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Tips For Navigating China’s 2020 Foreign Investment Law

By Robin Gerofsky Kaptzan, Esq.

On January 1, 2020, China made a bold move forward by opening its economy to foreign investors with the launching of its then new Foreign Investment Law of the People’s Republic of China (“FIL”). Throughout the COVID-19 pandemic, new businesses took advantage of the flexibility the FIL afforded companies, and there was little to no focus on FIL changes by existing foreign operated companies. The FIL replaced key laws in existence since the 1980s for joint ventures and wholly foreign-owned enterprises. The groundbreaking legislative now offers foreign investors greater business opportunities in China and meets China’s goal of creating a business platform on par with the global economy. The government’s goal is clear: all investments in China-domestic and foreign-are to be treated equally.

The 1980s rules mainly focused on the “nuts and bolts” for company setup-registration and organization-and not on specific investment areas and investor protection. Through the FIL, foreign investors are now entitled to equal access regarding specific investments, such as to land, tax exemptions, government funds, bidding projects, public comment about laws, preferential policy entitlements in certain regions and industries, and other critical rights foreign investors were not previously afforded. Greater protection for foreign investors is provided by prohibiting government officials from forcing them or their foreign PRC entities to transfer their technology and the opportunity to settle intellectual property disputes, allowing for business to be conducted on an equal playing field.

The FIL also allows for greater flexibility to foreign investors when setting up a China operation by removing significant mandatory provisions from the articles of association (the company’s governing rules). For a company currently operating in China, related regulations have been adopted allowing a five-year transition period for existing foreign-invested enterprises (by December 31, 2024) to revise the current company rules for consistency with the FIL. A few key changes are:

  • A board of directors was previously empowered to decide all major company issues. The FIL requires a shareholders’ board to be the top governing authority.
  • An organization called a board of supervisors was formerly required to monitor the shareholders. The FIL requires the board of supervisors to monitor the acts of the directors and senior managers.
  • The proportion of a foreign investment in a joint venture used to equal to the investment percentage. The FIL removed this right, making it a negotiable term.
  • Previously, key decisions (i.e.: amendment of bylaws, termination, and change in registered capital) were unanimously agreed upon by each of the directors (with a joint venture partner potentially having veto power for contributing more than 33% capital). The FIL no longer makes this veto power mandatory for a joint venture partner as it is now a negotiable term.
  • Under the rules of the former law, the amount registered capital could be reduced was limited. The FIL removed this right, making it a negotiable term.
  • Distribution of liquidation was not addressed in the prior law. The FIL requires the distribution of liquidation income according to the proportion of the shareholders’ investment.

Many important concepts mentioned in the new law are still surrounded by uncertainty and thus, require clarification. For example, the definition of the term “indirect investment” does not have a concise meaning, and the use and function of a foreign investment information reporting system and foreign investment security review system is created with broad verbiage. There is also concern with the language prohibiting government officials from forcing technology transfers. Although having the black letter law is promising, enforcement of the law remains unclear, and while specific rules and processes are expected to be introduced to clarify these issues and fill in the gaps, they do not exist to date.

Related Laws: The FIL continues to rely on a “Catalogue of Industries”, with the 2019 version identifying 1,108 industries in which the PRC government is promoting investment. A significant focus remains encouraging investing in Central and Western China, as the government has over the past decade. The FIL also continues to rely on a “Negative List“, with the Negative List 2020 predominantly including business areas where foreign investments are prohibited or restricted in China. The Negative List 2020 has reduced restrictive measures from 93 areas to 33 areas, providing access to investments in finance, automobile, agriculture, technology, and other industries.

Recommendations for Foreign Investors Before Filing Registration Documents & Launching or Engaging in Negotiations

  • Have a deep and clear understanding of an investor’s rights and obligations regarding corporate governance (especially about the abandoned mandatory principles and new ones allowing flexibility).
  • Inquire with the local government about its sentiment on certain issues.
  • Consider how the articles of association could be drafted or revised to a) influence the company’s operation in and out of China, and possibly with an offshore partner, and b) give flexibility (or not) in the event of a future buyout, IPO or other change in the corporate ownership.
  • Evaluate the big picture (global effect), including re-structuring.
  • Rely on a reputable consultant (after a background check), and not an unknown agent, for guidance and to artfully represent or negotiate for you.
  • Focus on the potential mismatch and confusion in the new law that could be caused by the co-existence of both laws for five years and address them long before the five-year transition period expires.
  • Understand what benefits have been afforded to you under the FIL and take advantage of them.

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Attorney Advertising. The information presented is not legal advice, is not to be acted on as such, may not be current and is subject to change without notice. You should not act upon any such information without first seeking qualified professional counsel on your specific matter.