” answer to this question.  However, the final published version of FIL does not have explicit provisions on this question.  A literal reading of FIL suggests that the answer to the aforesaid question should be “yes” because the Chinese citizen becomes a foreign citizen (foreign investor) when acquiring foreign citizenship.

Another question related to Chinese natural persons is that if a Chinese natural person invests in China through a foreign company under his/her control, whether such investment constitutes a foreign investment.  The 2015 Draft deemed such investment as investment by Chinese investors; but FIL continues to adopt the “incorporation place” principle – whether an investment constitutes a foreign investment will be determined based on the incorporation place (or nationality, in case of a natural person) of the investors.

11. “Investment in new projects” needs further clarification.

In addition to the greenfield investments and M&As, the scope of foreign investment stipulated in Article 2 of FIL includes “investment in new projects”.  Further clarification is needed for answering the following questions: whether “investment in a new project” refers to an investment project that foreign investors carried out through contractual arrangement (such as natural resources exploration and exploitation concession agreement, infrastructure construction and operation concession agreement, etc.) and how to apply the foreign investment administration system (such as information reporting system, security review system, etc.) to such new projects in practice.

12. Five-year transitional period

FIL grants a five-year transitional period after the FIL Effective Date in which FIEs established pursuant to the Three FDI Laws prior to the effectiveness of FIL may keep their original organizational forms.  However, it is not clear whether the joint venture contracts and articles of association of the existing FIEs will continue to be effective and enforceable during the transitional period, even if the Three FDI Laws will be repealed upon the FIL Effective Date.

The question is relatively complicated and requires a case by case analysis.  For example, some clauses in the joint venture contracts and articles of association will automatically become invalid due to the repeal of the Three FDI Laws, such as the unique terms in the Three FDI Laws that the joint venture contracts would come into effect only after the competent authority’s approval.  These terms will not lead to disputes even without revision.  However, other terms may need a negotiation between the parties before the amendment, such as the voting mechanism of the board of directors.  Some provisions are mandatorily required under the Company Law, so a revision is a must -- for example, the establishment of a shareholder meeting, the FIEs need to establish a shareholder meeting in compliance with the Company Law.  Therefore, it is necessary to amend the joint venture contract and articles of association and establish a shareholder meeting during the transitional  period.  While, other than those mandatory requirements under the Company Law, for provisions within the shareholder autonomy, there is no need to amend during the transitional  period, even when there is inconsistency with contents of the Company Law.

Does the requirement of the five-year transitional period means that the FIEs and the joint venture parties need to revise the existing joint venture contracts and articles of association during the five-year transitional period, and go through the relevant approval and filing procedures?  There is possibility that the parties may not reach an agreement with respect to some clauses.  What are the consequences if the transitional period expires while the parties still have not reached the agreement, or have not gone through the relevant approval or filing procedures?  FIL does not have provisions in this regard, which leaves uncertainty for the future.  For example, after the expiration of the five-year transitional period, there may be circumstance that the registration authority refuses to handle the relevant change filing on the ground that the company's articles of association do not comply with the provisions of the Company Law.  In addition, a shareholder may claim that certain terms of the agreement are invalid on the basis that the equity interest transfer method as stipulated in the joint venture contracts and article of association does not comply with the provisions of the Company Law.  In such circumstance, how will the court or arbitration tribunal apply the law?

13. The transitional period between the release day and effective day

The FIL will come into force on January 1, 2020.  During the period from March 15, 2019 through January 1, 2020 (the “Pre-effective Transitional Period”), foreign investment will continue to be subject to the Three FDI Laws.  However, considering the fact that after the repeal of the Three FDI Laws, the joint venture contracts and the articles of association formulated in accordance with the Three FDI Laws are subject to revision, during the Pre-effective Transitional Period, if the parties intend to, whether the FIL and the Company Law could directly apply when formulating the contracts and the articles of association? This question is pending clarification by the regulatory authorities.

