A New Era for Foreign Investment Legislation
By David Pan | Nigel Zhu | Ivy Hong
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A New Era for Foreign Investment Legislation
A Commentary on China Foreign Investment Law
On March 15, 2019, the Second Session of 13th National People’s Congress passed the People’s Republic of China Foreign Investment Law (hereinafter “FIL”), which will come into effect on January 1, 2020. Ever since the issuance of the draft of Foreign Investment Law (Literally, Law of Investment from Foreign Countries) in 2015, this biggest update in China’s foreign investment legislation has been drawing attention from all walks of life globally. Now that the FIL (Literally, Law of Investment by Foreign Investors) has finally been passed, the authors would like to share observation on the FIL, based on our experience of law practicing in the foreign investment area.
Lawyers
who started practicing law in recent years may have enjoyed the
convenience of filling out online forms to complete filings for
establishment or changes of a foreign invested enterprise (“FIE”). They
may not be aware that previously, in almost three decades every single
step in the establishment, change or deregistration of FIEs required
approvals by relevant department in charge. One of the authors remembers
vividly that over ten years ago, he had to run to the local commerce
bureau multiple times and discuss repeatedly with the clerk on details
in applications documents, just for an approval to establish a wholly
foreign-owned enterprise (“WFOE”). At this moment of passing the FIL,
the authors would like to give readers a glimpse of the history of
China’s foreign investment regulatory regime building up from scratch.
1. Era of Approval
1.1. The Foreign Investment “Trilogy”
At
the very beginning of China’s Opening-up, the Sino-Foreign Joint
Venture Law was passed on July 1, 1979. Subsequently, China passed the
Wholly Foreign-Owned Enterprise Law and the Sino-Foreign Cooperative
Joint Venture Law in 1986 and 1988 respectively. These three statutes
were collectively deemed as the Foreign Investment Law Trilogy (the “Law
Trilogy”), marking the beginning of China’s foreign investment
regulatory regime. The Law Trilogy established the three major foreign
investment channels, i.e. WFOE, Sino-foreign joint venture and
Sino-foreign cooperative joint venture. With the change in China’s
foreign investment environment and policies, the Law Trilogy was
subsequently amended several times and will ultimately be repealed upon
the FIL’s taking effect.
1.2. Catalogue of Foreign Investment Industry Guide
On
June 20, 1995, the former State Planning Commission, Economy and Trade
Commission and Ministry of Trade and Economic Cooperation jointly issued
the Guidance on Foreign Investment Industries Tentative Rules, and
published the first edition of the Catalogue of Foreign Investment
Industry Guide (the “Catalogue”). The Guidance on Foreign Investment
Industries Tentative Rules provided that an approval of foreign
investment must be premised on the fulfilment of industrial requirements
set by the Catalogue. Since 1995, China[1] updated the Catalogue seven
times, with the latest edition published in 2017. The Catalogue divides
foreign investment into four categories[2]: permitted, encouraged,
restricted and prohibited. The Catalogue specifies the encouraged,
restricted and prohibited industries for foreign investment, while
unspecified industries are all permitted. Falling into different
categories of foreign investment industries not only determines whether
the authorities will approve the investment and relevant approval
procedures, but also relates to whether foreign investors may receive
preferential tax treatment and other incentives.
2. Era of “Filing”
2.1. Draft Foreign Investment Law
The
Draft of Foreign Investment Law (Literally, Law of Investment from
Foreign Countries, draft for public comments) issued in 2015 triggered
heated discussion among foreign investors, and concerns among VIE
investors. The Draft intended to “rule out” the regulatory regime
established by the Law Trilogy, by introducing a ground-breaking
proposal to grant national treatment to foreign investors other than
those listed in a so-called “foreign investment special control
catalogue”. Another highlight of the Draft is that it defines “foreign
control” based on the notion of “nationality + actual control”. If the
“actual control” criteria were ultimately adopted, VIE investments would
be substantially impacted. That is, VIE investors, who were previously
barely regulated under China law, would be categorized as “foreign
investors” subject either to the Catalogue or to “foreign investment
special control catalogue”. Therefore, after the issuance of the Draft,
it received substantial attention from foreign investors. Although the
Draft did not become a law, a lot of principles and key points raised in
the Draft provided guidance on subsequent foreign investment
legislation.
