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Brief Commentary on the Foreign Investment Law (Draft) Changes, Highlights and Expectation

2019.01.18 ZHENG, Yu

On December 26, 2018, the National People’s Congress published the Foreign Investment Law of the People’s Republic of China (Draft) (the “New Draft”) in order to solicit public opinion. The New Draft is a revised version of an earlier draft of the Foreign Investment Law, originally issued by the Ministry of Commerce for public comment almost four years ago (the “First Draft”). The New Draft is significantly shorter than the earlier version, comprising just 39 articles, compared with the 170 articles that made up the First Draft. This would seem to indicate that the overall legislative goal for the Foreign Investment Law has shifted from its previous highly detailed operational approach to one that is now focused on principles and guidance. 


This article provides an overview of the structure of the New Draft, particularly in relation to the major changes since the First Draft, analyzes some key elements, and provides comments and suggestions as to how the New Draft might be improved.


1. Structure of the New Draft


1.1 Sections


The New Draft comprises five main sections:

(1)Definition and scope of foreign investment

(2)Investment promotion

(3)Investment protection

(4)Investment administration

(5)Legal liability


1.2 Major Differences from the First Draft


The following table provides a summary of the content of each of the five main sections of the New Draft and highlights the key differences when compared with the First Draft.


Main Content

New Draft

Major Differences

from First Draft

Definition

The New Draft defines foreign investment (Article 2) as “any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (“foreign investors”) within the territory of China”.

 

Specifically, the New Draft describes three types of investment activities that represent foreign investment:

 

(i) Foreign investors, separately or jointly, investing in new construction projects, establishing foreign-invested enterprises, or increasing investment in invested enterprises, in mainland China;

 

(ii) Foreign investors acquiring, by means of merger and acquisition, shares, equity interests, shares of property or other similar interest in enterprises in mainland China; and

 

(iii) Foreign investors making investments in mainland China through other means as provided by laws, administrative regulations or State Council provisions.


Whereas in the First Draft, foreign investors included “governments of other countries or regions as well as their affiliated departments or offices”, they are not mentioned in the New Draft, and so it is not clear whether they will be permitted to conduct foreign investment in the updated version.

 

Compared with the First Draft, the scope of foreign investment in the New Draft is significantly narrower, and, with the exception of the “catch-all clause”, is limited to foreign investors’ establishment of foreign-invested enterprises in mainland China by means of new set-up (i.e. greenfield investment) or merger/acquisitions.

 

The activities included in the First Draft listed below are no longer classified as foreign investment under the New Draft:

 

(i) Provide financing with a term of more than one year to an enterprise in China in which it owns shares, equity interests, shares of property or other similar interests;

 

(ii) Obtain concession rights to (a) explore and exploit natural resources, or (b) construct or operate infrastructure within the territory or jurisdiction of mainland China;

 

(iii) Acquire real estate rights, such as land use rights or building ownership in mainland China;

 

(iv) Control or own interests of domestic enterprises by contract, trust or other means; and

 

(v) Transactions conducted outside mainland China shall be considered a foreign investment if such transactions will result in the transfer of the de facto control of a domestic enterprise to a foreign investor. 

Investment Promotion

The New Draft emphasizes the aim of establishing a stable, transparent and predictable investment environment (Article 3), and clarifies that national policies in support of the development of enterprises shall apply to foreign-invested enterprises consistently with how they are applied to domestic-invested ones (Article 9).

It was not clear in the First Draft whether national policies in support of the development of enterprises would be consistently applied to foreign-invested enterprises. 


Investment Protection

The New Draft provides protection for investment in respect of state expropriation, profit remittance, intellectual property rights protection, technology transfer, administrative interference, governmental commitments and foreign investors’ complaints, namely that:

 

(i) The state shall not expropriate foreign investments. Should expropriation be required in the public interest, such expropriation shall be conducted in accordance with legal procedures and fair and reasonable compensation should be provided (Article 20);

 

(ii) Foreign investors’ capital contributions, profits and capital gains may be freely remitted outside China in RMB or foreign currency (Article 21);

 

(iii) The intellectual property rights of foreign investors and foreign-invested enterprises shall be protected in accordance with the law. The terms for any technology cooperation shall be determined through negotiation between the parties to the investment. Administrative means shall not be used to compel the transfer of technology (Article 22);

 

(iv) Foreign investment rules formulated by the Chinese government and its relevant departments shall be in compliance with laws and regulations, and shall not illegally (i) impair the legitimate rights of or impose additional obligations on foreign-invested enterprises; (ii) set any conditions for market access or exit, or (iii) intervene or influence normal production and operation activities of foreign-invested enterprises (Article 23);

 

(v) Local governments and their relevant departments shall strictly abide by all policy commitments made in accordance with law, and contracts concluded according to law. If any amendment to such commitments or contracts is required in the national or public interest, such amendment must be conducted through legal procedures and within authorized jurisdiction. Any loss to foreign investors or foreign-invested enterprises incurred thereof shall be compensated (Article 24); and

 

(vi) The complaint submission and handling mechanism for protecting rights of foreign-invested enterprises shall be improved (Article 25).

