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MHP君悦评论|Foreign Investment Law to Promote Fair Competition

2019-03-257347

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On March 15, 2019 the People’s Congress of China passed the Foreign Investment Law of the People’s Republic of China (the “Foreign Investment Law”). The Foreign Investment Law, which will become effective on January 1, 2020, represents the fundamental change and innovative improvement of China’s foreign investment legal system. It will replace the existing Law of the People's Republic of China on Wholly Foreign-owned Enterprises, Law of the People's Republic of China on Sino-foreign Equity Joint Ventures, and Law of the People's Republic of China on Sino-foreign Cooperative Joint Ventures (collectively, “Three FIE Laws”).


Over the past four decades Three FIE Laws and numerous regulations, rules, and policies have prompted substantive inflow of foreign direct investment. However, current laws, regulations, rules and policies are becoming incapable of addressing challenges and concerns arising from the further opening up of foreign investment; therefore, to draw more foreign investors, a fair and complete legal system is crucial.



Foreign Investment Law Spotlights Equal Treatment and Fair Competition 


Foreign investors and foreign investment enterprises (“FIEs”) in China have been in pursuit of equal treatment for years. As a response, the Foreign Investment Law underscores the principles of equal treatment and fair competition in many clauses, with an aim to provide protections equal to those that domestic enterprises are entitled to, including without limitation:


●State policies supporting enterprise development apply equally to FIEs (Clause 9)

●FIEs may equally participate in standardization work and enjoy equal application of mandatory standards (Clause 15)

●FIEs may equally participate in governmental procurement activities (Clause 16)

●FIEs may raise funds through a public offering of shares, corporate bonds and other securities (Clause 17)

●Pre-establishment national treatment and negative list for foreign investment access (Clauses 4 and 28)

●Conditions and procedures of industrial approval and registration apply equally to FIEs (Clause 30)

●Company Law, Partnership Enterprises Law and other laws and regulations apply equally to FIEs (Clause 31)



Foreign Investment Law Defines Foreign Investment for the First Time


Broad Foreign Investment Definition


Foreign investment refers to any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (the “Foreign Investors”) within the territory of China, including the following circumstances:


(1)Foreign Investors establish FIEs, either alone or together with any other investors, within the territory of China;

(2)Foreign Investors acquire shares, equities, property shares or any other similar rights and interests of an enterprise within the territory of China;

(3)Foreign Investors invest in any new project, either alone or together with any other investors, within the territory of China; 

(4)Foreign Investors make investment within the territory of China in any other ways stipulated under laws, administrative regulations or provisions of the State Council.


As a summary of the above, different from the current legal framework under which Three FIE Laws focus on new formations only while mergers and acquisitions are regulated by administrative regulation issued by the Ministry of Commerce and other ministries, the Foreign Investment Law has covered: 

(1)new formations; 

(2)mergers and acquisitions; 

(3)new project investments; 

(4)any other ways that are acknowledged by laws, administrative regulations or provisions of the State Council.

Issues Remain to be Seen


● Whether VIE is legally permissible?


However, the definition does not mention the Foreign Investor’s controlling domestic enterprises or holding equity in domestic enterprises by contracts, trust or other ways. Such ever appeared in a draft of Foreign Investment Law back to 2015. It remains to be seen if the abovementioned “other ways” will include the VIE and similar arrangement. Compared to longstanding issue of VIE, it is more urgent to pass the law to help China-US trade negotiations and further deepen reform and opening-up in order to improve China’s overall business environment and meet economic slowdown challenges. From this perspective, it is wise enough to adopt a catch-all clause in the definition.


● Whether Chinese natural persons can partner with Foreign Investors?


Seems No. Thee FIE Laws exclude Chinee natural personas from establishing joint ventures with foreign investors, with an exception that according to the merger and acquisition regulation, a Chinese natural person, as a shareholder of a domestic enterprise, may continue to be the shareholder of the FIE converted from the domestic enterprise after the acquisition of equities by foreign investors.

 

Unfortunately, the Foreign Investment Law fails to detail “any other investors”. Although some assume it does not prohibit Chinese natural persons from cooperating with Foreign Investors, China’s Constitution (as amended in 2018) still provides that foreign natural persons, enterprises or other organizations may conduct economic cooperation with Chinese enterprises and other economic organizations, without mentioning Chinese natural persons (Clause 18).


