China's Draft Foreign Investment Law - A Move Towards A Unified Legal System

The 2018 Draft, however, deletes from the definition of “foreign investment” “controlling domestic enterprises or holding rights and interests in domestic enterprises through contracts, trusts, etc.”, along with certain other scenarios, namely, the “providing financing of terms of one year or more to domestic enterprises in which [the foreign investor] holds an interest”, “acquiring concessions for the exploration and development of natural resources, or obtaining concessions for the construction and operation of infrastructure within territory of China or other regions under the jurisdiction of China” and “acquiring real estate rights such as domestic land-use rights and real estate ownership within the territory of China.” Instead, the 2018 Draft adds a catch-all provision, namely, “investments made by foreign investors in China through means stipulated by laws or administrative regulations or other methods prescribed by the State Council.” In addition, the concept of “actual control” and related provisions as first proposed in the 2015 Draft are deleted in their entirety.

Besides the above most significant difference, the 2018 Draft is also different from the 2015 Draft in certain other respects, for example:

1. The 2018 Draft has substantially simplified the original provisions in the 2015 Draft in connection with access administration, national security review, information reporting and coordination in handling of complaints, which in our view have been left for future implementation rules for the Foreign Investment Law.
2. While keeping the chapters in connection with investment promotion and investment protection, the 2018 Draft also further adds or enhances certain concrete provisions, including that: (i) in the process of foreign investment, technology cooperation conditions shall be determined by all investment parties upon negotiation, and no administrative organ or functionary thereof may force the transfer of any technology by administrative means; (ii) local governments at all levels and their departments concerned shall strictly keep policy commitments lawfully made to foreign investors and foreign-funded enterprises and perform all contracts concluded according to the present laws; and (iii) where the State expropriates foreign investment as per public benefit requirements in a special circumstance, statutory procedures shall be followed, and “fair and reasonable” compensation shall be paid.

How would the three foreign capital laws – (Law on Sino-Foreign Equity Joint Ventures, Law on Sino-Foreign Contractual Joint Ventures and Law on Foreign Capital Enterprises) differ from the new Foreign Investment Law? What regulations are kept or omitted?

The three foreign capital laws regulate three different types of foreign-invested enterprises respectively, while the new Foreign Investment Law provides for a unified legal system for all foreign-invested enterprises, regardless of the specific type of a foreign-invested enterprise.  On the other hand, the 2018 Draft adopts a “national treatment plus negative list” standard, namely, for the fields not mentioned in the negative list for foreign investment access, management shall be conducted under the principle of consistency of domestic and foreign investment. In this regard, a lot of rules under the existing three foreign capital laws, that are substantially different from the general Companies Law, particularly those in relation to access administration and corporate governance, may be modified or even abolished after the new Foreign Investment Law comes into effect.

How has the reform of FDI regulations over the last 40 years fit in the legal framework of the draft foreign investment law?

The Reform of FDI regulations is consistent with China's general reform and opening-up over the last 40 years. The draft foreign investment law adopts the principle of “national treatment plus negative list”, namely, except for those requirements or restrictions specifically provided in the negative list, as amended from time to time, a foreign-invested enterprise shall be treated in the same manner as a domestic enterprise.

The 2018 draft has temporarily set aside issues relating to the VIE structures – what are the issues that currently surround the legality of VIE structures, and how do you think VIE structures will be regulated or dealt with if the 2018 draft law comes into force?

The VIE structures, also known as “agreement control” or “contractual arrangements”, refer to achieving actual control and consolidation in financial statements of PRC operating entities through various contractual agreements rather than through equity ownership. Since 2000, when Sina completed its U.S. initial public offering through adopting a VIE structure, VIE structures have been widely used by PRC enterprises that involve foreign investment restricted or prohibited industries (such as technology, media and telecommunications, private education, etc.) to create overseas red-chip structure for the purpose of financing or listing overseas.

However, currently effective PRC laws and regulations have not clearly characterized VIE structures, including whether VIE structures are legal and whether an actual control via VIE structures shall be subject to the same regulation as equity ownership. While the 2015 Draft for the first time listed VIE structures as a form of foreign investment via the concept of “actual control”, the 2018 draft has deleted provisions in relation to the concept of “actual control” in their entirety and thus has temporarily set aside issues relating to VIE structures. If the 2018 Draft is adopted in its current form, the VIE structures will remain in the gray area and may still be subject to certain future legislation or regulations pursuant to the catch-all clause in the 2018 Draft.

In what ways does the 2018 draft law encourage foreign investment?

The 2018 Draft encourages foreign investment in the following respects:

1. The State does not expropriate foreign investment, and in case of expropriation as per public benefit requirements in special circumstances, statutory procedures shall be followed, and fair and reasonable compensation shall be made (Article 20);
2. Foreign investors may freely transfer out their profits according to the laws (Article 21);
3. The State protects the intellectual property of foreign investors and foreign-funded enterprises, and no administrative organ or functionary thereof may force the transfer of any technology by administrative means (Article 22);
4. Normative documents concerning foreign investment enacted by the governments at all levels and their departments shall comply with laws and regulations (Article 23);
5. Local people's governments at all levels and their departments concerned shall strictly keep policy commitments lawfully made to foreign investors and foreign-funded enterprises and perform all contracts concluded according to the laws (Article 24);
6. The State establishes a complaint mechanism for foreign-funded enterprises (Article 25); and
7. A foreign investor or foreign-funded enterprise may legally establish and freely join in a chamber of commerce or association (Article 26).

Which industries will be most affected by the new law should it come into force?