2.2. The “Filing” Reform
The Foreign
Invested Enterprise Establishment and Change Filing Administration
Tentative Rules (“Tentative Rules”) took effect on October 8, 2016. The
Tentative Rules abolished the approval regime that has been implemented
for four decades, and provided that other than FIEs in industries
subject to “special state market-entry control mechanisms”, the
establishment and change of FIEs may be completed by filing with
commerce authorities, as opposed to obtaining approvals. Accordingly,
the 2017 Catalogue amended restricted and prohibited items and combined
them into a list of “foreign investment market entry special control
measures (foreign investment market entry negative list)”. The Law
Trilogy and their implementation rules were amended accordingly. Since
then, the foreign investment regulatory regime evolved to the “filing +
negative list” mode, which significantly simplifies the establishment
and change procedures of FIEs.
3. Other Notable Laws
In
addition to the laws mentioned above, a full spectrum of foreign
investment related laws and regulations also play an important role in
China’s foreign investment regulatory regime, such as the Foreign
Investor Strategic Investment in Listed Companies Administrative
Measures (2005), the Foreign Investor Acquisition of Domestic Company
Rules (2006), the Notice on Establishment of Security Review Mechanism
for Foreign Investor’s Acquisition of Domestic Companies (2011), the
Foreign-Invested Projects Approval and Filing Measures (2014), and
China’s pilot measures experimented in its free trade zones, as well as
other foreign investment laws and regulations on FIEs’ foreign exchange,
taxation, finance, foreign debt and business operations.
As it
can be seen from the above, China’s foreign investment regulatory regime
has been evolving and improving since its inception. In recent years,
major simplification and reforms have occurred to the previous
regulatory regime, which formed the rudiments and laid a solid
foundation of the FIL. The FIL is the natural result of the evolvement
of China’s foreign investment regulatory regime.
As
a fundamental and comprehensive law on foreign investment, the FIL
repeals (mainly the Law Trilogy), amends or supplements the existing
foreign investment laws and regulations. Below is the authors’
preliminary review of the FIL, making a comparison of its key points
with the corresponding provisions under the existing laws and
regulations.
1. General
1.1 Definition and Circumstances of Foreign Investment
The
FIL defines foreign investment, foreign investors and FIEs, and sets
forth the specific types of foreign investment. The FIL abandons the
decade-long distinction between WFOE, Sino-foreign joint venture and
Sino-foreign cooperative joint venture, and defines them collectively as
FIEs. In the future, the words "wholly foreign-owned enterprise",
"Sino-foreign joint venture" and "Sino-foreign cooperative joint
venture" will no longer appear in the column of "enterprise type" in the
business license of FIEs. At the same time, the corporate governance of
certain FIEs, which differs from those prescribed by the Company Law,
will need to be adjusted according to the requirements of the Company
Law.
It is worth mentioning that the enumeration of foreign
investment in the FIL includes a catch-all clause of “other forms of
foreign investments in accordance with laws, regulations or provisions
of the State Council”. This denotes that although the FIL does not
explicitly list other forms of foreign investment such as the VIE
investment, in the future, such "alternative" foreign investment may
still be seized in the scope of "foreign investment". The application of
such catch-all clause and the specific impact needs to be analyzed in
conjunction with the then effective negative list of foreign investment.
2. Investment Facilitation
2.1 Fair Competition
Unlike
previous normative documents, the FIL, in the form of law, clearly
stipulates the promotion of FIEs’ equal participation in formulating
standards, fair participation in government procurement, and expanding
financing channels of FIEs. This will undoubtedly promote the
development of foreign investment by offering a better protection of the
legitimate rights and interests of foreign investors and FIEs.
3. Investment Protection
3.1 Nationalization/Taking
The
FIL emphasizes the established principle of “no expropriation” on
foreign investment. At the same time, the FIL emphasizes that in the
circumstances that foreign investment is subject to expropriation due to
special conditions, such expropriation must meet the principles of
"public interest needs" and "compliance with legal procedures". As to
compensation standard, the FIL stipulates that foreign investment
subject to expropriation should be indemnified with "fair and
reasonable" compensation. This new clause enhances the protection of
foreign investment, compared with the "corresponding compensation"
stipulated by the existing law.