Compared with the First Draft, the New Draft points out and emphasizes for the first time the following responsibilities of governments to protect foreign investment:

 

(i) Administrative means shall not be employed to compel the transfer of technology;

 

(ii) Foreign investment rules shall be formulated in compliance with laws and regulations; and

 

(iii) Government shall strictly keep all policy commitments made in accordance with law, and perform all contracts concluded according to law.





Investment Administration

The New Draft specifies three investment administrative systems for foreign investment:

 

(i) Pre-establishment National Treatment and Negative List administrative system (Article 27);

 

(ii) Foreign Investment Information Reporting system (Article 31); and

 

Foreign Investment National Security Review system (Article 33).

The New Draft sets out only the principles that underlying the three administrative systems for foreign investment. The First Draft, by contrast, provided highly detailed, practicable provisions for each of the three systems in respect of specific content, conditions, application requirements, elements for review, review procedures, time limits, etc. The implementation of the three systems under the New Draft will be dependent upon the concurrent formulation and implementation of any relevant supporting regulations.

Legal Liability

The New Draft stipulates the following legal consequences for any violation of the negative list or laws and regulations:

 

(i) Violation of the Negative List

 

Foreign investors shall be ordered to make rectification or stop investment activities, or dispose of shares and assets within the prescribed time limit, or take other necessary measures to restore to the original state prior to investment. If there have been any gains derived from such investment, such gains shall be considered illegal and confiscated by the government.

 

(ii) Violation of laws and regulations

 

Foreign investors shall be subject to investigation in accordance with laws, blacklisted in credit information systems, and subject to sanctions taken by relevant authorities. 

Compared with the First Draft, the New Draft does not stipulate any legal consequences for the violation of Information Reporting or the National Security Review system. In addition, administrative sanctions are also removed from the possible legal consequences of a violation of the negative list. Under the First Draft, this could have resulted in a fine of between RMB 100,000 and RMB 1,000,000 or up to 10% of the illegal investment amount.




2. Highlights of the New Draft


Among the highlights of the New Draft are the clear responses to various long-held concerns from foreign investors and foreign-invested enterprises, which should go some way to improving the environment for foreign investment and shoring up foreign investors’ confidence in investing in China. They include:


2.1 National treatment: Unless otherwise stipulated by laws or administrative regulations, national policies to support of the development of enterprises will apply in the same way to foreign-invested enterprises as they do to domestic-invested ones (Article 9);


2.2 Prevention of compulsory technology transfer: The terms of any technology cooperation associated with foreign investment shall be determined by all investment parties through negotiation. Administrative means should not be used by administrative agencies or their officers to compel the transfer of technology transfer (Article 22); and 


2.3 Governmental commitment: Local governments and their relevant departments shall strictly keep all policy commitments made according to law, and perform contracts concluded according to law (Article 24). 


3. Comments and Suggestions to Improve the New Draft


While the New Draft incorporates various advances, we believe there remain further opportunities for improvement or clarification in order to ensure the clear operability of the New Draft after its formal issue: 


1. Definition of “Foreign Investor” and “Foreign Investment” (Article 2, Paragraph 2)

“For the purpose of this law, foreign investment refers to any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (“foreign investors”) within the territory of China”, including…”

Comments/Suggestions

We believe that the current definitions of “foreign investor” and “foreign investment” are insufficiently clear, and that as they stand, they may cause confusion in practice. The main issues are:

 

(i) It is not clear whether “foreign investors” includes foreign or regional governments, and international organizations.

 

(ii) Since, in addition to direct investment, the definition of investment includes “indirect investment”, it is not clear whether for an investment in China, the identity of its foreign investor shall be determined by such investor’s ultimate controlling shareholder.

 

(iii) It needs to be clarified whether an investment made in China by an overseas company that is controlled by a Chinese company will be classified as “foreign investment”.

 

We believe that it is necessary to clarify in the New Draft whether the identity of a “foreign investor” will be determined by the place of registration of the foreign investor that directly holds shares, equity or interest of the invested enterprise in China, or by the place of registration of the ultimate controller of such foreign investor. If it is the latter, a definition of “control” is also required.

 

Given the increasing number of overseas investments emanating from China, a lack of such criteria may lead to severe confusion regarding whether investment in China conducted by overseas companies directly or indirectly controlled or wholly-owned by Chinese enterprises or natural persons will be governed by the Foreign Investment Law.

 

Moreover, with increasing numbers of Chinese citizens migrating overseas and foreign citizens becoming resident in China, we suggest that there is a need for clarification as to whether an enterprise invested in China by foreign individuals that acquire Chinese nationality or by Chinese citizens that obtain foreign nationality shall be governed by the Foreign Investment Law.


2. Disclosure of Judicial Awards (Article 10, Paragraph 2)

“Regulatory documents and judicial awards in relation to foreign investment shall be timely disclosed to the public pursuant to laws.”

Comments/Suggestions

We suggest the need to clarify that the disclosure of judicial awards related to foreign investment shall not apply to cases involving state secrets or business secrets.

