China: China's Foreign Investment Law——New Rules And Their Impacts

Last Updated: 3 April 2019
Article by Aaron Yizhou Deng
Most Read Contributor in China, September 2019

Foreign direct investment of China has been ranking No. one among developing countries for twenty-seven consecutive years, according to reports of the United Nations Conference on Trade and Development (UNCTAD)[1]. In that backdrop, on March 15th, 2019 the annual session of the National People's Congress (NPC), China's top legislature passed the PRC Foreign Investment Law ("Law"), which is a long-expected landmark legislation and was signed into law on the same day to be effective as of January 1st, 2020.

This article is intended to provide a general observation and legal analysis of the essence of the Law from a lawyer's perspective, so that foreign investors who have already made investments or are interested in investing in China can know the new rules and policies as well as their impacts upon existing and potential investments in China.

1. Purposes – Better Protection, Policy Uniformity, Predictability and Transparency

The Law is primarily aimed at providing better protection for foreign investors' legitimate rights and interests, creating a law-based business environment that is internationalized and enabling, and hence ushering into a new era China's reforms and opening-up cause." For foreign companies in China, I think everyone is waiting for the law to be passed, as it will create a level playing field," said Harley Seyedin, president of the American Chamber of Commerce in South China[2].

With the view to improving China's policy uniformity, predictability and transparency in respect of foreign investment, the Law will replace the three currently effective laws on foreign investments, namely the Law on Chinese-Foreign Equity Joint Ventures, the Law on Wholly Foreign-Owned Enterprises and the Law on Chinese-Foreign Contractual Joint Ventures. That being said, those three laws will be repealed once the Law comes into force on January 1st, 2020 pursuant to Article 42 of the Law.

In addition, Uniformity means inclusiveness as well. As Article 2 of the Law states, the Law has a seemingly omnipotent scope of jurisdiction, covering all forms of foreign investments except for financial investment (such as investment in banking, securities, trust and insurance sectors, which are and will continue to be separately regulated). In particular, unlike its predecessors, the three currently effective laws of foreign investment which regulate only foreign direct investments, the Law regulates both foreign direct investments and various indirect investments such as merger and acquisition ("M&A"), which in fact are not regulated in the three currently effective laws of foreign investment, but through separate regime of ministerial-level rules and enactments, despite them being active for many years in China.

However, it is worth noting that the Law has only one article pertaining to the specific rules applicable to foreign M&A (Article 33), which mandates that any foreign M&A of business within China or any other forms of concentration of undertakings shall be subject to regulatory review of concentration of undertakings. As the Law is basically the "constitution" of China's foreign investments, it was supposed to lay down general principles only, and hence expectably more detailed applicable rules will be formed by the State Council in the light of the Law and the currently effective regulations such as the Interim Rules on the M&A by Foreign Investors of Domestic Businesses of 2003.

2. Investment Entry – National Treatment Plus Negative List

Currently foreign investments have not yet been fully on an equal footing with domestic investments when it comes to some respects of investment treatments. For example, a foreign investor may be required to make certain percentage of cash capital contribution to start a business while a domestic investor in the same sector is not so required.

The Law will change the above scenario after its effectiveness. Its Article 4 provides for the so-called pre-entry national treatment plus negative list regimes. The national treatment regime means that in the course of foreign investment entry foreign investors and their investments will be given the level of treatments no lower than that of the treatments offered to their Chinese counterparts. For instance, regulatory authorities will apply the same criteria and standards to review a foreign investor's application for carrying out a certain sector of regulated business, such as film production as applied to Chinese investor's application.

The second regime refers to the government's power to administer the negative list, a list of investment categories in which foreign investments are forbidden or restricted.

According to Article 28, foreign investors are free to enter those sectors of business which do not appear in the negative list, and hence enjoy national treatments.

While the negative list is maintained, and subject to annual adjustment, by the State Council (but not by any local governments) in its sole discretion, increasingly more business sectors will hopefully be open for foreign investors to enter going forwards. This is not only because China made such promises in her WTO commitment package, but also because China decides to deepen and intensify her opening-up program on a general basis.

3. Promotion of Foreign Investment – Multiple Measures

Multiple Measures have been created in the Law with an effort to enhance foreign investor's confidence and interest in investment into China.

First, to ensure equal participation in market competition, the Law (Article9) promises that various policies of the state to support industrial and commercial development will be equally applied to foreign investments.

Currently, such "policies" may include tax reduction, labor cost cuts such as lower percentage of the social insurance contribution by employers, favorable land use rents, and the like. All those favors will be offered to qualified foreign invested businesses after the effectiveness of the Law the same way as Chinese enterprises.

Second, the Law assures foreign investors of equal rights to industrial standards. They will be entitled to participate in standard-setting of their sectors on an equal footing with their Chinese counterparts. In addition, any industrial standards or requirements, whether old or new ones, will be applicable to foreign invested businesses on an equal basis after the effectiveness of the Law, pursuant to its Article 15.

