FIL, 6 things to know | 外商投资法，六点须知
1. Equity JV, Cooperative JV and WFOE will cease to exist
Since China opened its door to the world in 1978, all foreign investors may invest in China via three different forms of legal entities, namely, Equity Joint Venture (the “Equity JV”), Cooperative Joint Venture (the “Cooperative JV”) and Wholly Foreign Owned Enterprise (the “WFOE”), each of the legal forms is governed by separate legislations.
However, at the same time, there is a parallel system for domestic enterprises, they may be established in the forms of companies or partnership enterprises under the Company Law and Partnership Enterprise Law respectively, but neither legislation has any effect on foreign investments.
The FIL, for the first time, unifies the differences, once it enters into force on January 1, 2020, it will repeal the current laws on foreign investment, therefore, Equity JV, Cooperative JV and WFOE will cease to exist, all new foreign investments will adopt the legal forms provided under the Company Law and Partnership Enterprise Law, which are as same as domestic enterprises.
2.It will be the parties’ autonomy to decide how to run the company
Under the current system, the legislations on Equity JV and Cooperative JV provides certain restrictions on the parties’ autonomy when they are deciding JV’s essential issues. For instance, a JV’s board of directors holds the highest power and authority in the JV, it should be constituted by the representatives from both parties, the quorum of a board meeting requires 2/3 of the directors attending, and only all attending directors vote in favor a resolution regarding (1) amendment to the JV’s AoA; (2) suspension or dissolution of the JV; (3) increase or decrease the JV’s registered capital; (4) the merger or separation of the JV, such resolution may be passed. Moreover, if one JV party intends to assign its shares in the JV to a third party, such assignment shall not be valid unless it is approved by the other JV party.
Since FIL will repeal the Equity JV and Cooperative JV laws, the above restrictions will also be abolished. Foreign investors will enjoy more autonomy when negotiating the terms on the issues of corporate governance with their Chinese partners.
3.The parties will have the final say on profit sharing
The soon to be repealed Equity JV law provides that, the JV’s profit shall be shared according to the equity ratio of the parties in the JV, therefore, the Equity JV partners cannot decide on other profit sharing mechanisms. If they wish to break the rule on profit sharing, they have to form a Cooperative JV, which is governed by a different legislation.
After 2020, should the foreign investors intend to form a JV with their Chinese partners, they may negotiate an acceptable profit sharing mechanism they deem fit, which will be protected by the Company Law.
4.The approving system will be replaced
It has been a long practice of Chinese authorities to exam and approve each foreign investment before it becomes final. Although the approving procedure has been relaxed since 2015, the FIL finally replaces it with the negative list system, information report system and security review system.
Negative list: it was first introduced in the Shanghai Free Trade Zone in 2015, and it has become a successful try out since then, with the help of the FIL, it will further become the common practice of the country to receive foreign investment. Under the FIL, the authority will regularly issue the negative list to the public, save the prohibited and restricted fields specified in the list, foreign investors are free to invest.
Information report system: Once the investors decide to invest in the fields other than the prohibited or restricted ones under the negative list, they may complete the investment by submitting the investment information through the enterprise registration system and the enterprise credit information publicity system to the authority.
Security review system: Although it is common to be subject to security review when investing in the US and the EU, it is the first time in China such system is introduced in the legislation. Therefore, like most developed countries, China will also establish a security review system to oversee foreign investments.
5. Investors’ rights will be widely protected
FIL outlines a number of specific rights of foreign investors which shall be protected:
● The State's various policies in support of enterprise development shall apply equally to foreign invested enterprises (Article 9);
● The State protects the right of foreign invested enterprises to equally participate in the setting of standards, and reinforces the information disclosure and social supervision for the setting of standards (Article 15);
● The State protects foreign invested enterprises' participation in government procurement activities through fair competition. Products produced and services provided by foreign invested enterprises shall be treated equally (Article 16);
● Government authorities and their employees shall keep the trade secrets of foreign invested enterprises confidential, and shall not divulge or illegally provide such secrets to others (Article 23);
● Local governments shall not create rules that impair foreign invested enterprises' legitimate rights and interests or increase their obligations, nor shall they set any market access and exit conditions, or intervene the normal production and operation activities of any foreign invested enterprise (Article 24);
● Local governments shall keep the policy commitments made to foreign investors and perform all contracts concluded with them. If any policy commitment or contract needs to be changed due to national interests or public interests, the foreign investor concerned shall be compensated (Article 25).
6.Transition periods in the FIL may be problematic
The FIL provides two transition periods for foreign investment in China. First of all, the transition period between now and January 1, 2020. As discussed above, the current foreign investment laws will be repealed when FIL enters into force, therefore, in theory, the current laws are still in effect until 2020. However, it is unclear for the investor who wishes to incorporate a JV now on how to negotiate and execute its JV contract, should they rely on the existing laws or the new law? unfortunately, the FIL stays silence on such issue.
The second transition period is the five-year period (between 2020 and 2025) specified in the FIL, it states that all present foreign invested enterprises have five years to reserve their current legal formation and adopt the new law in such period. Such transition can be problematic, especially for Equity JV and Cooperative JV, as they were not incorporated under the Company Law, their corporate structures are significantly different from domestic companies. For instance, in a JV, its board of directors holds the highest power and authority, but they lack of board of shareholders, in which, pursuant to the Company Law, should be the most powerful organ in a company. Therefore, in order to comply with the new law, Equity JV and Cooperative JV may need to rewrite their JV contracts and AoAs, and register again to the authority. During the rewriting process, it is likely the JV partners will have serious discussions on how to manage their company in light of the new law.
Mr. Chao Han
DHH Hangzhou Office
Head of International Investment