Foreign Investment Law Outlines Investment Promotion Measures


Chapter 2 of the Foreign Investment Law outlines the measures that the Chinese government would like to take to promote foreign investment:


Investment Promotion Measures 


To improve transparency of foreign investment laws, regulations and policies:  

● Government will listen to FIEs’ opinions when formulating laws, regulations and policies and publicly announce any foreign investment related policies and governmental documents in a timely manner (Clause 10)

●FIEs may participate in standardization work (Clause 15)


To ensure equal development and equal participation

●Enterprise development policies apply equally to FIEs (Clause 9)

●FIE may equally participate in governmental procurement activities (Clause 16)

●FIE may equally conduct financing through a public offering of shares, corporate bonds and other securities (Clause 17)


To strengthen governmental services to foreign investment

●Government will establish a sound foreign investment consulting and service system (Clause 11)

●Government will provide convenient, efficient and transparent governmental services (Clause 19)


To explore further opening up for foreign investment

●China will strengthen international cooperation and local trials in order to explore new routes for foreign investment (Clauses 12 and 13)


Issues Remain to be Seen


How China’s commitments can be implemented

The much streamlined 42-clause Foreign Investment Law underlines very high-level commitments, without providing any details about how committed promotion measures will be implemented. It is foreseeable that Chinese government would publish various regulations and rules to implement the Foreign Investment Law; however, past experience indicates that to implement slogan-type commitments would be tough, technically and economically, let alone implementation regulations or rules might deviate from the substantive clauses due to known or unknown reasons.



Foreign Investment Law Highlights Investment Protections


The Foreign Investment Law addresses the concerns of the Foreign Investors and FIEs over expropriation and its compensation, remittance of dividend, protection of IP and local governments’ performance of commitment.


Not to Expropriate

●China does not expropriate the investment of Foreign Investors except that the investment may be expropriated or requisitioned with fair and reasonable compensation for public interests (Clause 20)

●Government should make fair compensation for its change of commitments or concluded contracts (Clause 25)


To remit capital and dividend freely

●FIE may transmit freely into and out of China in RMB and foreign exchange capital contributions, dividends, capital gains, assets disposal incomes, royalties, compensations, liquidation proceeds and others (Clause 21)


To protect IP and technology

●China protects all the intellectual properties of Foreign Investors and FIEs (Clause 22)

●No administrative authorities or its personnel may force the transfer of technology (Clause 22)


Special requirements on government and its staff

●Government and its staff shall be obligated to keep all business secrets confidential (Clause 23)

●Government shall not impair FIEs’ legitimate interests or increase their obligations in the absence of laws and regulations basis (Clause 24)

●Government shall perform its policy commitments to Foreign Investors and FIEs and concluded contracts (Clause 25)

●Government shall establish a compliant mechanism for FIEs (Clause 26)

To join the chambers of commerce and associations

●Foreign Investors may organize and join chambers of commerce and associations (Clause 27)



Foreign Investment Law Streamlines Investment Administration


China’s legislation on foreign investment is “crossing the river by feeling the stones”. After years of foreign investment administration trials in the Shanghai Pilot Free Trade Zone, the Foreign Investment Law will administer foreign investment according to the system of pre-establishment national treatment plus a negative list.


Foreign Investment Administration


Pre-establishment national treatment plus a negative list

In brief, under such administration, foreign investments out of the negative list will no longer require governmental approval but filing and registration. Along with the gradual reduction of restricted sectors in the negative list, foreign investment’s market access becomes broader and broader. The Foreign Investment Law provides the followings:

●Foreign Investors shall enjoy treatment no less favorable than that afforded to Chinese investors and their investments at the stage of investment access (Clause 4)

●Foreign Investors must not invest in industrial sectors prohibited by the negative list (Clause 28)

●Foreign investments in industrial sectors restricted by the negative list shall comply with the restrictive conditions (Clause 28)


Foreign investment information reporting

●A foreign investment information reporting system will be formed, under which Foreign Investors or FIEs shall submit foreign investment information to the Ministry of Commerce (Clause 34)


Foreign investment review

●Anti-trust Review (Clause 33)

Foreign Investors’ acquisition of domestic enterprises and other business concentrations shall be subject to anti-trust review

●Security Review (Clause 35)

China will conduct security review of foreign investments affecting or likely affecting the national security.


Issues Remain to be Seen


●Whether current national security review will be broadened

Current national security review is limited to Foreign Investors’ mergers and acquisitions of domestic enterprises and foreign investment in pilot free trade zones. There is no guideline of national security review about new formation of FIEs outside pilot free trade zones. Since the Foreign Investment Law requires security review of all foreign investments, it is very likely that a more comprehensive national security review system will be set up. 


●What current FIEs need to do within 5-year grace period

The Foreign Investment Law offers a 5-year grace period during which current FIEs may keep their corporate forms established under the Three FIE Laws. It would mean that FIEs who are Sino-foreign equity joint ventures and Sino-foreign cooperative joint ventures shall change their corporate forms in accordance with the Company Law, Partnership Enterprise Law and other applicable laws and regulations within the grace period. Especially, some of Sino-foreign cooperative joint ventures are legal entities without independent legal person status and they may have to go through more complicated change process.


No one would underestimate the importance of the Foreign Investment Law in attracting more foreign investment and facilitating structural reforms necessary for China’s long-term economic upgrading. But to activate those clauses in the Foreign Investment Law and make them enforceable would be a long way to go.

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