29 Nov 2019 China legal update: Implementing Regulations on the Foreign Investment Law of the People’s Republic of China (Draft for Comment)
I. Legal News
Implementing Regulations on the Foreign Investment Law of the People’s Republic of China (Draft for Comment)
In order to ensure the effective implementation of the Foreign Investment Law (FIL), the Ministry of Justice, together with the Ministry of Commerce and the National Development and Reform Commission have publicized the Implementing Regulations on the Foreign Investment Law of the People’s Republic of China (Draft for Comment)1 on November 1st, 2019. The deadline for the public to contribute their comments on the Draft for Comment would be December 1st, and the Draft for Comment is expected to be passed in December 2019 and come into effect together with FIL on January 1, 2020. The Draft for Comment intends to clarify the issues which are not been clearly addressed in FIL. We abstract several essential provisions from the Draft for Comment that may be of your concern and set out our analysis below for your reference.
• Clarify that foreign investors can set up a foreign-invested enterprise with Chinese individuals (Article 3)
Article 3 of the Draft for Comment for the first time makes it clear that “other investor” provided in the FIL when defining the scenario of foreign investment2 includes Chinese Individual.
It is acknowledged that before the issue of the Draft for Comment, in principle, if a foreign investor would like to set up an equity joint venture (EJV) or a contractual joint venture (CJV), it can only partner with Chinese enterprises or organizations and cannot partner with Chinese individuals3 except for certain circumstances. For example, one exception is that the existing Chinese individual shareholders of a domestic company that is invested by foreign investors are, subject to approval, allowed to remain as the shareholders of such company after being transferred to a foreign invested enterprise.4 And, another exception is that in certain area in some city, such as Beijing, foreign investors are allowed to partner with Chinese individuals to set up CJV or EJV.5
Therefore, if Article 3 is adopted, it would extend the scope of Chinese parties with which foreign investors may partner. Since, along with the development of the economy in China, a lot of entrepreneurs with good reputation are well known by foreign investors, this change may grant the opportunities for foreign investors to choose the best partner in China for their business, regardless of such partner is a Chinese individual.
• Cancellation of approving and filing formalities at Commerce Committee (Article 38)
Under the current foreign investment procedures in China, if a foreign investment falls into the restricted category under the Negative List, it shall be subject to the approval by competent commerce commission; and if a foreign investment is not under the Negative List, it needs to be recorded with Commerce Committee.
Article 38 under the Draft for Comment provides that competent administration for market regulation (AMR) will examine whether a foreign investment meets the requirements (such as shareholding ratio or senior management personnel) if such foreign investment falls into the scope of Negative List when applying to establish a foreign invested enterprise. If other competent authorities have examined the aforesaid matters, AMR will not examine again.
According to our understanding and our consultation regarding the aforesaid Article 38, the foreign investment procedure which is to be established is that if a foreign investment is under the scope of Negative List, it shall be subject to examination of AMR or other competent authorities (in circumstance that certain certificate for certain business scope is required before applying for business license), and foreign investors would not need to go through formalities with Commerce committee for approval; if a foreign investment is not under the scope of Negative List, the investors would also not need to file with Commerce committee, they could go through formalities with AMR or other competent authorities for business license or relevant certificates.
Therefore, if the principle described under the above-mentioned Article 38 can be adopted, it would simplify administrative formalities for investors. Investors would not need to go through formalities with Commerce committee directly no matter whether the foreign investment falls into the scope of Negative List or not.
• Further clarify the arrangement on the existing foreign invested enterprises after FIL comes into effect
In the current legal framework of foreign investment in China, basically, there are three types of foreign-invested enterprises (FIE), which are wholly foreign-owned enterprise (WFOE), EJV, and CJV. In principle, these three types of FIEs are separately governed by three sets of special laws, which are the Wholly Foreign-Owned Enterprises Law, Sino-Foreign Equity Joint Ventures Law, and Sino-Foreign Cooperative Joint Ventures Law. In addition to the aforesaid three sets of special laws, the PRC Company Law will be applicable when there are no special rules in these three sets of laws.
Article 42 of the FIL provides that the three sets of laws mentioned above will be invalidated when the FIL comes into effect on January 1, 2020, and the existing WFOEs, EJVs and CJVs could maintain their organization form within 5 years after January 1, 2020 (“Transactional Period”). Since, after FIL comes into effect, the PRC Company Law would be the main source of law for FIEs to structure their companies, the existing FIEs would need to change their form of structuring to meet the requirements under the PRC Company Law.
