Recently, China’s ministry of Commerce (MOFCOM) released the initial draft of its proposed revised Foreign Investment Law (FIL) for public review and commentary. The draft, presents a significant change in the thinking of Chinese Regulators as it would see the consolidation of what are now three separate laws. The proposed FIC would take the place of the current Wholly Foreign-Owned Enterprise Law (WFOE Law), the Sino-Foreign Equity Joint Venture Law (EJV Law) and the Sino- Foreign Cooperative Joint Venture Law (CJV Law).
Of particular note in the draft FIL is a substantial reform to the standards for determining whether a given foreign company is indeed a “Foreign Investor.” Previously, Chinese law looked to the place of company registration to determine whether a company investing in China would be considered foreign. Under the current system, where a Company Based in the USA established a WFOE, and the WFOE subsequently established a subsidiary Chinese company, that Chinese company would not be considered a Foreign Invested Enterprise (FIE) under the Law. Additionally, where one or more Chinese nationals established a company in a foreign jurisdiction, and that company established a presence in China, the new China company would be considered a Foreign Invested Enterprise.
Under the proposed new system, the law would look to “Actual Control,” meaning that company established in China by the WFOE would also be considered a FIE, while the company established abroad and controlled by Chinese nationals may not be considered a FIE. The law goes so far as to state that if out of mainland China transaction results in the transfer of equity to the Actual Control of a Foreign Investor, that Foreign Investor would be deemed under the new FIL to be investing in mainland China.
Along with the new focus on looking to “Actual Control” of China entities, the draft law would increase the range of issues which would be subject to review on national security grounds. Under the law, and foreign investment which may potentially damage national security is subject to national security review. IN this regard, Actual Control will not be considered in determining which investments are subject to review. This leaves plenty of discretion for Chinese regulators to define damage to national security in a potentially very broad manner, creating uncertainty for potential foreign investors.
The Draft FIL will leave corporate governance of all foreign invested enterprises to comply with the general
Company Law
. This is in contrast to certain elements of the previously laws which dictated the numbers of directors some FIE’s must have and who may serve in such roles. The draft law would give currently established FIE’s a three year grace period to ensure they are in compliance with the
Company Law
.
Specifically as relates to Joint Ventures:
• EJV’s will be required to change the highest authority of the company from the board of directors to the shareholders’ meeting;
• an unincorporated CJV will be required to incorporate as a limited liability company or a foreign-invested partnership; The CJV will be required to revise the highest authority in the company to be in line with the Company law, or the Partnership Law;
• Profit distribution for a former EJY will be allowed to modified and redistributed as the Company Law does not contain the strict equity proportionality requirements of the Current EJV law.; and
• Henceforth it will be easier to sell shares of an EJV as consent to sell will only need to be received from more than half of the non-selling shareholders, rather than all the non-selling shareholders according to the EJV Law or CJV Law.
Overall it is likely that the proposed changes to the FIE establishment and governance regime will be a positive step toward increased efficiency in the establishment of a variety of company structures, and will simplify foreign investment. This continues a trend starting from March 2014 in which initial capital requirements for newly established companies, and capital contribution timelines were eliminated in favor of investor choice.
China is eager to simplify company registration processes as part of push to maintain high levels of foreign investment in the face of a gradually slowing domestic economy. Some potential foreign investors may be spurred to jump at current opportunities for simplified company establishment. However, foreign companies should maintain awareness of the myriad operational laws which domestic and foreign companies alike must deal with in China. Labor laws, product registrations and inspections, and intellectual property protection remain the main area’s our firm sees Foreign Companies encountering problems within China. Foreign Companies in China should take care to address these issues thoughtfully.