The Foreign Investment Law of the People's Republic of China (“Foreign Investment Law” or the “FIL”), adopted at the Second Session of the Thirteenth National People's Congress of the People's Republic of China (PRC) on March 15, 2019, will be effective as of January 1, 2020. Upon this effective date, 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Joint Ventures (hereinafter collectively referred to as “Previous Three Foreign-Invested Enterprise Laws”) will be repealed by the newly-adopted FIL.

What influence will the implementation of the FIL have on existing Foreign-invested Enterprises (“FIEs”) in the mainland China? What preparations shall be made, and what shall be taken into consideration in advance by the existing FIEs for complying with the FIL to be implemented in just half a year? What are the new opportunities for the foreign investors proposing to invest in the mainland China in the near future? This article will take the Previous Three Foreign-Invested Enterprise Laws, the FIL and relevant foreign exchange control provisions into account to answer the above questions in different chapters herein.

Chapter I. What is the legal definition of foreign investment under the FIL? What will happen to the existing and proposed VIE structure upon the implementation of the FIL?

Chapter II. Will the FIL affect the equity joint venture contracts (applicable to the Sino-foreign equity joint ventures), cooperative joint ventures contracts (applicable to the Sino-foreign cooperative joint ventures) and shareholder contracts (applicable to the wholly foreign-owned enterprises) of existing FIEs or FIEs to be established?

Chapter III. What will be the breakthroughs in the form of capital contribution to the capital of FIEs upon the implementation of the FIL?

Chapter IV. Do the FIEs need to adjust their corporate governance structure and bylaws (and/or joint venture contracts) in compliance with the FIL?

Chapter V. Will there be any change to the requirements for foreign debt quota upon the implementation of the FIL? Will the concept of total investment amount of the FIEs exist upon the implementation of the FIL?

Conclusion and suggestions

The Previous Three Foreign-Invested Enterprise Laws only define the foreign-owned enterprises, Sino-foreign equity joint ventures and Sino-foreign cooperative joint ventures, but do not provide a clear legal definition of “foreign investment”. In this regard, Article 2 of the FIL provides a detailed legal definition of “foreign investment” for the first time. “Foreign investment” (“Foreign Investment”) is defined in details under the FIL as “the investment activity in mainland China directly or indirectly conducted by natural persons, enterprises or other organizations of foreign countries (“Foreign Investors”), including the following four types: (1) Foreign Investors establish a foreign-invested enterprise in mainland China independently or jointly with any other investors; (2) Foreign Investors acquire shares, equities, property shares or any other similar rights and interests of an enterprise in mainland China; (3) Foreign Investors invest in a new project in mainland China independently or jointly with other investors; and (4) Foreign Investors invest in any other way as may be stipulated by laws, administrative regulations or provisions of the State Council.

VIE Structure (i.e. Variable Interest Entity) is usually used where foreign investors (including overseas enterprises established outside mainland China by Chinese investors) invest in certain business industries that have prohibitions or restrictions on foreign investments regulated in the PRC foreign investment industrial policy, and as a result of that, it is popular in China. Although foreign investors are prohibited or restricted by the PRC foreign investment industrial policy to invest in the equities or shares of the domestic companies that have licenses to operate in such prohibited or restricted business industries (“Domestic Operating Companies”), under VIE Structure, they may exercise de facto control over these Domestic Operating Companies through a series of complex contractual agreements, rather than through equity ownership, and then consolidate financial data of these Domestic Operating Companies into the financial statements of their own, eventually sidestep the PRC prohibitions or restrictions policy on foreign investments. Therefore, to a certain extent, by using VIE Structure, foreign investors might be considered to have actually “invested” in or obtained the “property interest” of these Domestic Operating Companies.

