Compliance Reminder: the 3rd Year of Foreign Investment Law

Foreword

On New Year’s Day, 2020, China’s Foreign Investment Law has come into force. Replacing the former Sino-Foreign Equity Joint Venture Enterprise Law, the Sino-Foreign Co-operative Joint Venture Enterprise Law and the Wholly Foreign-Owned Enterprise Law (collectively the “Three Foreign Investment Laws”), the nascent law proclaims that all existing foreign enterprises have to adjust their forms and organs according to the Company Law or the Partnership Law and make registrations of these transitions before Jan. 1st, 2025 (the “Grace Period”), otherwise the market supervision and management department will not handle other registration matters applied by them and will publicize such relevant situations. 

On the other hand, the draft amendment of the Company Law (the “Draft Amendment”) was simultaneously summoned on Dec. 20th, 2021, which implied that a new version of the Company Law might be enacted within the Grace Period. Thus, to comply with the Foreign Investment Law, the foreign invested enterprises (the “FIEs”) and respectively foreign investors should also focus on the Draft Amendment and be prepared for probable alterations.

This year is the third year after the Foreign Investment Law came into effect. This article aims to review the impact of the Foreign Investment Law on FIEs, reminding them to complete corresponding adjustments in a timely manner in accordance with applicable laws and regulations, and also reminding them to pay attention to the new impact of the Company Law and the Draft Amendment on the FIEs. 

I.Key takeaways from the Foreign Investment Law

Overall, the protection and management of foreign investment are further regularized by the Foreign Investment Law.

i.Establishment of "pre-establishment national treatment and negative list" management system on market access and simplification of registration procedures

The Foreign Investment Law established the "pre-establishment national treatment and negative list" management system to provide equal treatment to foreign and domestic investments on market access, except for industries listed in the Special Management Measures for the Market Entry of Foreign Investment (the “Negative List”) published by Chinese government periodically. For both existing or planning foreign investments, a better and fair business competition environment is guarantied by law. 

At the same time, it is clarified in the Regulations on Implementation of the Foreign Investment Law that the market supervisory department of the State Council and its local branches are endowed to manage registrations applied by the FIEs. By now, foreign investments have experienced the transition from sole approval system established by the Sino-Foreign Equity Joint Venture Enterprise Law in 1979, then to the dual-track system (i.e. for industries that are on the Negative List, the FIEs shall obtain approvals from the Ministry of Commerce or its local branches before registration with the registration authority; for industries outside the Negative List, the FIEs shall file with the Ministry of Commerce or its local branches before registration with the registration authority) from 2016, and now the one-stop registration system of the market supervision department (offices). For foreign investors, it would be less time-consuming and more convenient to make relative registrations.

ii.Liberalisation of foreign exchange control, strengthen protections for intellectual property rights 

To keep balance on international payments, China had taken a stringent foreign exchange management policy, which frequently caused the concern of foreign investors regarding the remittance of funds. The Foreign Investment Law clarifies that funds and lawful incomes can be transferred inward and outward freely. Furthermore, the law not only proclaims the protection for disposition rights of foreign investors on their legal business activities and profit, but also helps to liberalize foreign exchange control.

Besides, it is often criticized by the international community and foreign investors for claiming that Chinese administrative authorities forced foreign investors to transfer their intellectual property rights by direct or indirect administrative means. Consequently, the Foreign Investment Law also reaffirms protection over foreign investors’ intellectual property rights by adding the article that all administrative departments and their staff are forbidden to coerce or imply foreign investors to transfer their technologies by implementation of administrative licenses, administrative inspections, administrative penalties or administrative coercion. The aforementioned provisions will help dispel foreign investors' concerns regarding intellectual property issues and provide the legal foundation for the protection of their intellectual property rights in China.

iii.Establish complaint mechanism for foreign investors  

It’s innovative for the Foreign Investment Law to establish a complaint mechanism for foreign investors. Which would help to standardize dealing with foreign investors’ complaints, thereto making it more convenient for foreign investors to safeguard their rights. Local regulations have been successively specified for future right-safeguarding procedures.

iv.Clarifying validity of governments’ commitments

Over the last decades, when it comes to foreign investments, to fulfill the goal of attracting foreign investments, local governments sometimes would sign investment agreements with foreign investors that promised the later certain preferences. However, the validity and enforceability of government commitments in such investment agreements are often controversial. The Foreign Investment Law and its implementing regulations recognize the validity and enforceability of the legal parts in these commitments. Besides, according to the Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Administrative Agreement Cases carried out on Jan 1st, 2020, it will be supported by the court when investors claim to ask administrative agencies to continue performing contractual duties, ask for compensations for the caused damages and penalty. Please kindly note that arbitral clauses in such administrative agreements (investment agreements) are invalid according to jurisdictional interpretations, hence arbitral clauses should be avoided when signing investments agreements with local governments.  

