The Trend to Further Reform: Contemplated Changes to the Foreign Investment Laws In China

The Trend to Further Reform: Contemplated Changes to the Foreign Investment Laws In China

On December 9, 2013, two years after the People's Republic of China made its 12th Five Year Plan for Foreign Capital Utilization and Overseas Investment, which aims to optimize the foreign investment regime in China, the PRC Ministry of Commerce ("MOFCOM") published a notice seeking comments on its proposal to amend the three laws on foreign investment: (i) the Chinese-Foreign Equity Joint Ventures Law ("EJV Law"), (ii) the Chinese-Foreign Contractual Joint Ventures Law ("CJV Law"), and (iii) the Wholly Foreign-Owned Enterprises Law ("WFOE Law") (collectively, "FIE Laws").

The FIE Laws were last amended in 2000 and 2001, and those amendments were primarily intended to support China's WTO accession at that time. However, the FIE Laws and implementing regulations not only are outdated in many respects, given the rapid growth of foreign investment in China over the recent decades, but also lack necessary clarity and specificity. As a result, legal professionals in China have been discussing potential amendments to the FIE Laws ever since the amendments to the PRC Company Law in 2005.

Changes Most Likely to Occur

The Regulatory Approvals for the Establishment of, Major Changes to, and Termination of Foreign-Invested Enterprises ("FIEs") in Most Industries May Be Repealed. As a new step in further reforming the foreign investment regime in China, FIEs in the new Shanghai Free Trade Zone ("Shanghai FTZ") will not be subject to regulatory approvals for their establishment or for major changes or termination, except for those in the industries that appear on the "negative list." One spokesman for MOFCOM previously expressed that this "negative list" system in the Shanghai FTZ would provide some arguments in favor of amending the FIE Laws to abolish the regulatory approvals for FIEs, except for those that appear on the national "negative list." According to the Decision on Temporarily Adjusting Administrative Examination and Approval or Special Access Measures in the Shanghai Free Trade Zone, issued by the State Council on December 21, 2013, 24 types of regulatory approvals will be suspended for FIEs in the industries not appearing on the "negative list" and will be replaced by a filing-based administrative system. Therefore, based on the new practice in the Shanghai FTZ, future amendments to the FIE Laws might eliminate the approval procedures applicable to the establishment of, major changes to (including increase and decrease of registered capital and equity transfer), and termination of FIEs that fall outside a national "negative list." If this amendment receives legislative approval, it would remove major hurdles that have tightly regulated foreign investment projects in China for more than 30 years.

The Current Annual Inspection System May Be Changed to an Annual Reporting and Public Notice System. According to the measure adopted in the Certain Opinions of the State Administration for Industry and Commerce on Supporting the Development of the Shanghai Free Trade Zone, issued on September 26, 2013, all enterprises should, within the prescribed time period each year, submit their annual reports to the relevant office of the State Administration for Industry and Commerce via a market player credit information disclosure system. In addition, such enterprises should release their annual reports to the public for inquiry by all entities and individuals. Given that the amendments to the FIE Laws will likely be based on the new practice in the Shanghai Free Trade Zone, as pointed out by Zhou Hanming, vice chairman of the Shanghai People's Political Consultative Conference and a well-known law professor, this change is highly likely to occur in the proposed amendments to the FIE Laws. Although the current annual inspection system might be simplified to a self-reporting system, companies should still be prudent in their business operations and be responsible for the truthfulness and legality of their annual reports. As a result of this self-reporting system, a list of those enterprises with noncompliant operations could be prepared, and those enterprises that fail to disclose annual reports according to the specified time limit may be recorded through the market player credit information disclosure system.

