China's New Foreign Investment Law: Implications for the Future of FIEs

Adopting the Company Law as the basis for revised joint venture constitutional documents will also offer more flexibility for the parties in some respects.  For example, under the Company Law, dividends may be distributed in proportions that differ from equity percentages upon the agreement of the shareholders.  While such agreed dividend distributions are permitted under the CJV law, the EJV law requires that dividends be distributed according to equity proportions.  Also, under the EJV and CJV laws, a transfer of equity by one party requires the consent of the other parties to the joint venture, whereas the Company Law only requires the consent of a majority of the other shareholders in a limited liability company but gives the parties the ability to provide for different transfer restrictions in the articles of association.  This new flexibility may also result in some parties to existing EJVs and CJVs negotiating for changes to dividend distributions or transfer restrictions when revising constitutional documents to comply with the organizational requirements of the Company Law.

For most existing WFOEs, no significant changes to the organizational structure or constitutional documents should be required because WFOEs have already been required to follow the requirements of the Company Law in this respect.

Presumably, the existing regulations implementing FIE laws will also be repealed in due course and replaced with implementing regulations for FIL.  This may also result in further changes to existing FIEs.  For example, the Company Law only requires approval by shareholders representing two-thirds or more of the voting rights of the company of any amendment of the articles of association, increase or reduction of the registered capital, the division, merger, dissolution, or change of the form of the company, while the implementing regulations for the EJV and CJV laws require that such matters be approved unanimously by the directors present at a board meeting.  Similarly, the Company Law requires that liquidation proceeds be distributed to shareholders according to equity proportions, while the EJV and CJV laws' implementing regulations allow for the parties to agree that liquidation proceeds will be distributed in proportions that differ from equity percentages.

Other Implications of FIL for Foreign Investors and FIEs

Pre-establishment National Treatment under the "Negative List" System

Article 4 of FIL provides that China will implement a management system of pre-establishment national treatment and negative list for foreign investment. This means that foreign investors will be given the same access as domestic investors and special administrative measures will only apply to foreign investment in sectors listed in the negative list issued by relevant authorities.  This does not represent a significant development in so far as foreign investment approvals have essentially been limited to negative list sectors since 2016.  Nonetheless, this will offer new opportunities and benefits for foreign investors to the extent that the negative list is liberalized to open up previously restricted areas of investment.  In practice, enforcement of these national treatment provisions at all levels of government and among all regulatory authorities (for example, at the stages of project approvals and obtaining regulatory permits) will be necessary to ensure their effectiveness in overcoming local prejudice and political influence by domestic stakeholders.

Foreign Exchange Controls

Article 21 provides that a foreign investor may, in accordance with the law, freely transfer inward and outward its contributions, profits, capital gains, asset disposal income, intellectual property royalties, lawfully obtained compensation or indemnity, liquidation income, etc. within the territory of China in renminbi or a foreign currency. In practice, inward and outward remittances are still subject to the purview of the foreign exchange regulator and the banks. Because this provision is qualified by "in accordance with law" language, it does not alter existing foreign exchange regulations that apply to FIEs and payments to foreign investors, so it is uncertain if any changes will be immediately forthcoming in this respect. For example, under existing regulations governing the capital account of FIEs, except for specialized investment companies, such as foreign invested investment companies and venture capital enterprises, manufacturing and service FIEs are not permitted to use registered capital funds to invest in subsidiaries or acquire equity or shares in another company; they also cannot use such funds to repay intercompany loans. Thus, this provision does not represent any new developments in this respect and merely summarizes the current situation.

