The Impact Of China’s New Foreign Investment Law.

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Asia Pacific Legal Updates

 

9 April, 2019

 

 The Impact Of China’s New Foreign Investment Law.

 

On 15 March 2019, China approved a new foreign investment law to further expand its opening up to, and promotion of, foreign investment. The new law enhances protections for foreign investors’ rights and interests, and standardises foreign investment regulation.

 

The new Foreign Investment Law of the People’s Republic of China, summarised in our previous e-bulletin will come into effect on 1 January 2020. Whilst the broad provisions of the new law create a general framework that places foreign investors and foreign-invested enterprises (FIEs) on an equal footing with domestic investors and domestic companies, there are aspects that require further clarification.

 

This bulletin analyses some of the open questions.

 

Five-year transitional period

 

The new foreign investment law unifies the existing foreign investment legal regime under a single, consolidated piece of legislation. It will replace the existing suite of legislation on foreign investment, namely the Law on Wholly Foreign-owned Enterprises, the Law on Sino-Foreign Equity Joint Ventures and the Law on Sino-Foreign Cooperative Joint Ventures. Under the new law, any FIE established after 1 January 2020 will need to comply with either the Company Law or the Partnership Enterprise Law of the PRC (as applicable) in respect of areas such as organisational form, corporate structure and governance.

 

Most FIEs in China nowadays are established within the current legal framework and laws mentioned above. The new foreign investment law provides a five-year transitional period starting from 1 January 2020 in which FIEs established prior to the new law's commencement date can retain their original organisational forms.

 

Since wholly foreign owned enterprises are basically limited liability companies incorporated in accordance with the Company Law, there will be no substantial impact on such enterprises. However, Sino-foreign cooperative joint ventures and Sino-foreign equity joint ventures established under the existing regime will need to restructure to meet the Company Law or Partnership Enterprise Law requirements. In particular, there are significant differences between the existing regime and the Company Law in a number of aspects including the following:

 

Matter

Company Law

Law on Sino-Foreign Equity Joint Ventures

Law on Sino-Foreign Cooperative Joint Ventures

 

Investment percentage of foreign investor

No restriction

Generally no less than 25%

Generally no less than 25%

 

Highest authority

Shareholders' meetings

Board of directors

Board of directors or joint management committee

 

Minimum number of members in the board

Permitted to have one executive director

No fewer than three directors

Board of directors or joint management committee must have no fewer than three members

 

Quorum

None

Two thirds or more directors

Two thirds or more of the members of the board of directors or joint management committee

 

Term of directors

No more than three years

Four years

No more than three years

 

Voting mechanism for major matters (e.g. increase of registration capital and total investment)

Approval by shareholders representing more than two-thirds of the voting rights

Unanimous approval by directors present at the meeting

Unanimous approval by members present at the meeting

 

Profit distributions

Distributions based on proportion of paid-in capital, unless otherwise agreed by all shareholders

Distributions based on registered capital ratios

In accordance with contractual joint venture contract

 

Equity transfer restrictions

Approval by more than half of the other shareholders, unless otherwise agreed in the articles of association

Unanimous approval by the other shareholders

Unanimous approval by the other members

 
 

During the transitional period, we expect that the local bureau of the State Administration for Market Regulation (essentially the business registry) may in practice require FIEs to update their articles of association and joint venture agreements to bring them in line with the Company Law before it will process registration of any corporate changes.

 

Given this, we recommend that foreign investors start considering the necessary amendments to their joint venture agreements to avoid any future delays in processing registration of corporate changes.

 

New FIEs to be established before 1 January 2020

 

Since the new law will take effective on 1 January 2020, technically Sino-foreign cooperative joint ventures and Sino-foreign equity joint ventures established between now and that date will still be subject to the existing regime and laws. However, the effect of the new law should be taken into consideration, and we recommend that new FIEs consult with the local competent authorities whether they should adopt the existing regime and laws as governing law and transit to the Company Law or the Partnership Enterprise Law over the 5-year transitional period.

 

Other issues

 

Chinese citizens investing in FIEs

 

The existing laws on Sino-foreign equity joint ventures and cooperative joint ventures do not allow Chinese citizens to invest in Sino-foreign joint ventures.

 

However, Chinese citizens are permitted to remain as investors in FIEs upon obtaining relevant approvals of competent PRC authorities under existing merger and acquisition provisions, if they are shareholders of the domestic companies before its acquisition by foreign investors. The new foreign investment law does not specifically deal with whether Chinese citizens are permitted to invest generally in FIEs making the position under the new law still unclear.

 

Regulation of VIE structures remains uncertain

 

Despite the earlier draft of the new foreign investment law attempting to include regulations on VIE structures, the officially approved version of the new law remains silent on VIE structures. However, the definition of “indirect foreign investment” in the new law includes a miscellaneous clause which leaves it open for the authorities to include VIE structures with the scope of the new law in the future.

 

Capital contribution in the form of shares and acquisitions in the form of share exchanges

 

The new law does not include any restrictions on the ratio between total investment and registered capital of a FIE, the form of capital contributions to a FIE by foreign investors or the form of payment for acquisitions of a domestic PRC company by foreign acquirers (e.g. under Document No. 10, cross border share swap is subject to very stringent requirements and approval of MOFCOM). It remains to be seen whether the Chinese government will revise the relevant regulations to remove these restrictions.

 

The reform of the foreign investment regime is a systematic project and requires various foreign investment regulations to be amended. We will keep a close eye on developments and the release of implementation regulations and measures and will keep you updated.

 

herbert smith Freehills

 

 

For further information, please contact:

 

Nanda Lau, Partner, Herbert Smith Freehills

nanda.lau@hsf.com