It is still unclear whether the VIE Structure falls within the new definition of Foreign Investment defined by the FIL. However, literally, the new definition of Foreign Investment not only includes the circumstance where Foreign Investors acquire shares, equities, property shares or any other similar rights and interests of an enterprise in mainland China, but also includes a catch-all circumstance covering all other types of foreign investments (i.e. Foreign Investors invest in any other way as may be stipulated by laws, administrative regulations or provisions of the State Council). In addition, Chapter IV (Investment Management) of the FIL requires that Foreign Investment shall comply with the negative list for access of foreign investment (“Negative List”) listing the business industries in prohibitions or restrictions for foreign investment access. Furthermore, regarding the legal liabilities of non-compliance with the FIL, Chapter V (Legal Liability) of the FIL states that (i) where foreign investors invest in the prohibited business industries regulated by the Negative List, the relevant competent departments will order them to cease investment activities within a specified period and to restore the state before making the investment by disposing stock shares and assets or through other necessary measures; and the illegal proceeds would be confiscated accordingly; and (ii) where the investment activities of foreign investors violate the special restrictive administrative measures for access as prescribed by the Negative List, the relevant competent departments will order them to make corrections within a specified period and to take necessary measures to satisfy the requirements of special administrative measures for access. Last, Article 42 of the FIL gives a grace period for the existing FIEs established in accordance with the Previous Three Foreign-Invested Enterprise Laws to keep their original organization forms and other existing structures for five years upon the implementation of the FIL.

Therefore, the worst to be expected is that upon the implementation of the FIL, if relevant government departments incorporate the VIE Structure into the new definition of Foreign Investment under the FIL, Foreign Investors that are using VIE Structure currently would have a five-year grace period to restore their existing VIE Structure to the investment structure in compliance with the requirements of the Negative List, otherwise they may potentially violate the FIL in the way as mentioned above. Hence, for these foreign investors who are using VIE structure, we recommend them to pay close attentions on the regulatory trend on the VIE structure after the implementation of the FIL and, for avoidance of unnecessary losses, make necessary adjustments on their investment structure if necessary.

Regarding the administrative supervision over the equity joint venture contracts, cooperative joint venture contracts and shareholder contracts, under the Previous Three Foreign-Invested Enterprise Laws, equity joint venture contracts and cooperative joint venture contracts shall be subject to the administrative approval by relevant governmental authorities, and where two or more foreign investors propose to apply jointly for the approval for establishment of a wholly foreign-owned enterprise (WFOE), the duplicate copy of the executed shareholder contract shall also be filed to the relevant governmental authorities for record. However, while the Previous Three Foreign-Invested Enterprise Laws are still existing, on June 30, 2018, the Ministry of Commerce of the PRC (MOFCOM) promulgated the Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises (2018 Amendment), which have no longer required the administrative approval or record filing of the equity joint venture contracts, cooperative joint venture contracts and shareholder contracts and subsequent changes thereof. Furthermore, according to our latest oral confirmation with the competent MOFCOM, practically it does not administrate the equity joint venture contracts, cooperative joint venture contracts or shareholder contracts. In the FIL to be implemented in 2020, there does not exist any requirements of the administrative approval or record filing of those contracts either. Therefore, the FIL will lift such administrative supervision and amend the deviance of the regulatory requirements of those contracts in Previous Three Foreign-Invested Enterprise Laws from the actual practice of the MOFCOM.

Regarding the governing law of the equity joint venture contracts, cooperative joint venture contracts and shareholder contracts, prior to the implementation of the FIL, although the Law of the People's Republic of China on Wholly Foreign-owned Enterprises does not have mandatory requirement on the government law of shareholder contracts, the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures (“Sino-foreign Equity Joint Ventures Law”) and the Law of the People’s Republic of China on Sino-foreign Cooperative Joint Ventures (“Sino-foreign Cooperative Joint Ventures Law”) require that the conclusion, effectiveness, interpretation, performance and dispute resolution of the equity joint venture contracts and cooperative joint venture contracts be governed by the PRC laws. However, in the FIL, there does not exist any provisions regarding the equity joint venture contracts, cooperative joint venture contracts or shareholder contracts, nor any mandatory requirements of their governing law. Therefore, the FIL will give foreign investors more flexibility in choosing the governing laws of the equity joint venture contracts, cooperative joint venture contracts and shareholder contracts for establishment of FIEs in mainland China. 