3.2 Protection of Trade Secrets
Obviously,
pursuant to the principle of “rule of law in administration”,
administrative organs and their personnel should keep confidential the
trade secrets obtained in the course of performing their duties. Also,
many similar provisions are included in the existing law on various
administrative areas. Nevertheless, it is the first time that the
protection of trade secrets of foreign investors and FIEs is articulated
in a regulation at a level of law. The FIL shows that the Chinese
government attaches great importance to the protection of trade secrets
of foreign investors and FIEs. In tandem with the protection of
intellectual property rights mentioned in Section 3.4 below, this
provision will create a refined environment for the protection of
intellectual achievements of foreign investment in China.
3.3 Remittance of Foreign Exchange
The
FIL specifically provides the types of assets that foreign investors
can transfer abroad and expands the scope to include “capital
contributions”, “capital gains, “indemnities or compensations obtained
according to the law”, and specifically enumerating “intellectual
property royalties”. In particular, it emphasizes the "free remittance"
of foreign exchange. With the gradual relaxation of foreign exchange
control on foreign investment, the lawful and free remittance of the
above foreign exchange has gradually become an integral part of foreign
investment, which has already been supported by applicable
administrative laws and regulations on foreign exchange. The FIL’s
further clarification on this regard helps promote foreign investment,
by boosting the confidence of foreign investors.
3.4 Protection of Intellectual Property Rights
Intellectual
property protection has been a focus of foreign investors. The US
government’s 301 Report on China released in 2018 condemned that Chinese
laws and policies contain discriminatory provisions on technology
transfer and intellectual property rights (the Contract Law, the
Regulations on the Administration of Import and Export of Technology,
the Sino-foreign Joint Venture Law and its Implementation Regulations,
the Foreign Trade Law, etc.), which require or force foreign companies
to transfer technology by means of joint ventures, share ratio
restrictions, administrative approval procedures, etc.; and that China
imposes substantial restrictions and interventions on U.S. companies’
investments and activities, including restrictions on technology
licensing terms, which forces U.S. companies to license technology in
terms impartially unfair to favor Chinese licensees.
The FIL
emphasizes the protection of intellectual property rights of foreign
investors and FIEs, imposing legal liability for intellectual property
infringement, and encouragement of technical cooperation based on
voluntariness and business rules, and clarifies that “the administrative
organs and officials shall not use the administrative means to coerce
technology transfer". These provisions are expected to be embodied in
the amendments of relevant laws. Except for the share ratio restrictions
listed in the negative list, the shareholding ratio of other foreign
investors in FIEs may no longer be restricted. These new provisions will
help China refute accusations of compulsory technology transfer by
other countries and alleviate or even eliminate disputes.
3.5 Incentives and Government Commitments
The
FIL mentioned multiple times that the state and local governments can
adopt preferential measures within their statutory authority to
formulate foreign investment incentive policies. Moreover, in order to
protect the legitimate rights and interests of foreign investors, the
FIL requires local governments to strictly implement the “policy
commitments made according to the law” and “all contracts concluded
according to the law” in order to protect the legitimate rights and
interests of foreign investors. If it is necessary to amend the
commitment or contract for reasons of national and social interests,
foreign investors should be compensated according to the law. The FIL
also stipulates the establishment of a special FIE complaint mechanism,
and clarifies the administrative litigation rights of FIEs, so that
foreign investors and FIEs have ways to complain and litigate.
4. Investment Administration
The
FIL stipulates the following three major investment administration
mechanisms in the form of law. The implementation of these mechanisms
will depend on the synchronized formulation and implementation of
relevant supporting regulations.
4.1 Market-entry: Pre-establishment national treatment + negative list
The
FIL, in the form of law, sets forth a negative list administration
mechanism for foreign investment access, and clarifies that the
administration on industries other than those contained in the negative
list of foreign investment access will be conducted in the principle of
equal treatment to domestic and foreign investment. The current version
of the negative list of foreign investment access, the Special
Management Measures for Foreign Investment Access (Negative List) (2018
Edition), has 48 provisions, with 15 provisions reduced from the 2017
negative list. It is expected that items on the negative list will be
further reduced along with further market opening-up in the future.
For
the content not covered by the Special Management Measures for Foreign
Investment Access (Negative List), the principle of equal treatment to
domestic and foreign investment will apply, which also reflects the
“national treatment” of foreign investment emphasized by the FIL.