That being said, foreign investors will likely be able to promote policy-lobbying either by themselves or through their agents such as a business society or chamber of commerce they join.

Third, foreign invested companies will definitely have more business opportunities which they could not have had before. The Law promises that foreign invested companies will, together with their Chinese counterparts be offered equal opportunities in supplying government procurement of goods or services through fair competition. Usually, government procurement are made through public tenders and bids. Hence, foreign investors will be able to bid for procurement tenders by all levels of governments. Given the scale of various governmental agencies and bodies and their enormous demands each year, foreign investors will hopefully make considerably more profits in the future by participating in government procurement.

Last but not least, foreign invested businesses will have rights to financing through public issuance of stocks or debentures, and hence will be able to expand their business in an easier way in China. This is revolutionary to the extent that China's financial markets are heavily regulated, and currently no foreign invested companies have been listed on Chinese stock exchanges such as the Shanghai or Shenzhen stock exchanges.

4. Protection of Foreign Investment – the Rule of Law

For one thing, the Law ensures free currency exchange and expatriation of foreign investors' capital contribution, profits, dividends, intellectual property licensing loyalties and any other legal income or properties, as well as foreign individuals (managers and employees)' personal income and properties, according to Article 21 of the Law.

It is noteworthy that while the Law is rather concise and short with only 42 articles, implying that every provision should pertain to the most important issues, nonetheless the whole Article 21 basically repeats the promises largely similar to those that have already been in place in the currently effective laws, but with more detailed specification of the categories of income and properties eligible to free exchange and expatriation. This fact may indicate that mind has been made up to truthfully get rid of the legal barriers impeding the free disposal by foreign investors and foreign personnel of their income and properties. Predictably China's foreign exchange control in those respects will be considerably loosened for purposes of the Law.

Also, promises have been made under the Law to strictly protect foreign investors' intellectual properties, as widely expected previously.

Pursuant to Article 22, the state will protect foreign investors' intellectual properties both before and after they have been invested into business, and any intellectual property violations will be brought into justice. The same Article ensures voluntary technological collaboration by foreign investors, requiring governments to refrain from any kind of forcibly transfer of technologies as well as to keep confidential foreign investors' trade secrets.

In fact, measures had already been adopted before the promulgation of the Law in that regard. For instance, the State Administration of Intellectual Properties carried out reform programs to intensify law enforcement and employed many more professional employees to oversee and investigate intellectual properties related issues.

More importantly, three courts of justice have been established in the cities of Beijing, Shanghai and Guangzhou, the most developed regions of the country to focus on hearing and ruling intellectual property complaints and disputes. Even the Supreme People's Court, the top judiciary of the country has established a branch of intellectual property, indicating a resolute decision to implement intellectual property related laws and regulations in the most realistic and effective way.

Moreover, foreign investors' legal rights and interests will be further guaranteed by local governments under the Law. As a matter of fact, foreign investors' interests are under the impact of some local governments' variable and capricious policies from time to time. Hence, Article 24 mandates that local governments must make policies strictly within the scope of then-effective state laws (such as the Law) and enactments, without detriment to foreign investors' legal interests or increase to their obligations. With no powers to intervene in the business operation of foreign invested enterprises, local governments are also deprived of powers to set any conditions of market entry and exit, and therefore foreign investments will be run in a more stable and predictable manner without worries of being squeezed capriciously due to changes of local policies.

Further, to hold local governments to their legal obligations, the Law requires them to strictly honor their promises and contracts they entered with foreign investors or their businesses. In the past, it was likely for local governments and their agencies of certain localities to walk away from the promises or agreements they had made with foreign investors, causing damages without effective legal remedies to foreign investors. This will definitely change after the Law becomes effective.

In addition, to ensure the rights to society, the Law allows foreign invested enterprises to legally establish and voluntarily participate in business societies or chambers of commerce. This is the first time foreign investors (through their investments) are authorized to form their business societies, implying China's more open mindset and investors' more powers to voice and lobby.

5. Administration of Foreign Investment – Equal Standards

China has a separate regime of regulatory standards specifically applicable to foreign invested businesses only. Indeed, a couple of years ago the central government had a ministry of "Foreign Economy and Trade" charged with duties to oversee foreign investments, which was cancelled and the remaining functions of which has been incorporated into the current Ministry of Commerce due to China's promise of national treatment in her WTO entrance commitments.

With the Law the separate regime will be fundamentally repealed and superseded by an equal regulatory regime of both foreign and domestic investments.

First, the same procedures and criteria as applied to domestic enterprises will be applied to foreign investments when it comes to regulatory review of applications for sector-specific entry approvals and/or licenses in respect of certain business sectors, such as entertainment and education, under Article 30 of the Law. This provision will further ensure and increase foreign investors' equal opportunities of market competition.