II.Key takeaways from the Company Law and the Draft Amendment

According to the Foreign Investment Law, FIEs formed according to former Three Foreign Investment Laws ought to adjust their forms and organs of enterprises in accordance with the existing Company Law or Partnership Law before Jan. 1st, 2025.

In light of that most existing FIEs are Sino-foreign equity joint ventures, if the structures of enterprises are to be designed unchanged, the FIEs would be most likely to choose the enterprise forms as limited liability companies or companies limited by shares. So this article will focus on the issues that existing Sino-foreign joint ventures need to deal with under the Company Law and the Draft Amendment.

The existing Company Law was amended in 2018. The Draft Amendment was summoned on Dec. 20th, 2021 and is now collecting public advice.

i.Key takeaways from the existing Company Law

a) Alteration of forms

According to the Foreign Investment Law, FIEs should adjust their forms to limited liability companies or companies limited by shares or partnerships in accordance with existing Company Law or Partnership Law. Consequently, Sino-foreign co-operative joint ventures will be no longer lawful forms of FIEs, thus remaining Sino-foreign co-operative joint ventures should alter their enterprise form into legal ones before the expiration of the Grace Period.

b) Adjustments on organs of the enterprise

（1）Highest authority   

According to the Sino-Foreign Equity Joint Venture Enterprise Law, the board of directors is the highest decision-making organ. Both the Sino-Foreign Equity Joint Venture Enterprise Law and its implementing regulations didn’t make articles on (general) shareholders’ meeting. In practice, the board of directors exercises powers of both the board of directors and (general) shareholders’ meeting. In this context, it acts as representative of shareholders meanwhile participating in the enterprise’s daily management. On the contrary, the Company Law clarifies that all companies should organize shareholders’ meeting or general shareholders’ meeting depend on the forms of their companies (shareholders’ meeting in limited liability companies, general shareholders’ meeting in companies limited by shares), and should register following changes of shareholders, directors and company’s articles of association， etc. according to the applicable laws.

（2）Appoint of supervisor or board of supervisors

There were no articles about supervisor or board of supervisors in the Sino-Foreign Equity Joint Venture Enterprise Law. But the Company Law requires companies to appoint supervisor or board of supervisors depend on the form and scale of their companies (in general, both limited liability companies and companies limited by shares shall establish a board of supervisors, except limited liability companies with relatively fewer shareholders or of a relatively smaller scale may appoint one to two supervisors instead of establishing a board of supervisors). Therefore, shareholders of FIEs should start further consultations and negotiations on matters such as the establishment of boards of supervisors (or appointment of the supervisor), respectively candidates and appointment rights, and completion of subsequent appointments and corresponding change registrations in time.

（3）Legal representative

According to the Sino-Foreign Equity Joint Venture Enterprise Law, legal representative of an enterprise can only be its chairman of board of directors. But the Company Law widens the choice from only the chairman of board of directors, to the inclusion of the chairman of board of directors, executive director and manager. As a result, shareholders can negotiate the appointment of legal representative rather than appoint the chairman of board of directors directly. Thus the management of personnel in enterprises can be more flexible. Decision right over company management between shareholders can also be much more balanced from the premise that the control right is settled.

c) Shareholding and capital contributions

（1）Limitation on shareholding ratio is removed

The Sino-Foreign Equity Joint Venture Enterprise Law claimed that foreign investors’ shareholding should not be less than 25%. This limitation is not mentioned in the Company Law so that shareholding of FIEs will be more negotiable and flexible. However, to access to certain incentive policies such as over customs, there are still certain limitations on shareholding ratio. For example, FIEs should keep their foreign share-holding ratio over 25%, otherwise exemption of customs can’t be received when they contractually importing equipment or the parts of the equipment according to relative laws. So, it is suggested that business needs in general should also be considered when deciding shareholding ratio in capital contribution between domestic and foreign investors. 

（2）Limitation over technology and equipment capital contribution is concealed

According to the Sino-Foreign Equity Joint Venture Enterprise Law, technologies and equipment used in capital contribution must be advanced and exigent for China, otherwise foreign investors may be responsible for damages caused by technical insufficiency. The Company Law clarifies that investors can invest in kind or other non-monetary assets that are measurable in currency and can be legally transferred. Therefore, as long as the capital contribution is legally effective, the responsibility for damages caused by technical insufficiency is not a thing to be worried about, which would, to a certain extent, incentive foreign shareholders to import wider scope of technologies and equipment to their China-based FIEs.

ii.Key takeaways from the Draft Amendment

 a) More choices of company forms and ways of capital contribution

The Draft Amendment adds articles about “One-person company limited by shares.” So there might be more choices regarding the form of the FIEs when foreign investors establish FIEs in China in the future.