14. Amendment of the contracts and the articles of association, establishment of shareholder meeting, and the adjustment of the rules of the board of directors

For EJVs and CJVs in the form of limited liability companies, one significant feature in the corporate governance is that the board of directors is the highest authority, which determines all major matters of the enterprise.  Both the EJV Regulations and CJV Regulations have set forth a list of matters subject to the unanimous resolutions of the board of directors.

With the repeal of the Three FDI Laws, these provisions will also become history.  Thereafter, pursuant to the Company Law, for any FIE in the form of a limited liability company, the shareholder meeting will be the highest authority, and the shareholder meeting and the board of directors will divide their responsibilities and authorities in accordance with the Company Law.  The amendment of the company's articles of association, increase or decrease of the registered capital, and the merger, division, dissolution or change of the company's form are no longer the matters subject to unanimous resolutions of the board of directors, but are subject to affirmative vote of shareholders representing no less than two-thirds of the total voting power participating in a shareholders meeting.  In addition, the Three FDI Laws and the Company Law also have inconsistencies regarding the number of board members, the term of office, the quorum required for board meetings, and appointment of directors -- the Company Law provisions shall govern after FIL comes into effect.

In light of the above, after FIL coming into force, the existing FIEs will need to revise the joint venture contracts and the articles of association as soon as possible.  The adjustments may include: (i) adjusting the highest authority of the company from the board of directors to the shareholder meeting; (ii) adding relevant provisions regarding the power of the shareholders, the voting methods, etc.; and (iii) adjusting relevant provisions regarding the duties and responsibilities of the board of director, the election method of directors, the voting mechanism and the quorum of board meetings, etc.

Due to the difference between the Three FDI Laws and the Company Law in corporate governance, it is foreseeable that the investors will start a new round of negotiations on the corporate governance and the business terms associated therewith, when adjusting the joint venture contracts and articles of associations of their EJVs and CJVs in accordance with the Company Law.

15. Investment by Hong Kong, Macao and Taiwan investors

Under the current foreign investment legal regime, investment by Hong Kong, Macao and Taiwan investors are administrated with reference to the relevant provisions of the Three FDI Laws.  

However, Hong Kong, Macao and Taiwan investors do not fall within the scope of “foreign investors” under FIL, and FIL does not contain provisions about investment from Hong Kong, Macao and Taiwan.  Whether investment of Hong Kong, Macao and Taiwan will be administered with reference to the provisions of FIL is pending for clarification by the State Council and MOFCOM.

16. Sorting out and adjustment of existing foreign investment laws and regulations and special policies 

FIL clearly specifies that the Three FDI Laws will be repealed upon FIL taking effect.  However, it is silent about the validity of other administrative regulations, departmental rules and normative documents (the "Existing Foreign Investment Regulations") which were formulated based on the Three FDI Laws.  The most urgent issue to be solved is to release new regulations or revise or repeal those existing Foreign Investment Regulations in the area of commerce administration, development and reform, industry and commerce, foreign exchange and finance and taxation, etc. 

In addition, various rules, measures and policies have been issued to regulate FIEs’ operations, which include: (i) regulations on re-investment of FIEs inside China; (ii) regulations on the administration of total investment, registered capital and foreign debt of FIEs; (iii) regulations regulating foreign-invested investment companies and foreign-invested start-up enterprises; (iv) regulations on the merger and acquisition under the Circular 10 and the Administrative Measures on Strategic Investment.  How to sort out and adjust these policies also needs further clarification. 

SECTION III. Conclusion

The reform of the foreign investment administration regime is a systematic project.  After the formal enact of FIL, we will keep a close eye on further clean-up and adjustment of the Existing Foreign Investment Regulations and the release of implementation regulations and measures.  We also suggest that existing FIEs should pay close attention to the relevant provisions of FIL and the upcoming implementation regulations and measures, and should adjust their charter documents, organizational form, organizational structure and other matters in a timely manner and actively grasp new opportunities for foreign investment in the new era. 

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    It’s particularly worth noting that, the NDRC made restrictive interpretations with respect to the scope of sensitive projects.

    10 July 2018

    China's SAFE recently made several enhancements to an existing pilot program regarding the cross-border transfer of Chinese NPLs to foreign investors.

    12 June 2018

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