4.2 National Security Review
The
FIL once again clarifies the national security review mechanism for
foreign investment in the form of law, sets forth the principles of
establishing a foreign investment security review mechanism, and clearly
provides that security review shall be conducted on foreign investment
that affects or is likely to affect national security, covering both
foreign mergers and acquisition and green filed investment. However, the
FIL does not specify the details of the national security review
mechanism, such as the scope of the review, review body, factors to
consider, the initiation, the requirements for the application
documents, the procedures, the time limit for review, and the legal
consequences of the violations of security review reporting obligations.
All these details are expected to be stipulated by the specific
provisions of future national security review regulations.
It is
worth noting that the FIL stipulates that a security review decision
made under the foreign investment security review mechanism is the
“final decision”, which means that no administrative review or
administrative litigation for appeal is permitted.
4.3 Reporting
Current
foreign investment reporting in China mainly involves information on
the establishment and changes of FIEs submitted by FIEs or foreign
investors to competent commercial authorities, as well as annual
investment and business operation information submitted by FIEs. The FIL
provides the principles of foreign investment information reporting
mechanisms in the form of law, emphasizing that the content and scope of
the information reporting should be determined according to the
principle of "absolute necessity and strict control". This will help
reduce the reporting burden of FIEs while ensuring the necessary
supervision of foreign investment. Of course, the foreign investment
information reporting mechanism still needs to be formalized and refined
according to the specific implementation rules in the future.
This
chapter summarizes the key points of the FIL and its differences with
current foreign investment laws and regulations. Moreover, it is worth
mentioning that after the abolishment of the Law Trilogy, FIEs may face
substantial changes resulting from the application of basic laws such as
the Company law. It is advisable for FIEs to identify the difference
and make adjustments accordingly in a timely manner. Below we take the
example of the corporate governance of joint ventures and cooperative
joint ventures under the Law Trilogy to illustrate the major differences
in applying the Company Law.
After
the FIL takes effect, it will replace the Law Trilogy to become the
fundamental law of foreign investment. In the future, other than foreign
investment industries that require special regulation, the
establishment, change, operations and deregistration of FIEs will be
governed the same laws that apply to domestic companies, such as the
Company Law, the Contract Law and the General Part of Civil Law. As a
result, such laws will be enforced more ubiquitously and fairly. The
“pre-establishment national treatment + negative list” regulatory regime
will significantly reduce the administrative burdens of FIEs in their
whole life cycle from establishment through deregistration, and will
also expand the industries in which foreign investors can invest or
invest with conditions. The FIL’s provisions on free remittance of
foreign exchange, and protection of intellectual property rights and
trade secrets set the tone for addressing practical concerns of foreign
investors’ investment in China. Generally, the FIL is of epoch-making
importance to improving foreign investment in China, and will create a
new era for China’s foreign investment.
While acknowledging the
importance of the FIL, the authors believe that some parts of the FIL
require improvement either in subsequent amendment of the FIL or in
separate regulation. We just name a few examples for discussion purposes
below:
1. The Definition of “Foreign Investment” and “Foreign Investor”
Article
2 of the FIL provides that, foreign investment means any investment
activity directly or indirectly carried out by foreign natural persons,
enterprises or other organizations (hereinafter referred to as foreign
investors), including the following circumstances…
Probably due
to the objections to the definition of foreign investors in the Draft of
Foreign Investment Law, such definition is not adopted by the FIL.
Instead, foreign investors are defined as simply foreign natural
persons, enterprises or other organizations. Concise as the definition
is, it is tangled up with uncertainty. For example, it is unclear
whether “foreign” means “foreign nationality”, “established according to
foreign laws”, “located in foreign countries” or other explanations. By
this definition, does a foreign company controlled by a Chinese company
constitutes a foreign investor?
In addition, as for the
definition of “foreign investment”, the FIL includes both “direct” and
“indirect” investment by foreign investor. Does this mean that indirect
foreign investment shall be determined according to the ultimate actual
controller? If so, how should we determine “control”? No answers can be
found to these problems in the FIL.
The authors suggest that the
above issues be clarified when other relevant laws and regulations
related to foreign investment are formulated, so as to ensure the
certainty and guidance function of the FIL.
