Currently, foreign invested enterprises (“FIEs”), i.e. equity joint ventures („EJV“), cooperative joint ventures („CJV“) and wholly foreign-owned enterprises („WFOEs“) in the People’s Republic of China (“PRC”) are subject to special laws and regulations in addition to the PRC Company Law. The most prominent are the PRC Law on Sino-Foreign Equity Joint Venture Enterprises, the PRC Law on Sino-Foreign Corporative Joint Venture Enterprises and the PRC Law on Wholly Foreign-owned Enterprises (“FIE laws”) and their respective implementing regulations.
The establishment and the organizational structure of FIEs are different from those of domestic Chinese companies. For example, while domestic Chinese companies only have to be registered with the competent Administration for Industry and Commerce ("AIC"), FIEs additionally are subject to prior approval by the competent Authority of Commerce.
The highest organ of both domestic Chinese companies and WFOEs is the shareholders’ meeting. In contrast, EJVs and CJVs do not have a shareholders’ meeting. Their highest organ is the board of directors.
Domestic Chinese companies only have a registered capital. FIEs in addition to the registered capital also have a total amount of investment. The latter is important for the financing capacity for loans taken out from abroad. Under the current regulatory regime, the sum of the accumulated amount of mid-term and long-term loans taken out by a FIE from abroad and the balance of the short-term foreign exchange loans (i.e. up to one year term) is limited to the difference between the total amount of investment and the registered capital of the FIE.
The special regulatory regime for FIEs has long been criticized. On 19 January 2015, the PRC Ministry of Commerce (“MoC”) released the long awaited draft version of a PRC Foreign Investment Law (“Draft FIL”) on its official website for public comments. Once enacted, the FIL will considerably change the foreign investment regime in the PRC.
The most important changes included in the Draft FIL are as follows:
1. Abolishment of Special Business Vehicles for FIEs
The special business vehicles for FIEs in the forms of EJVs, CJVs und WFOEs will be abolished.
The Draft FIL grants a three-years transitional period to existing FIEs during which they shall change their organization forms or organizational structures and adjust to the new requirements. After this period, all FIEs are required to use one of the general business vehicles provided for by statutory PRC law. Basically, this means that FIEs have to adopt the organization form and structure of either limited liability companies or companies limited by shares under the PRC Company Law or of a partnership under the PRC Partnership Law. The company forms and structures available to FIEs and those available to domestic Chinese companies will be identical. The shareholders’ meeting will be the highest organ also for joint ventures. Logically speaking, also the concept of the total amount of investment should be abolished. However, the Draft FIL does not touch on this issue.
2. Harmonization of the Law regarding Foreign Investment
The current FIE laws mainly regulate the establishment, organizational structure and certain business activities of investments in the PRC made by foreign investors. Foreign investors are natural persons without Chinese nationality and legal entities incorporated outside the PRC.
The Draft FIL considerably broadens the application scope. It not only applies to the establishment, organizational structure and certain business activities of FIEs, but also to the following activities of foreign investors:
(1) acquisition of shares, equity, share of property, voting power or other similar equities of a domestic enterprise;
(2) financing with a term of at least one year to a domestic enterprise in relation to which the foreign investor has made an acquisition as set out in item (1) above;
(3) exploration and development of natural resources within the territory or jurisdiction of the PRC, or infrastructure construction or operation;
(4) acquisition of rights to immovable property such as the right to use domestic land or house ownership; and
(5) control over domestic enterprises or holding equity in domestic enterprises by contracts, trust or other ways.
Since the definition of “foreign investment” as mentioned above specifically refers to M&A activities, it is expected that not only the FIE laws but also the current regulations on M&A activities of foreign investors such as the Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors will be abolished simultaneously.
This broad definition of foreign investment provides for a very extensive application scope of the Draft FIL. In a best case scenario, the Draft FIL will replace a large number of existing regulations related to foreign investment and will ultimately create a uniform legal framework covering the whole range of the diverse forms of foreign investment – regardless of whether the specific investment project includes an actual physical presence in the PRC or not.
3. New Concept of Actual Control
The Draft FIL newly introduces the concept of “actual control”. Whether a company is considered to be a domestic company or a FIE not only depends on the question whether it was established by a Chinese or a foreign investor but also on the question who exercises the actual control over the company. For the determination of actual control, the definition in Article 18 of the Draft FIL not only refers to shares, equity and voting rights but also to the ability of exercising decisive impact through contractual, fiduciary or other agreements. Accordingly, foreign entities effectively controlled by Chinese investors may, under certain circumstances, apply to be treated as investment made by a Chinese investor. Vice versa, domestic companies effectively controlled by foreign investors are “deemed as foreign investors”. The latter wording appears to be a drafting error. It does not seem to make much sense to treat a domestic entity subject to foreign control as the foreign investor itself. It would be more logical to treat it as an investment made by a foreign investor and, accordingly, as a FIE. It remains to be seen whether these inconsistencies will be amended in future versions of the Draft FIL.
