From the 1 January 2020, Foreign Investment Law of the People’s Republic of China (“FIL”) becomes effective. The FIL adopted at the Second Session of the Thirteenth National People’s Congress marks a significant era for foreign investment in China and many foreign entities will be affected by the FIL. In this two-part series, we analysis the FIL to provide an in-depth understanding and main takeaway points for foreign companies working in China. 

Currently, foreign investment is divided into foreign direct investment and other foreign investment. Generally, foreign direct investment refers to investment activities of establishing new entities or purchasing existing entities. Whilst other foreign investment activities refer to foreign investment which falls outside of the scope of foreign direct investment foreign investment is divided into foreign direct investment and foreign. There are three main bodies of laws which regulate the four primary forms of foreign direct investment:

1. Sino-foreign Equity Joint Venture Law of The People’s Republic of China (“EJV Law”) governs equity joint ventures established between a foreign party and a Chinese legal entity.
   
   
2. Wholly Foreign Funded Enterprise of the People’s Republic of China (“WOFE Law”) governs wholly foreign enterprises which are wholly established by one or with other foreign investors.
   
   
3. Sino-Foreign Cooperative Joint Ventures of the People’s Republic of China (“CJV Law)” governs contractual joint ventures established between a foreign party and Chinese enterprise or other economic organisations.

However, with the adoption of the Foreign Investment Law (“FIL’’) from 1 January 2020, the above three laws shall be simultaneously repealed. FIL unites both foreign direct investment and other foreign investment into one unified law governing foreign investment, as well as paving the way to more consistency between domestic and foreign entities.

Effects of FIL for existing foreign companies in China

Under the FIL, foreign entities shall be governed by the Company Law and Partnership Enterprise Law. There is a five-year transition period for existing foreign entities in which the corporate governance, the operating structure shall be adjusted to comply with the Company Law or the Partnership Enterprise Law.

In terms of the Wholly Foreign-owned Enterprises (“WFOE”), there will be little impact from FIL since the Implementation Opinion on Issues relating to Application of Law for Administration of Examination and Approval and Registration of Foreign-invested Companies requires WFOEs to adhere to Company Law. Whilst for Equity Joint Ventures (“EJVs”) and Cooperative Joint Ventures (“CJVs”), such revisions will have a major impact, namely, the corporate governance of both EJVs and CJVs considerably varies from the entities which adhere to the Company Law.

The below table summarises the corporate governance and structural difference between the Laws.

Subjects	EJV Law	CJV Law	Company Law
Highest authority	Board of Directors	Board of Directors or Joint Management Committee	Shareholders
Powers and duties of highest authority	All major issues such as change of articles of association, increase and decrease of registered capital, merger or spin-off and dissolution.	All major issues such as change of articles of association, increase and decrease of registered capital, merger or spin-off and dissolution.	Deliberating on and approving majors matters including the modification of the articles of the association, the company’s capital reduction, merger or division of the company, and dissolution and liquidation of the company.
Voting rules for major issues	Unanimous consent of all directors present at a Board meeting.	Unanimous consent of all directors or members of the Joint Management Committee present at a meeting.	Favourable votes of shareholders holding two thirds or more of the voting rights.
Number of directors	No less than 3 directors.	No less than 3 directors or members of the Joint Management Committee.	3-13 board of directors or one executive director.
Quorum	Two-thirds or more of all directors.	Two-thirds or more of all directors or members of the Joint Management Committee.	As agreed by the shareholders.
Term of directors	4 years	No more than 3 years	No more than 3 years
Legal representative	Chairman of the Board	Chairman of the Board or director of the Joint Management Committee	Chairman of the Board, executive director or general manager

Legal Person

Under the current CJV law, CJVs are not required to be established as a legal person. Major elements of the partnership in a CJV are predominantly governed by the contractual joint venture contract, including investment or pre-requisite for cooperation, distribution of earnings or products, sharing of risk and loss, more of operation and management, ownership of property upon termination of CJV and so forth. With the elimination of the CJV law and the governance of the Company Law, CJVs without legal status should be established as a legal person and proceed in required administrative formalities such as articles of association, company incorporation and so forth. 

Corporate Governance

In both EJVs and CJVs, corporate governance is significantly impacted. Currently, the highest authority in both EJVs is the board of directors and in CJVs, either the board of directors or the joint management team shall be adjusted to the board of shareholders and a three-tier board shall be established. Under the Company, corporate governance consists of the board of shareholders as the highest authority, the board of directors as the governance of the daily management and the board of supervisors. The board of shareholders convenes on the resolutions for the major issues of the company and shareholder voting rights are based on each shareholder’s respective capital contributions unless the articles of association specify. The board of directors or one executive director is appointed by the board of shareholder to execute the resolutions of the board of shareholders and govern the daily management of the company.

With the highest authority of the company shifting from the board of directors or joint management team to the board of shareholders, the determination of the company will rest on the board of shareholders. Any resolutions on major matters including the appointment of the directors, supervisors and senior positions are concluded with two-thirds of the majority voting rights. Therefore, such changes offer more flexibility in the decision-making mechanism and may decrease deadlock situations between shareholders, since unanimous consent is no longer required. However, since the voting right of shareholders is dependent on the respective capital contributions, minority shareholders may hold less influence than majority shareholders.

Share Transfer

Under the current EJV and CJV laws, share transfers to a third party shall obtain the consent of all other shareholders, whilst under the Company Law, only the consent of the majority of the other shareholders is required. Again, the share transfer is much flexible than before, however, any shareholders who disagree to the proposed transfer shall purchase the share to be transferred. Refusal to the purchase the share shall be deemed as consent to transfer. Additionally, other shareholders shall have the right of first refusal on the purchase of the share.

Business administration

From the effective date of the FIL, existing EJVs and CJVs are allotted a five-year transition period to implement requisite changes. Companies should complete any company alterations such as articles of association, changes in directors, terms of directors accordingly to record-filing procedures as provisioned in the relevant laws, rules and regulations. Otherwise, where joint ventures do not complete such corporate changes, the competent department for commerce shall order any such company to make corrections within a prescribed time limit, and if such corrections are not made within the prescribed time, a penalty of no less than RMB 100,000 and not more than RMB 500,000 shall be imposed.

In streamlining foreign companies under the Company Law and Partnership Enterprise Law, foreign companies will be subject to the same governance as domestic companies. In other words, it is a strong signal that the Chinese government is paving the way to equal treatment for both foreign and domestic companies, thus addressing concerns of foreign investors. Furthermore, the relevant implementation measures will likely be released in the coming months to provide more definition and clarity to the FIL.

The takeaway from this post

China’s update on Foreign Investment Law, to be effective from 1 January 2020,  will govern the activities of all individual foreign investors and foreign-invested enterprises (FIEs). Investors paying close attention to changes in Chinese foreign investment law and those who are proactive in preparing for such changes will be at an advantage going forward. To this end, knowledge and preparation are key. Horizons can both keep you in-the-know and provide the type of advice that will allow you to act quickly and remain ahead of your competitors.

If you have concerns related to Foreign Investment Law of the People’s Republic of China (“FIL”), please contact Horizons at talktous@horizons-advisory.com to schedule a consultation session. From RMB 1,500 per session, Horizons can provide insight, expertise and the right solutions for you. 

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