The Gavel – March 2015 – Draft of the new PRC Foreign Investment Law

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Draft of the new PRC Foreign Investment Law

Introduction:

The Ministry of Commerce of PRC (MOFCOM) on January 19 2015 published the draft of the proposed new Foreign Investment Law (中华人民共和国外国投资法 -草案征求意见稿) (hereinafter “FIL”) for comments and discussions.

This draft represents a substantial change for the foreign investments in mainland China, a further expected step to bring more uniformity among the various PRC laws, currently divided into two different regimes:

One governing the domestic investments, in accordance with the PRC company law and the other relevant rules;
One governing the foreign investments in accordance with three main different laws, for equity joint-ventures (“EJVs”), cooperative joint-ventures (“CJVs”) and wholly-foreign owned enterprises (“WFOEs”).

This new FIL once promulgated it shall abrogate the current three laws regarding foreign investment in China. In this article we will comment the main changes the Chinese legislator would like to introduce with the FIL.

Definition of Investors

According to the draft the investors are identified as foreigner entities / individuals by nationality and by a standard of “control” including the “Domestic enterprises controlled by any foreigner entity or individual”.

Furthermore for the purpose of this law controlling a domestic enterprise or hold the rights and interests of a domestic enterprise through contracts, trusts and other means it is considered a foreign investment. (See the par. VIEs for more details)

Regarding the Chinese Investors this new law includes natural persons, allowing the natural person to be part of a Foreign Invested Enterprise, while before the laws defined Chinese investors only as enterprises and institutions.

“The New Incorporation system”

Under the draft all the foreign investors and foreign-invested enterprises, solely or partially invested by foreign investors, pursuant to article 4 shall comply with Chinese domestic laws, namely the PRC company law and the other relevant laws governing the domestic investments.

With the exception of the restricted and prohibited business to the foreign investors under the Catalogue of Special Management Measures for foreign investment (hereinafter “Catalogue of Special Management Measures”), they will enjoy national treatment when investing in Mainland China.

The Catalogue of Special Management Measures will replace the current “Catalogue for the Guidance of Foreign Investment Industries” which divides business and industry sectors into different categories: allowed, encouraged, restricted and prohibited.

The new Catalogue represents a “Negative list” based on that one of the China Pilot Shanghai Free Trade Zone, where the sectors not mentioned are completely opened.

Moreover FIEs shall not be subject to the prior approval from MOFCOM to be incorporated but only foreign investment projects under the restricted category of this Negative list shall be subject to access approval of the competent foreign investment department of the State Council (art. 26).

National Security Review

In the draft of the FIL is still present a strong control of the authorities under the National Security Review. Under the new draft in the Chapter 4 the foreign investor may apply for the national security review, but in some circumstances it may be triggered ex officio by any related authority and party, and in this case the authority shall notify the party.

The review is proposed for any foreign investment that endangers or may endanger national security.

Therefore this statement is deemed too general, and any specification is given by the law for the definition of national security, the draft in the art. 57 provides just a list of factors that shall be considered during the review, ending with an Item 11 opened to broad interpretations “Other factors necessary to be considered in the opinion of the Joint Conference.”

Perhaps the authorities still maintain a great discretion to decide which investment endangers or may endanger the national security, without any possibility for the foreign investor to apply for an administrative reconsideration or file an administrative lawsuit against the review. (art.73)

New Information reporting system

In order to replace the current approval system, the draft sets up a new information reporting regime.

All the foreign investment projects will be required to submit reports on the foreign investment related information to the competent department of the State council, prior to the investment or within 30 days from the date of investment (art.85)

In addition the new system requires for the FIEs a periodic report, annually or quarterly (in exceptional cases). Several information are required including some not required under the current approval regime e.g. actual controller, investment source etc. (Art.87)

Implication on existing Foreign Investment Enterprises ( FIE )

As stated by art. 157 of the draft a FIE lawfully established under the previous regime shall within 3 years from the effective date of the Law, changes its organizational form and structure pursuant to Company Law and the other relevant provisions.

Therefore the draft at the moment is silent in case the FIEs fail to change is organizational structure within 3 years.

Effect on VIE structures

Another noteworthy effect of this law will regard the risky VIE structures, used by Chinese and Foreign investors for several reasons, the most important are: avoiding the restrictions and burdensome procedures imposed by Chinese laws on foreign investments, and raising overseas financial funds by Chinese company in order to be listed in foreign exchange markets (usually these options are also combined).

Several well-known giant enterprises are using this kind of structure, but they might change if the draft will be enacted.

Indeed according to art. 11 item 4) Domestic enterprises controlled by foreigners shall be deemed as foreigner investments. In addition art. 15 provides different activities that are referred as foreign investments, while art. 18 specifies the meaning of “control”, in which the typical structure of a VIE falls in.

Finally the draft establishes also legal liabilities for circumventing the law, including administrative and criminal liabilities.

Conclusion

The new draft on foreign investments was long awaited in order to beef up the liberalization of certain sectors and to ease the procedures and restrictions imposed to the foreign investments.

However for several reasons this draft is really far away to reach those goals. Moreover in the initial idea of the Chinese legislator this draft shall eliminate the difference in treatment between foreign investment and a local one but at the moment we tend to believe that this draft it can be considered still a work in progress.

The call for comments ended last February 17, now the relevant authorities shall study the opinion received and work on the draft of the final FIL that we believe shall be promulgated within this years. We will keep you posted.

This article is intended solely for informational purposes and does not constitute legal advice. Although the information in this article was obtained from reliable official sources, no guarantee is made with regard to its accuracy and completeness.

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