Under the current FIE laws, FIEs are considered and treated as domestic companies. According to the Draft FIL, FIEs with a foreign majority shareholder might be regarded as a foreign investor in the future. This might offer new opportunities in some areas. For example, a contract between two Chinese contracting parties is mandatorily subject to PRC law. Under the current laws, this also applies for contracts between FIEs and domestic Chinese companies. Theoretically and in line with the current wording of the Draft FIL, it might be possible to stipulate foreign law as the governing law for contracts between FIEs and domestic Chinese companies in the future. In other areas, the treatment of FIEs as foreign companies might result in massive disadvantages. E.g., often only domestic companies are allowed to participate in tenders for public procurement.
4. National Treatment and Negative List Approach
Article 6 of the Draft FIL establishes the principle of national treatment for foreign investment. Foreign investors making investments within the territory of the PRC are entitled to national treatment unless provided otherwise. This essentially means that foreign investors shall have the right to make investments on the same terms and conditions as Chinese investors without being subject to additional approval requirements or sectoral restrictions, however, only, if the respective project does not fall within the scope of a so-called negative list (“Negative List”).
Under the current legal regime, all FIEs are subject to approval requirements. E.g., the establishment and liquidation of a FIE, the increase or decrease of its registered capital and the transfer of its shares require approval from the competent Authority of Commerce. Upon the entry of effect of the Draft FIL, the current approval requirements for FIEs will be abolished. Unless a specific project falls within the scope of the Negative List, an application for registration may be directly submitted to the competent AIC. Additionally, there are reporting obligations for all foreign investment projects (for details see Item 5 below). However, they can be fulfilled after registration is completed. Thus, the current system of an ex-ante approval will be replaced by a system of registration and ex-post reporting. In theory, this will be less burdensome for foreign investors and represents a significant improvement compared to the current system.
The Negative List approach follows the example of the model adopted in the China (Shanghai) Pilot Free Trade Zone (“FTZ”). So far, no drafts of the Negative List have been published yet. However, the experiences up to now with the negative list approach in the FTZ have been rather disappointing. A significant number of investment projects formerly subject to approval have simply been shifted into the negative list. As a consequence, the reforms in this respect have just been window-dressing. Indirectly and through the back door of the negative list, approval requirements continue to exist for many projects. Hopefully, the Negative List of the FIL will be significantly shorter than the current negative list of the FTZ.
5. Information Reporting System
Regardless of whether a project falls into the Negative List or not, both foreign investors and FIEs will have to fulfill several reporting obligations through an online system of the MoC.
An investment implementation report has to be submitted before or latest 30 days after the implementation of an investment. Changes of actual investments have to be reported within 30 days after the respective change has occurred. The information to be provided includes
- basic information of the foreign investor, such as its name, domicile, actual controller, contact details etc.,
- basic details of the foreign investment, such as the investment amount, the investment field, the respective investment ratios and ways of contributions, and
- basic details of the foreign invested enterprise, including its name, domicile, equity structure, investment amount and amount of the registered capital etc.
Further, prior to April 30 of each year, all FIEs have to submit an annual report including the same information as required for the investment implementation report and the report of changes, i.e.
- basic information of the foreign investor,
- basic details of the foreign investment, and
- basic details of the foreign invested enterprise.
In addition, further information has to be provided with regard to
- business conditions,
- financial accounting information,
- investment, import and export trade between the FIE and its investor and the investor’s affiliates, and
- major lawsuits, administrative reconsiderations and administrative or criminal penalties within the PRC.
Larger scale FIEs, i.e. FIEs with total assets, sales or an operating revenue exceeding RMB 10 billion or with more than 10 subsidiaries, will have to submit reports on a quarterly basis within 30 days after the end of each quarter.
6. National Security Review
Under the current regulations, M&A projects in certain security-related industries are subject to national security review. The Draft FIL gives the impression that the scope of such national security review will be expanded. According to the wording of the Draft FIL, any foreign investment which “endangers or might potentially endanger” national security shall be subject to national security review in the future. As a consequence also greenfield investments and investment projects in industries not covered by the current security review regulations may be required to go through national security review in the future.
Since the current version of the Draft FIL is quite vague, it is expected that future versions of the Draft FIL and/or implementation rules yet to be published will provide further guidance and clarification in this regard.
In conclusion, once enacted, the PRC Foreign Investment Law will fundamentally change the regulatory regime for foreign investment in the PRC. The proposed abolition of the special FIE laws, the intent to further relax restrictions on foreign investment and the implementation of the concept of national treatment has long been awaited and is much to be welcomed. However, there are still inconsistencies, ambiguities and gaps in the current version of the Draft FIL. They hopefully will be addressed before the final PRC Foreign Investment Law is enacted. Also, in the end only the actual implementation practice of the PRC Foreign Investment Law will show whether it will indeed bring major improvements for foreign investors in the PRC or not.