Government Procurement

Article 16 states that China will guarantee that FIEs can participate in government procurement activities through fair competition, and products produced and services provided by FIEs within China will be treated equally in government procurement.  This general provision on its own will unlikely result in any immediate, noticeable changes for foreign investors and FIEs.  Existing government procurement laws and regulations already contain provisions on fair competition and non-discrimination with respect to government procurement generally, but foreign investors have long complained of local favouritism in government procurement. Therefore, detailed implementation and stricter enforcement of these general provisions in FIL will likely be required to change the actual procurement practices of local governments and state-owned entities and bring about tangible results for FIEs. Moreover, this provision only applies to FIEs and will be of limited benefit to foreign entities that are concerned about misappropriation of intellectual property that may occur in the course of localizing manufacturing in China.  Further clarification is also required as to what products will be considered to be "produced" in China.

Complaint Mechanism for Foreign Investors

Article 26 provides that a complaint mechanism will be established for FIEs and where an FIE or its investor deems that any administrative act of an administrative department or official infringes its legitimate rights and interests, it may seek reconciliation and resolution through the complaint mechanism.  Due to the lack of detail regarding this complaint mechanism, it is unclear whether it will offer any realistic and practical recourse to foreign investors that are subject to unfair or illegal treatment by government authorities or officials. Presumably, any new system to be established will be put in place in due course and detailed in future implementing regulations. To date, foreign investors have generally been hesitant to pursue administrative litigation against government officials under existing mechanisms out of fear of political reprisals that could affect their business and also out of concerns regarding the objectivity and predictability of local courts. In order for foreign investors to feel comfortable utilizing such avenues of recourse offered by this new provision and any detailed implementation regulations put in place to implement it, the continued development of judicial independence and rule of law in China is needed.

National Security Review

Article 35 requires that a security review system for foreign investment be established, and any foreign investment affecting or has the possibility of affecting national security must undergo a security review. In addition, any decision made upon the security review, in accordance with the law, will be final. It is unclear how this system will differ from the current national security review system which has been in place since 2011 under relevant Ministry of Commerce notices, and more specifically, whether it will expand national security reviews to sectors other than those currently specified under relevant rules. However, this provision of FIL does represent a new development which may be unwelcomed by foreign investors in so far as it specifies that decisions made pursuant to a security review are final and immune from challenge through administrative review or litigation.

Anti-monopoly Filings

Article 33 specifies that foreign investors who acquire a company within the territory of China through mergers and acquisitions or participate in the concentration of undertakings by other means will be subject to the examination for concentration of undertakings as stipulated by the PRC Anti-monopoly Law (中华人民共和国反垄断法).  This provision simply refers to the existing requirements of the Anti-monopoly Law and therefore unlikely to result in any changes to current requirements or practices with respect to foreign investors carrying out mergers and acquisitions in China.

Restrictions in the Banking, Securities and Insurance Sectors

Pursuant to Article 41, foreign investors who invest in financial industries such as banking, securities and insurance or manage investments in financial markets such as securities and foreign exchange markets within China will be subject to other Chinese laws and regulations governing such investments and activities, which will prevail over FIL. This provision suggests that there will be no immediate changes to the requirements applicable to foreign investment in these sectors.

Impending Winds of Change

The repeal of FIE laws and the application of the Company Law and other laws to FIEs after the five-year transition period will require certain changes to the existing organizational structure of EJVs and CJVs.  In implementing these changes, parties to joint ventures may find it necessary to renegotiate other terms of their constitutional documents and commercial agreements in order to comply and maintain the legal basis for those documents.  With respect to the other provisions that have implications for foreign investors and FIEs, however, it is unclear what changes, if any, will result in the current regime in which foreign investors and FIEs must comply with, due to the general nature of these articles.  This will depend on the changes to existing regulations and any new implementing regulations that follow from these FIL provisions. It is anticipated that additional changes in these respects will ultimately benefit FIEs and foreign investors in China.

Grace Tso, M&A Partner, Baker McKenzie

Zhi Bao, M&A Partner, Baker McKenzie FenXun (FTZ) Joint Operation

Vivian Wu, Senior Counsel, FenXun Partners

Scott Silverman, Special Counsel, Baker McKenzie