Second, the legal requirements of foreign investments' corporate governance structures will simply follow the Company Law, Partnership Enterprises Law and other laws of business associations, as amended from time to time, which were otherwise applicable only to domestic enterprises, according to Article 31. Currently the governance structure of a foreign-invested company is subject to different requirements from that of a domestically invested company. For instance, currently the directors of the board of a Chinese-foreign equity joint venture company should be appointed by the Chinese and foreign shareholders of the company respectively[3], while the directors of a domestically invested company should be elected by the shareholders' meeting, under Article 37 of the Company Law. After Jan. 1st, 2020, a foreign-invested company's board directors will also be elected and replaced by the shareholders' meetings collectively, not appointed by shareholders any longer. Therefore, it will be up to the percentage of the equity shares a foreign investor holds of a company whether the foreign investor may gain control of the board and in turn, of the company.

It is worth noting that under Article 31, a foreign invested business will be able to take the legal form of a partnership, while currently it may only be in the form of a company, indicating more flexible and freer options of business forms will be available to foreign investors.

Also, some burdensome but universally applied regimes are remained in the Law. Among others Article 34 provides for investment information reporting requirements, and Article 35 stipulates a state security review regime. Obviously, China has just followed the universal general practices in those respects.

6. Labor and Employment - Highlighted Matters

The Law has two articles pertaining to labor and employment as below, indicating concerns about labor protection of foreign-invested businesses:

Article 32 mandates that foreign investors operating business in China should comply with all the laws of the state and administrative regulations of the State Council concerning labor protection and social security. Under the current legislation scenario, "the laws and administrative regulations" here refer to China's Labor Law, Employment Contract Law, Mediation and Arbitration of Labor Disputes Law, Employment Promotion Law and the Social Insurance Law, as complemented by the State Council from time to time.

Article 32 reiterates the applicability of relevant employment laws to foreign invested companies because there have occurred quite a lot of violations or deviations by foreign invested businesses from relevant labor and employment enactments which were otherwise supposed to be equally observed by foreign invested companies. That being said, it is predictable for the said labor and employment laws to be administered and enforced by the authorities in a stricter manner after the effectiveness of the Law. For instance, more inspections and consequently more fines and other penalties are likely to be imposed if foreign invested companies are found to have broken the labor law rules.

The other article of the Law seems to be even more eye-catching. Article 8 regulates trade union issues. Under this article, a foreign invested company must cause to be established a Chinese trade union organization as per the applicable law with an effort to maintain employees' rights and interest, and must also provide necessary conditions for the activities of the trade union as required by law. By "conditions" here it first refers to the fee a company with a trade union is required to contribute to the union by the monthly rate of 2% of the aggregate monthly salaries of all its employees; it also means the welfare benefits a company is expected to provide to trade unions and its cadres and members, such as payment guarantee for employees involved in trade union related activities.

The said article 8 is put in place in the background that currently many foreign invested companies in China are reluctant to establish trade unions despite of the statutory requirements, out of fear for the high rate of union fee contribution as well as other concerns such as possible negative influence of the union. Expectably this will be significantly changed after the effectiveness of the Law. This is because going forward, the authority is likely to intensify the enforcement of relevant laws such as the PRC Trade Union Law in order to ensure the implementation of Article 8 of the Law.

As a matter of fact, Chinese trade unions at a company level are all deemed as affiliates to the All-China Trade Union and thus under its leadership. Chinese trade unions have been known as among the mildest ones in the world in respect of negative influence upon employers. Most of the time, trade unions here in China are friendly and helpful to the employers they are affiliated to.

In summary, obviously the Law indicates China's resolute determination to boost and intensify her opening-up programs which have been carried on for over 40 years, there by substantially relieving foreign investors from worries about conservative policy changes and considerably improving their confidence and interest in investment and doing business in China. Such determination was further embodied in the national treatment to foreign investments, transparency and predictability of policies, checking of local governmental powers, and removal of extra burdens otherwise imposed on foreign investments. However, as the Law is designed to be a fundamental legislation in respect of foreign investment regulation, more detailed and specific enactments and decrees are expected to be adopted and implemented within the framework of the Law after its effectiveness on January 1st, 2020. "The predictability, transparency, and non-discrimination bent of the law will improve the business environment," commented Sourabh Gupta, a senior fellow at the Washington-based Institute for China-America Studies[4].

Footnotes

[1] http://www.npc.gov.cn/englishnpc/news/2019-03/15/content_2083577.htm, logged on Jan. 19,2019.

[2] http://www.npc.gov.cn/englishnpc/news/2019-03/15/content_2083577.htm, logged on Jan. 19,2019.

[3] According to Article 6 of the Law on Chinese-Foreign Equity Joint Venture Enterprises, which is currently in force but will be superseded by the Law after Jan. 1st, 2020, members of the Board of Directors of a joint venture company shall be appointed and replaced by the Chinese and foreign shareholders of the company respectively.

[4] http://www.xinhuanet.com/english/2019-03/18/c_137905230.htm, logged on Jan. 19,2019.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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