Regarding the statutory requirements of the proportion of capital contribution by foreign investors to Sino-foreign equity joint ventures and Sino-foreign cooperative joint ventures, prior to the implementation of the FIL, 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 Sino-foreign Cooperative Joint Ventures and their implementation rules require that the proportion of capital contribution by a foreign investor to a Sino-foreign equity joint venture or a Sino-foreign cooperative joint venture shall in general be no less than 25 percent. However, in the newly adopted FIL, it is notable that there is no requirement of the minimum proportion of capital contribution by foreign investors. Therefore, upon implementation of the FIL in 2020, foreign investors can liberally determine the proportion of capital contribution to be contributed to FIEs based on commercial considerations.

Regarding the form of capital contribution by foreign investors, the Previous Three Foreign-Invested Enterprise Laws provide different statutory requirements for the form of non-cash capital contribution by foreign investors respectively. For example:

■ WFOEs: The machinery and equipment contributed by the foreign investors shall be indispensable to the production of the FIEs. Where foreign investors make contributions to WFOEs in the form of industrial property or know-how, relevant detailed materials shall be submitted to competent governmental authorities for approval, and such authorities are entitled to examination and inspection on these materials.

■ Sino-foreign equity joint ventures: The machinery, equipment and other materials contributed by the foreign investors shall be indispensable to the production of Sino-foreign equity joint ventures. Where foreign investors make contributions in form of industrial property or know-how, the foreign investors shall compensate any losses due to their fraudulent contributions in form of outdated technology or equipment. Furthermore, the contributions in form of machinery, equipment, other materials, industrial property or know-how shall be approved by competent governmental authorities.

■ Sino-foreign cooperative joint ventures: Where each party of a cooperative enterprise uses its own property or property rights as investment or as the condition of cooperation, the party must not set up any mortgage or encumbrances on such investment or condition.

On one hand, the FIL to be implemented in 2020 does not stipulate the statutory form of capital contribution by foreign investors, nor any provisions requiring that foreign investors must obtain approval for their non-cash capital contribution. On the other hand, the FIL emphasizes that “the state encourages technical cooperation based on free will and commercial rules in foreign investment. Technical cooperation conditions shall be determined under the principle of fairness by all investment parties upon negotiation”. Therefore, it is indicated that in terms of the form of capital contribution by foreign investors, administrative supervision will make concession to commercial considerations and thus provide more flexibility for cooperation between Chinese and foreign investors.

Prior to the implementation of the FIL, there are statutory requirements specially applicable to Sino-foreign equity joint ventures and Sino-foreign cooperative joint ventures on the highest authority, the composition of the board of directors and the powers and functions under 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 Sino-foreign Cooperative Joint Venturesand their implementation rules, including, but not limited to the followings: (i) the highest authority of Sino-foreign equity joint ventures shall be the board of directions, while the highest authority of Sino-foreign cooperative joint ventures shall be the board of directors or joint management committee; (ii) the increase or reduction of the registered capital, merger, division, dissolution, liquidation or change of company form or amendment of the articles of association of the company (“Important Matters”) shall be resolved by all members of its highest authority of the company (i.e. the board of directors or joint management committee); and etc.