Given that the new law applies to foreign investment in all industries, we do not foresee any particular industry that will be most affected by its enforcement itself. However, according to comments by MOFCOM spokesperson, Feng Gao, at a regular press conference on December 27, 2018 after the release of the 2018 Draft for public comments, “foreign shareholding restrictions will be further relaxed especially in the fields of education and medical care, to which foreign investors pay close attention and in which there is a large gap in the domestic market.”

What are the types of foreign investment that will be affected under the new law – and what type of changes should legal advisers be aware of when advising clients?

Concurrently with adding a catch-all provision which authorizes other laws, administrative regulations or the State Council to stipulate other means of foreign investment, the 2018 Draft deletes from the definition of “foreign investment” the following means of foreign investment as shown in the 2015 Draft:

1. providing financing of terms of one year or more to domestic enterprises in which [the foreign investor] holds an interest;
2. acquiring concessions for the exploration and development of natural resources, or obtaining concessions for the construction and operation of infrastructure within territory of China or other regions under the jurisdiction of China;
3. acquiring real estate rights such as domestic land-use rights and real estate ownership within the territory of China; and
4. controlling domestic enterprises or holding rights and interests in domestic enterprises through contracts, trusts, etc.

Except for the catch-all provisions, the types of foreign investments expressly stipulated in the 2018 Draft are the following:

(i) that a foreign investor invests in any new construction project, establishes a foreign-funded enterprise or increases investment independently or together with any other investor; and

(ii) that a foreign investor acquires shares, equities, property shares or any other similar rights and interests of an enterprise within the territory of China by means of mergers and acquisitions.

The types of foreign investments under the 2018 Draft do not expand the original scope prior to the 2015 Draft. Nevertheless, foreign investors shall be reminded that those types of foreign investment that have been deleted from the 2018 Draft may still apply to certain specific industries or circumstances based on the catch-all clause. For example, the Several Opinions on Deepening the Reform of Preschool Education and Regulating its Development circulated by the Central Committee of the Communist Party of China and the State Council (中共中央国务院关于学前教育深化改革规范发展的若干意见) on November 7, 2018 expressly prohibits social capital to control non-for-profit kindergartens via VIEs or contractual arrangements.

What are some of the restrictions that will be relaxed on foreign investment?

The 2018 Draft emphasizes that the State shall implement the management systems of pre-establishment national treatment and negative list for foreign investment; save as otherwise provided under international treaties or agreements that the People's Republic of China concludes or joins in, such provisions shall prevail. That means, any restrictions on foreign investment in certain industries pursuant to certain laws, regulations or administrative rules, that are not listed in the negative list, shall not bind the relevant foreign investors or foreign-funded enterprises according to the 2018 Draft. For example, the currently effective Provisional Measures for the Administration of Medical Institutions in the Form of Sino-foreign Equity or Contractual Joint Venture (中外合资、合作医疗机构管理暂行办法) expressly provides that, the ratio of equity or rights and interests of the Chinese joint equity or co-operation party to a medical institution in the form of Sino-foreign equity joint venture or contractual joint venture shall not be less than 30%.  However, the foregoing equity percentage restriction is not found in the latest negative list (2018 version). According to the legislative spirit indicated in the 2018 Draft, the foregoing provisions shall either be incorporated into the negative list or be declared void ever.

How does the Foreign Investment Law draft fit in with China's overarching aim to protect intellectual property? What are the provisions affecting IP?

Pursuant to the 2018 Draft, the State shall, according to the law, protect the intellectual property rights of foreign investors and foreign-funded enterprises, protect the legitimate rights and interests of holders of intellectual property rights and the relevant right holders, and encourage technology cooperation on the basis of free will and business rules. The 2018 Draft also emphasizes that, in the process of foreign investment, technology cooperation conditions shall be determined by all investment parties upon negotiation, and no administrative organ or functionary working therein shall force the transfer of technologies by administrative means.

Could you explain the draft's focus on preventing 'forced technology transfer,' the aim behind this regulation and what are the key issues these provisions will help to regulate and solve?

Certain foreign investors or even certain foreign countries have concerns over alleged “forced technology transfer;” these allegations are without basis to our knowledge. Such concerns also arise during the Sino-U.S. economic friction. The 2018 Draft makes an effort to address this concern by expressly providing that no administrative organ or functionary may force the transfer of any technology by administrative means in the process of foreign investment.

What do you think of the 2018 draft law, and what would be your recommendations to improve the current draft law to have a positive impact?

In our opinion, the 2018 Draft is a valuable and successful effort to establish a unified legal system for foreign investment. What we recommend the most to improve the current draft is that the law need to make clear: (i) whether the three types of foreign-funded enterprise survive after the Foreign Investment Law abolishes the three foreign capital laws; and (ii) whether the principle of “national treatment plus negative list” means that any restrictions on foreign investment other than stipulated in the negative list shall be void automatically, or that the competent authority need to go through all these laws and regulations and make necessary revision first.

How is the 2018 draft law in line with China's opening-up policies? Could you give some examples?

The 2018 Draft is in line with China's opening-up policies by establishing a series of investment promotion and investment protection rules. For example, the 2018 Draft expressly emphasizes that a foreign-funded enterprise may conduct financing by means of the public offering of shares, corporate bonds and other securities and so on. In fact, a foreign-funded enterprise is not prohibited from listing in A-share market pursuant to the current laws. However, there are only a few foreign-funded listed company in the A-share market due to various reasons. The 2018 Draft, if adopted, may be followed with certain further implementation rules so as to encourage more foreign-funded enterprises to participate in open capital markets activities in China. Another example is that the 2018 Draft provides that the State shall guarantee foreign-funded enterprises' fair participation in government procurement activities, and products produced by foreign-funded enterprises within the territory of China shall be equally treated under government procurement. That means, the government procurement is also open to foreign-funded enterprises according to the principle of fairness and equality.