3. Negative List (Article 27)


“Foreign investors shall not invest in prohibited areas on the negative list for foreign investment access.

 

Foreign investors investing in restricted areas in the negative list for foreign investment access shall comply with the conditions provided by the negative list.

 

Foreign investment in areas outside the negative list for foreign investment access shall be administered under the principle of consistent treatment for domestic and foreign investment. ”


Comments/Suggestions

Since the scope of foreign investment negative lists applied in free trade zones is different from that of the national version, we suggest there is a need to clarify that the negative list of the relevant free trade zone shall prevail if it is different from the national version. 

4. National Security Review (Article 33)

“China shall establish a foreign investment national security review system to perform security reviews on foreign investment that affects or may affect national security. National security decisions made according to the law shall be final.”

Comments/Suggestions

The New Draft only provides that there shall be a foreign investment national security review system, without further specifying any detailed rules, such as in terms of the scope and content of the review, requirements of application documents, procedure or time limit of the review, etc. Currently, the only rules that regulate a national security review of foreign investment are the Notice of the General Office of State Council on the Establishment of a Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors and the Notice of the General Office of State Council on the Promulgation of the Trial Measures on National Security Review for Foreign Investments in Pilot Free Trade Zones. There is no clear legal basis for a national security review of foreign-invested enterprises that will be newly incorporated outside free trade zones. We suggest that an ancillary foreign investment national security review regulation shall be formulated and implemented simultaneously with the Foreign Investment Law.

 

In addition, with the New Draft indicating that a review decision shall be “final”, we suggest there is a need to clarify whether “final” should be taken to mean that a decision cannot be appealed, whether through administrative reconsideration or administrative litigation.

 

Furthermore, as a national security review is an important element in the administrative system for foreign investments, in order to ensure its effective compliance and implementation, we suggest that the legal consequences of any violation of the national security review filing obligation be provided in the Foreign Investment Law.

5. Transition from the Laws on FIEs

“This law shall come into force as from MM/DD/YYYY, on which the Law of the People's Republic of China on Sino-foreign Equity Joint Ventures, the Law of the People's Republic of China on Wholly Foreign-owned Enterprises and the Law of the People's Republic of China on Sino-foreign Cooperative Joint Ventures shall be repealed simultaneously.”

Comments/Suggestions

Following the reforms to the system for filing foreign-invested enterprises and the introduction of the negative list, foreign-invested projects outside the scope of the negative list have been required only to file, with the set-up of such enterprises governed by the Provisional Measures on Administration of Filing for Establishment and Change of Foreign-Invested Enterprises (Amended version)[1]. Foreign-invested projects that fall within the negative list shall still be subject to approval and governed by the three separate laws that apply to the three kinds of foreign-invested enterprises (FIEs), and to the respective implementation regulations.

 

With the three laws on FIEs and their implementation regulations due to be repealed simultaneously upon the effectiveness of the Foreign Investment Law, it will be necessary to issue a regulation for approval of foreign investment projects that are subject to approval under the negative list. This will provide a clear legal basis for implementing the relevant approval requirements, procedures, time limit, etc. applicable to foreign investment projects under the negative list after the three laws on FIEs have ceased to be effective.

6. Governing Law of Joint Venture Contract and Cooperative Contract

N/A

Comments/Suggestions:

Article 12 of the Implementing Regulation of the Law of the People's Republic of China on Sino-foreign Equity Joint Ventures provides that, “the formation of a joint venture contract, its validity, interpretation, execution and the settlement of disputes under it shall be governed by the Chinese law.” Article 55 of the Implementing Regulation of the Law of the People's Republic of China on Sino-foreign Cooperative Joint Ventures provides that, “the formation of a cooperative contract, its validity, interpretation, execution, and the settlement of disputes under it shall be governed by Chinese law.”

 

The above regulations shall be repealed once the Foreign Investment Law comes into effect. In the absence of any rules in the New Draft regarding the law governing joint-venture contracts, cooperative contracts or relevant share transfer contracts, it remains unclear whether the parties to joint venture or cooperation contracts will be free to choose themselves which is the governing law, pursuant to the PRC Contract Law. We suggest that this point be further clarified in the Foreign Investment Law.

7. Applicability of Foreign Investment Law to Investors from Hong Kong, Macau and Taiwan

N/A

Comments/Suggestions:

The definition of “foreign investor” in the New Draft does not cover investors from Hong Kong, Macau or Taiwan, whose investments in mainland China were previously considered to be “foreign investment”. Therefore, we suggest that the Foreign Investment Law clarify whether the law shall apply, by reference, to investment in mainland China made by investors from Hong Kong, Macau and Taiwan.



4. Outlook


President Xi Jinping announced at the 2018 Annual Meeting of Boao Forum for Asia that China will take major measures to expand its opening up and create a more attractive investment environment. The issuance of the Foreign Investment Law will be an important step in China’s ongoing objective to open up and to attract more foreign investment. We hope the New Draft can be further improved in order to ensure that the Foreign Investment Law is able to support the attainment of these goals.


JunHe will closely follow the progress of this important legislation and provide relevant updates accordingly.

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