Regarding the above mentioned arrangement, lots of investors are concerned of the following issues: (i) what happens to the existing agreements between the partners in a FIE; (ii) what is the specific procedure for changing the organization form of a FIE; (iii) what is the consequence if a FIE fails to change the organization form within the Transactional Period.
The Draft for Comment has answered the above mentioned questions to some extent as follows:
(i) Article 43 of the Draft for Comment provides that after the implementation of the FIL, arrangements between the partners, such as the profit distribution method and the residual property distribution method may stay unchanged within the period of cooperation and joint venturing.
However, under this Article 43, we understand that the scope of arrangements that could stay unchanged is not clear. It mentioned that profit distribution method and the residual property distribution method may stay unchanged, it is uncertain that whether all arrangements, especially provisions in the articles of association of a FIE, between the parties could stay unchanged.
And, since the Sino-Foreign Equity Joint Ventures Law and Sino-Foreign Cooperative Joint Ventures Law would be invalidated after FIL comes into effect, the board of directors, as the supreme authority organ, of an EJV or CJV may function without legal basis before transforming their organization form, since according to the Company Law, the supreme authority organ of a company would be shareholders meeting.
(ii) Article 42 of the Draft for Comment provides that AMR will further formulate, clarify and disclose the specific guideline on the changing formalities.
(iii) according to Article 42 of the Draft for Comment, a six-months grace period is set out for FIEs to change their organization forms, which is the six months after January 1,2025. If any FIE still fails to change its organization form within the grace period, AMR will not deal with other registration application submitted by such FIE, and may disclose relevant information on the corporate information disclosing system.
Basically, from the Draft for Comment, clearer guidelines and clarifications are needed from AMR which would specify the detailed procedures and requirements for changing the organization form.
• Further emphasis on IP protection
The Draft for Comment emphasizes the protection of IP of FIEs.
Article 24 provides that the State will establish a punitive damages system against intellectual property infringement, promote the establishment of a mechanism for rapid synergistic protection of IP rights, and improve the mechanism for diversified settlement of disputes over IP rights and the mechanism for assistance in safeguarding IP rights. IP rights of FIEs shall be equally protected.
Article 25 provides that the administrative departments shall not force or indirectly force foreign investors or FIEs to transfer their technology.
Since IP protection is always an issue of highly concerned of foreign investors, the strengthening of protection of IP rights of foreign investors would be a positive element for a foreign investor to invest in China and maintain their business in China.
To summarize, the Draft for Comment has clarified some unclear issues in the FIL, but certain issues, such as the procedures on changing organization form of a FIE within the Transitional Period still need to be further clarified. It is noticeable that the principle reflected by the articles in the FIL and the Draft for Comment is to promote the foreign investment in China, although foreign investors may still face potential problems in practice which are to be dealt with by PRC government, such as the connection and conflicts between the FIE and other existing laws.
II. Hot Topic
1. Achievements in Criminal Trial in China
On October 23rd, the Supreme People’s Court reported to the Standing Committee of the National People’s Congress on the strengthening of criminal trials since 2014.
One of the striking points is that Chinese courts have concluded 10,859 cases of organized crime since the beginning of 2018, which shows “the great achievements” of the act called “Crime crackdown”（扫黑除恶）. It’s a campaign starting from January 2018 to the end of 2020 to fight against organized crime and crack down gangs and triads. This 3-year nationwide campaign held by the Party Central Committee and State Council clarifies duties of each department and list out 10 specific behavior concerning organized crime, with an emphasis on corrupt officials who protect criminals from criminal gangs.
This campaign combined with another act called “combat corruption and build a clean government” (反腐倡廉). With the joint effort of approximately 40 departments, courts at each level across the country have concluded 194,000 cases on bribery, corruption and malpractice since 2014. Meanwhile, some 14,000 people who offered bribes were also given criminal punishments.6 This act covers a wide range of officials, from the highest level to the basic-level in village and countryside.
1. See the original document in
2. In the FIL, it provides four scenarios of foreign investment, one of which is “Either individually, or together with other investors, establishes foreign-invested enterprises”
3. Art. 1 of the PRC EJV Law.
Art. 1 of the PRC CJV Law.
4. Art. 54 of Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors.
5. Art. 12 of the Regulations of Zhongguancun National Independent Innovation Demonstration Zone.
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