2. Local Governments’ Power to Formulate Foreign Investment Policies
Article
18 of the FIL provides that “local people’s governments at or above the
county level may, according to laws and regulations and local
legislations, formulate foreign investment promotion and facilitation
policies and measures within their statutory authority”. The term
“foreign investment promotion and facilitation policies and measures” in
this article is very vague; the term "policy and measures" may include
not only local legislations or local government regulations, but also
"red-letterhead documents" of local governments. In addition to the
controversy about the legal effect of these "red-letterhead documents",
there is also great uncertainty about the scope of "promotion and
facilitation policies and measures" which these "red-letterhead
documents" can touch upon. Although the FIL restricts the local
governments’ power authority to "according to laws, administrative
regulations and local rules", the nature of "red-letterhead documents"
may still give rise to local governments’ inappropriate de facto
"law-making" power. If these policies are related to the requirements
for foreign investment access, then undoubtedly they should be regulated
by State laws and regulations only, while local governments shall have
no such power authority. If these policies related to preferential
policies for foreign investment, local governments may introduce various
preferential policies on land, tax and even social welfare of employees
in order to attract foreign investment. If so, such local policies will
not only affect fair competition in the market, but also cause labor,
environment, land, taxation and other issues.
Therefore, the
authors suggest that Article 18 be deleted when the FIL is revised. If
not deleted, the content and scope of “foreign investment promotion
policies and measures” that can be formulated by local governments
should be expressly set forth by law.
3. Five-year Transition Period
Article
42 of the FIL provides that FIEs established pursuant to the Law
Trilogy may retain the current organizational forms within five years of
the FIL’s taking effect. The purpose of this article is clearly to
provide a transition period to existing FIEs after the FIL takes effect.
Retaining “the current organizational forms within five years”,
however, does not make much sense. First, the current organizational
forms of FIEs are WFOEs, joint ventures and cooperative joint ventures,
which will remain the same before or after the FIL takes effect. Then
what does “retaining the current organizational forms within five years”
exactly mean? Second, if “organizational form” refers to the “WFOE”,
“joint venture” or “cooperative joint venture” names, then why does it
matter whether they are retained or not? If it refers to “corporate
governance” of FIEs, why does FIL not articulate? Last, the FIL is
silent on what FIEs that retain current organizational forms should do
after the five-year period.
The authors suggest that separate
laws and regulations clarify and refine this provision, so that there is
a concrete and detailed guidance to FIEs on this provision.
The
FIL, a fundamental and framework legislation on foreign investment,
aims to unify the regulatory regimes for both domestic and foreign
investment and to uniformly apply basic laws such as the Civil Law, the
Company Law and the Contract Law to domestic companies and FIEs. The FIL
reserves room for requisite legislation of laws and regulations on
foreign investment issues that require special regulation. The authors
believe that the combination of uniform application of basic laws and
other special regulations on foreign investment will give China’s
foreign investment a more open-tolerant and fairer environment, and that
China can better use foreign investment to develop, transform and
upgrade its economy.
【注释】
[1] The Catalogue was initially issued by the former State Planning Commission, Economy and Trade Commission and Ministry of Trade and Economic Cooperation, and subsequently updated and issued by the National Development and Reform Commission and Ministry of Commerce.
[2] Due to restrictions imposed by the Catalogue, foreign investors (or Chinese investors of the so-called “round trip” investment) who wish to invest in restricted or prohibited industries (in particular the telecommunication sector) gradually adopted an investment vehicle that is different from the channels provided under the Law Trilogy – variable interest entity (VIE). The essence of VIE is for foreign investors to establish an ordinary WFOE, which is used to control domestic companies operating in the restricted or prohibited industries (in terms of foreign investors) through contractual means. Thus, the profits of the domestic company can be transferred to the WFOE and foreign investors may consolidate the domestic company’s financial statements for the purpose of offshore fundraising or listing. Although strictly speaking, VIE is a way of foreign investment and to certain extent circumvents China’s foreign investment regulation, the Chinese government has not yet regulated VIE: it has neither outlawed VIE, nor has it ratified VIE. As a result, VIE as a foreign investment vehicle has been existing till today. For various reasons, the FIL does not specifically rule on VIE, and in the foreseeable future this foreign investment vehicle will continue to exist.
Authors:
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