However, upon the implementation of the FIL, the corporate governance structure and bylaws (and/or joint venture contracts) of the FIEs will be subject to the provisions of the Company Law of the People's Republic of China (“Company Law”), the Partnership Enterprise Law of the People's Republic of China (“Partnership Enterprise Law”) and other applicable laws as domestic enterprises are. Take the limited liability companies as an example: After the implementation of the FIEs, the bylaws (and/or joint venture contracts) shall be made substantially modifications accordingly in compliance with the Company Law, including but not limited to the followings: (i) The FIEs shall establish the shareholder meeting as its highest authority; (ii) accordingly, the voting mechanism for the Important Matters of a FIE will be changed from the previous requirement of “consent of all the directors present at the meeting” to “consent of the shareholders representing two-thirds of voting rights” required by the Company Law; and etc.

Therefore, the implementation of the FIE will unify the corporate governance structures, powers and functions, and rules of procedure of shareholder meetings and board of directors of both domestic enterprises and the FIEs.

The foreign debt is a loan facility that a company may use to borrow funds from the outside of mainland China. Generally, regarding the foreign debt quota of a FIE, the FIE may borrow the foreign debt in the amount calculated based on the difference between its registered capital and total investment amount (“Investment Gap Model”).

In addition, on January 12, 2017, the People’s Bank of China (PBOC) deployed another type of calculation of foreign debt quota that is called macro-prudential management model (“Macro-Prudential Management Model”) by promulgating the Notice of People’s Bank of China on Matters Concerning Macro-Prudential Management on All-round Cross-border Financing(“Notice”). Under the Macro-Prudential Management Model, the quota of an enterprise = the capital or the net assets of the enterprise × the leverage rate of cross-border financing (i.e. 2) × the macro-prudential adjustment parameters (i.e. 1).

The Notice also allows the FIEs and foreign-funded financial institutions to choose either the Investment Gap Model or the Macro-Prudential Management Model for calculating their foreign debt quota within a one-year transitional period from the date of the Notice. After the end of the transitional period, foreign-funded financial institutions have automatically been governed by the Macro-Prudential Management Model as required by this Notice. Regarding the FIEs, the Notice does not set the automatic application of the Notice on the FIEs, but provides that after the end of the transitional period, the management mode of cross-border financing for the FIEs shall be determined by the PBOC and the State Administration of Foreign Exchange (SAFE) according to the overall implementation of this Notice. As of the date of this article, although two years have passed since the end of transitional period, based on our communications with the competent SAFE, the FIEs are still able to choose either the Investment Gap Model or the Macro-Prudential Management Model for calculating their foreign debt quota, but once made, the choice cannot be changed.

The concept of total investment amount of the FIEs no longer exists in the context of the FIL to be implemented in 2020. Whether the relevant governmental departments will completely repeal the Investment Gap Model upon the promulgation of supporting regulations is still unknown. We recommend that the FIEs with demand for foreign debt evaluate the differences on applying the two types of the calculations of foreign debt quota for calculating their foreign debt quota. If the Investment Gap Model is still favorable to certain FIEs based on the results of evaluation, we also recommend that these FIEs borrow foreign debts as soon as possible before the implementation of the FIL.

■ After many rounds of modifications of the draft of the FIL, the FIL was passed finally and is awaiting its implementation date that is the New Year’s Day in 2020. Then the current foreign investment management regime will be changed by the FIL to a large extent, including, but not limited to, the legality of existence of VIE structure, more flexible and liberal corporations between Chinese and foreign investors in Sino-foreign equity joint ventures and the Sino-foreign cooperative joint ventures, more flexible and liberal form of capital contribution by foreign investors. In addition, the corporate governance structure and bylaws (and/or joint venture contracts) of the FIEs will also need to be substantially modified.

■ From our view, although the FIL only has six pages with most of the brief and principle provisions, most of its brief provisions could support the future matching regulations as principles. In addition, according to the MOFCOM’s recent announcement, it is actively promoting the formulation of the matching regulations to support the FIL, implementing a comprehensive clean-up of existing administrative regulations on foreign investment, and promoting the relevant work of “repealing, revising and introducing”. Therefore, we will continue to follow up the relevant supporting regulations to be introduced by the MOFCOM and then give more analyses based on our experiences.