On January 19, 2015, China's Ministry of Commerce (“MOFCOM”) released the first draft of its new Foreign Investment Law (中华人民共和国外国投资法). The proposed Foreign Investment Law (“FIL”) is intended to replace three existing laws which currently govern foreign investment in China: (i) the Sino-Foreign Equity Joint Venture Law (“EJV Law”), (ii) the Sino- Foreign Cooperative Joint Venture Law (“CJV Law”) and (iii) the Wholly Foreign-Owned Enterprises Law (“WFOE Law”). The new FIL will significantly change the existing regulatory landscape controlling all foreign investment in China, below please find a concise summary of the major components of the new FIL.
An analysis of the Draft Foreign Investment Law reveals that it has been modeled, in part, on the regulatory frameworks from several Western countries, including the Investment Canada Act and the Foreign Acquisitions and Takeovers Act 1975 (Australia). Specifically, the definition of “foreign investor” appears to have been adopted directly from the Australian Act, which identifies foreign investors based upon an actual “control” test, i.e. enterprises (whether based onshore or offshore) under the control of foreign investors will be treated as foreign investors. It is worth noting that a foreign investment regulatory regime based on the concept of control will likely cause the Foreign Investment Law to have extraterritorial effect. Article 15 of the Draft FIL specifies that, if an offshore transaction causes the transfer of actual control over an onshore enterprise to a foreign investor, such foreign investor will be deemed as investing onshore. In addition, a number of provisions in relation to information reporting have been modeled on the Investment Canada Act, and the foreign investment special administrative catalogue (i.e. the ‘negative list’), is also based on an internationally accepted entry clearance mechanism.
National Security Review
Compared with the existing regulations, the Draft Foreign Investment Law expands the scope of matters that are subject to national security review. Any Foreign Investment that damages or may potentially damage national security is subject to a unified national security review regime, regardless of industry sector or whether it is controlled by a Foreign Investor. This is an extremely broad coverage, and even though the Draft Foreign Investment Law highlights a number of areas that are subject to particular review attention (such as national defense, key infrastructure and key natural resources), this expanded regime still raises much uncertainty to foreign investors. Guidelines on national security review will be promulgated separately, which hopefully may provide more detailed clarifications.
It is also worth noting that Foreign Investors may not withdraw their applications of national security review without MOFCOM’s prior consent, and administrative reconsideration and administrative litigation are not available for any decision of national security review.
Transition From the Current Regulatory Regime.
The Draft Foreign Investment Law will no longer regulate corporate governance issues for enterprises with foreign investment; instead, they will be required to follow the same requirements as domestic enterprises under the Company Law, the Partnership Law and the Law on Individual Proprietorship Enterprises. The Draft Foreign Investment Law gives existing EJVs, CJVs and WFOEs (“FIEs”) a three-year transitional period to conform with these laws.
The following are some of the potential changes to existing joint venture contracts and articles of association:
• Changing the highest authority of an EJV from the board of directors to the shareholders’ meeting according to the Company Law;
• Changing the legal status of an unincorporated CJV to either a limited liability company or a foreign-invested partnership; the highest authority of a CJV should no longer be the board of directors or the joint management committee, it should either be changed to the shareholders’ meeting according to the Company Law or follow the provisions in the Partnership Law;
• Changing the profit distribution ratio of an EJV since profit sharing among shareholders is not required to be proportionate to equity ratio under the Company Law; and
• Amending the pre-emptive right requirement so that selling shareholders of an EJV or a CJV will only need to obtain consents from more than half of the non-selling shareholders (rather than all the non-selling shareholders according to the EJV Law or CJV Law). This is particularly favorable to the selling shareholders of an EJV or a CJV which has multiple partners.
There is little doubt that the Draft Foreign Investment Law, when promulgated, will bring fundamental changes to the foreign investment regulatory regime in China. While the Draft Foreign Investment Law appears to be a very positive sign of the Chinese government’s determination to relax restrictions on foreign investment, several important issues regarding the new law still need to be answered.
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