China's New Foreign Investment Regime

Orrick, Herrington & Sutcliffe LLP

Effective 1 October 2016, China replaced its approval regime for foreign investments with a filing regime, except where such investments fall within the Negative List.

Approval vs. Filing

Since China first promulgated its joint venture laws in the late 1970s and the 1980s, any establishment of sino-foreign equity joint ventures (EJVs) or cooperative joint ventures (CJVs), wholly foreign owned enterprises (WFOEs) or foreign-invested joint stock companies (collectively, foreign invested enterprises or FIEs), or any change in their capital structure (e.g., transfer of equity or injection of capital), had required the prior approval of the Ministry of Commerce (MofCom, which as used below can refer to Central Ministry of Commerce or any of its local counterparts).

Under the new regime, unless an FIE is in an industry that appears on a Negative List, instead of MofCom’s prior approval, it needs only to file with MofCom (a) before the issuance of its business license but after name pre-verification, or (b) within 30 days after issuance of its business license, and file the following changes with MofCom within 30 days after the occurrence – (i) changes to basic information of the FIE (such as change of name, change of address, increase and decrease of registered capital or total investment, change to ultimate actual controlling person(s)), (ii) changes to basic information of the investors of the FIE (such as name, nationality or address, place of source of funding), (iii) transfer of equity interests (or shares) or cooperative interests, (iv) merger, division, termination, (v) pledge or transfer of an FIE’s property or interests to an entity located outside China, (vi) recouping of investment in advance by a foreign shareholder of a CJV; and (vii) entrusted operation and management of a CJV.

The filing is made online through the foreign investment comprehensive management system, and documents are submitted online.  Within three working days of a filing, either the filing is considered complete, or MofCom will respond with further questions or comments.

The Negative List (which references China’s 2015 Foreign Investment Catalogue) includes 17 industries where the Chinese Government encourages foreign investments, 38 industries where foreign investments are restricted, and 36 industries where foreign investments are prohibited.  Previously, when MofCom evaluated whether to approve any formation or capital change of every single FIE, it needed to take into account whether such FIE was in one of the 349 industries that were encouraged, 38 industries that were restricted, or 36 industries that were prohibited.  With a shift to a filing regime, MofCom’s prior approval is needed only in respect of particular industries.

Certain Exceptions

Investments by foreign invested investment enterprises, or foreign invested venture capital enterprises, are considered “foreign investments,” and are therefore subject to the same filing regime and Negative List.

Service trading enterprises established by Hong Kong and Macao service providers according to Closer Economic Partnership Arrangement (CEPA) are still governed by the Administrative Measures for the Record-filing of Investment in the Mainland by Hong Kong and Macao Service Providers (for Trial Implementation).

Acquisition of non-FIE entity or assets of a domestic entity (including an FIE) by a foreign entity is still subject to MofCom’s prior approval in accordance with the Provisions on Foreign Investors' Merger with and Acquisition of Domestic Enterprises or Circular No. 10, irrespective of whether it falls into the Negative List.

Reinvestments by FIEs will still be governed by the Interim Provisions on Investment Made by Foreign-Invested Enterprises in China, which means filing to local MofCom is required if it is in an industry where foreign investments are encouraged or permitted, and approval by MofCom is required if it is in an industry where foreign investments are restricted.

Certain Implications

As China’s foreign investment regime shifts from approval to filing, the constitutional documents such as joint venture agreements and articles of association for most FIEs no longer need to be reviewed and approved before they become effective.  The foreign investment process is streamlined, and agreements and documents may take effect on the date of execution.  Further, the constitutional documents may now contain various contractual terms that used to face uncertainty during the MofCom review and approval process.  Customary contractual terms for international investors such as call options, put options, tag-along rights, and drag-along rights, may now be agreed between Chinese and foreign equity holders and provided for in an FIE’s constitutional documents, and the exercise of these rights no longer need prior approvals from MofCom.  That said, in our view, there may still be uncertainties surrounding liquidation preference and redemption rights for particular equity holders or class of equity holders, or the ability for foreign lenders to take and exercise equity pledges.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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