The Requirements for Contributing Registered Capital to FIEs May Be Relaxed. On December 28, 2013, the Standing Committee of the National People's Congress passed certain amendments to the PRC Company Law, effective as of March 1, 2014. Under these amendments, minimum registered capital for establishing an enterprise in China will no longer be required; further, the 20 percent initial capital contribution and the 30 percent minimum cash contribution will no longer be required either. As a result, without such mandatory requirements, the power of determining the amount and schedule of capital contributions will rest with the shareholders, as stated in the company's Articles of Association. This relaxation of capital contribution requirements will likely have direct impact on similar requirements currently under the FIE Laws as well as the implementing regulations and rules. If comparable amendments were made to the FIE Laws or otherwise become applicable to the FIEs in China, foreign investors would also have flexibility in capitalizing their investment projects in China, as they do in many market economy countries.

Our Suggested Changes

In light of the historical development of the foreign investment regime in China over the past 30 years or so, two regulatory systems—one under the PRC Company Law governing domestic and foreign companies, and the other under the FIE Laws governing all foreign investment activities in China—coexist and apply to all FIEs established in China. Although Article 218 of the Company Law provides that "where there are otherwise different provisions in any law governing foreign investment, such provisions shall prevail," the coexistence of these two regulatory systems makes the pragmatic application of the PRC Company Law and the FIE Laws quite difficult. Therefore, we suggest that the expected amendments to the FIE Laws be structured with sufficient clarity and specificity so as to provide for a transparent and efficient correlation between the FIE Laws and the PRC Company Law and other domestic laws and regulations that are applicable to all domestic companies and FIEs incorporated in China.

The PRC Company Law Should Apply to the General Administration of All Domestic and Foreign Companies Established in China. For purposes of consistency and transparency, the relevant provisions governing the following major corporate aspects of enterprises could be removed from the FIE Laws and integrated into the PRC Company Law: (i) company incorporation; (ii) capital contribution; (iii) organizational structure; (iv) finance and accounting; (v) liquidation and dissolution; and (vi) and other similar provisions equally applicable to domestic and foreign companies in China. For any special provisions governing only FIEs, such as special requirements on corporate governance of Chinese–foreign joint ventures, a new chapter titled "Special Provisions for Foreign Investment Enterprises" could be added to the PRC Company Law.

The EJV Law, CJV Law, and WFOE Law Should Be Consolidated as One Foreign Investment Law. This one-law system should regulate foreign investment policies including: (i) market access, including but not limited to the size, form, term, ownership proportion, industries and sectors, and other general terms exclusively governing foreign investment; (ii) preferential treatment; (iii) tax deduction and exemption; (iv) administration of foreign exchange; and (v) nationalization and expropriation. Furthermore, because FIE- related implementing regulations and administrative rules are scattered across numerous government authorities and areas, it would provide more efficiency and transparency to integrate various FIE-related laws and regulations into either the Foreign Investment Law or a special chapter of the PRC Company Law. For example, administrative rules such as the Certain Provisions on Change of the Equity Interests of the Investors of a Foreign-Invested Enterprise, issued on May 28, 1997; the Provisions on Merger and Division of Foreign-Invested Enterprises, issued on November 22, 2001; and the Provisions on Foreign Investors' Merger with and Acquisition of Domestic Enterprises, issued by MOFCOM on June 22, 2009 should all be consolidated and rewritten in the new Foreign Investment Law or a special chapter of the PRC Company Law as well as their implementing regulations. In other words, only Foreign Investment Law should regulate the relevant policies, thereby leaving the specific corporate governance and business operational matters in the PRC Company Law.

We believe that the suggested changes discussed above could best serve the needs and protect the interests of both Chinese domestic enterprises and foreign investors. However, it will undoubtedly take much time and effort to achieve such a major legislative restructure. As mentioned above, the corporate law reform has already commenced, as reflected in the establishment of the Shanghai FTZ and the latest amendments to the PRC Company Law. These are intended to bridge the gap between the PRC Company Law and the FIE Laws, all moving in a direction more conducive to foreign investors and investment. Based on our experience in working with multinational corporate clients in China over the years, we are optimistic that a more efficient and transparent legal system governing foreign investment in China will be put in place in the near future.

Lawyer Contacts

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Patrick H. Hu

H. John Kao

Ian Liao

Jessie Tang

Liming Yuan

Ross Keene

Peilin Liu, an associate in the Shanghai Office, assisted in the preparation of this Commentary.

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