As for capital contribution, it is common to invest in credit or equity in practice. But both measures are not admitted by law, the Draft Amendment has included them in the scope of legal capital contribution. For foreign investors, it might be much easier and lower-cost to raise funds yet legally guaranteed with more choices.

b) Organs of company and relative naming

Shareholders’ meeting and general shareholders are differentiated in terms of the name in the Company Law by the forms of enterprise, while the two have the substantive same functions and powers. But the Draft Amendment, no longer makes any distinction and there will be shareholders’ meeting only. If the draft regulations comes into force, the substantive functions of the shareholders' meeting will not be changed for FIEs, but it is necessary to pay attention to the unification of the name of the shareholders’ meeting in the registration or document preparation.

In the case of not establishing a board of director in limited liability company, according to the Draft Amendment, the management power should be given to one or two appointed directors rather than one executive director alone. Therefore, if FIEs choose to change into limited liability companies without the board of directors, they need to pay attention to the final regulations on this matter in the Draft Amendment, and make reasonable arrangements and adjustments to the personnel, numbers and functions of director(s) or board of directors in accordance with applicable laws and regulations .

The Draft Amendment allows companies not to set supervisor or board of supervisors, but there must be an auditor committee in the board of directors. Thus FIEs should also focus on the change of the law and prepare whether to adjust or remove supervisor or the board of supervisors according to the actual needs of the company, so as to reduce company management costs.

 c) Emphasize duties of directors, supervisors and other senior officers 

To keep pace with the practical trend that the duties of directors, supervisors and other senior officers have been strengthened, the Draft Amendment also emphasizes the duties of these positions. Directors, supervisors and other senior officers will be liable when shareholders commit incomplete capital contribution or withdraw capital contribution, and damages caused by the illegal distribution of profit or reducing registered capital under their management. It is quite common for FIEs to have directors, supervisors or other senior officers from abroad, which means it is necessary for FIEs to grasp the corresponding legal changes in a timely manner on the one hand, and make sure or train the respective personnel to be clearly aware of these duties on the other hand to avoid incompliance for both FIEs and the staff themselves.

 d) Turn social responsibilities into legal responsibilities

Besides the basic responsibility to comply with laws and regulations, the Draft Amendment also clarify responsibilities of companies to protect the rights of employees, customers and relative communities; to protect the environment and public benefit. These regulations are in line with international practice, which reflects the importance and concern of corporate social responsibility from the legislative perspective. From the perspective of a global compliance structure, multinational companies can take this opportunity to establish a group compliance system with general applicability, therefore will reduce the cost of building a global compliance system in the long run for multinational companies. 

III.Summary

Not only the Foreign Investment Law, but also the Company Law and the Draft Amendment all show China’s efforts on creating a better business environment with greater equality between foreign and domestic investors and legal reformation on higher efficiency and compliance of enterprises’ management.

For foreign investors, it is necessary to adapt to legal adjustments in timely manner. Although there is a grace period of five years, it’s not easy for FIEs to make changes in a short time. In fact, the change is not only about updating and preparation of forms and positions, but more importantly, about the transition of core domination. Details concerned to interests are to be negotiated, which is no doubt to be a long and complicated procedure, such as the transition of the highest power from the board of directors to the shareholders' meeting, it involves not only the adjustment of the organ’s name, but also other sensitive matters, including the distribution of rights of the board of directors and the shareholders’ meeting, the adjustment of personnel of the board of directors, the decision-making mechanism of the shareholders’ meeting and the board of directors.

The earlier the negotiation starts, the more chances for foreign investors to optimize the management of FIEs and for FIEs to gain competitiveness in the Chinese market. For FIEs, costs may increase rapidly in short term along with sophisticated adjustments. On the contrary, to better accustom the pace of business competition and meet the needs of the local market, it’s also an opportunity for FIEs to thoroughly reevaluate and adjust legal, human resources and financial management with the help from professional agencies (such as accounting firms and law firms), thus to optimize organization and management of enterprises and comply with applicable laws and regulations.

Authors:

Li WANG

Senior Counsel

Ms. Wang has worked for a leading German law firm for several years. She has advised domestic and foreign clients on their investments in Europe and China in such a wide range of industries as automobile, energy and technology. With extensive experience, she counsels on joint ventures, M&As, PE and general corporate matters. 

Areas of Practice: merger and acquisition, foreign direct investment, and corporate matters

Email: wangli@zlwd.com

Tel: 186 1609 3525

Yushan LI

Intern, graduated from Beijing International Studies University with a bachelor's degree in Law and English.