Background and purpose of the new law
On Jan. 19, 2015, the Ministry of Commerce of China (“MOFCOM”) published the draft of the Foreign Investment Law (“draft”) to solicit public comments. The draft, once finalized, will replace the existing Foreign Invested Company Law, the Sino-Foreign Equity Joint Venture Law, and the Sino-Foreign Cooperative Joint Venture Law (collectively, the “Three Foreign Investment Laws”).
The key purpose of the draft is to grant “national treatment” to all foreign investment, except that which falls under the “Special Administrative Measure List” (“Negative List”). This advisory will summarize the major points of the draft, as well as some issues that need to be further clarified.
Redefining the concept of “foreign investment”
The draft significantly broadens the scope of “foreign investment.” This broadened scope will include the following activities conducted by foreign investors: (1) green field investments; (2) acquisitions of Chinese companies; (3) provision of long-term finance to the Chinese subsidiaries of the foreign investors; (4) obtaining a right of resource exploration and infrastructure construction or operation; (5) purchasing real estate; (6) controlling Chinese companies by contracts or trusts; and (7) offshore transactions that result in foreign investors obtaining control of Chinese companies.
More importantly, in addition to the current mechanical and straight-forward standard for deciding whether an investor is a foreign investor (e.g., whether such investor is registered outside China or is not a Chinese citizen), the new standard includes “ultimate control.” That means, in addition to the current scope of foreign investors, if a Chinese company that is ultimately controlled by a foreign individual or entity engages in “foreign investment” activities, then such Chinese company and such activities will also be subject to the applicable foreign investment restrictions.
On the other hand, the draft also provides that, if a foreign company is ultimately controlled by a Chinese individual or entity, then when such foreign company invests in an industry which falls within the scope of the Negative List (as defined below), it may apply to the MOFCOM to be recognized as a “Chinese investor” and avoid the Negative List restrictions on foreign investment.
Simplified foreign investment process
Under the draft, foreign investors whose investments are not included in the Negative List are no longer required to apply for the approval from the local branch of the MOFCOM. Rather, similar to the Chinese domestic investments, the foreign investors may simply register such investment with the local Administration for Industry and Commerce (“AIC”).
The Negative List will be enacted by the State Council separately. According to the draft, the list will further divide the industries on the list into: (1) the Prohibition Category, which is not open for foreign investment; and (2) the Restriction Category, which is restricted for foreign investment.
National security review
The draft incorporates a national security review process. The draft provides for a reviewing commission (“Reviewing Commission”) to be formed by the MOFCOM, the National Development and Reform Commission, and relevant ministries to conduct the national security review for any foreign investment.
The national security review process may be triggered if: (1) the foreign investors voluntarily apply for the national security review, when they believe there is a risk that the contemplated investment may be found to jeopardize the Chinese national security; or (2) the Reviewing Commission takes the initiative in starting the security review process. The Review Commission may also conduct such a review upon the application of relevant governmental authorities, associations or companies.
At least in concept, this national security review process and the Reviewing Commission appear to be comparable to the review conduct by the Committee on Foreign Investment in the United States (CFIUS), formed pursuant to the 1988 Exon-Florio Amendment to the Defense Production Act, to conduct national security reviews of foreign-controlled investments in the United States.
It is also worth noting that all the administrative decisions under the national security review process are exempt from any judicial review. This provision also has an interesting parallel in the U.S. national security review process. During the summer of 2014, the Court of Appeals for the District of Columbia, in Ralls Corp. v. CFIUS, held that a portion of the CFIUS national review process was, in fact, subject to judicial review. The Ralls court overturned President Obama’s rejection of a windfarm investment by a company controlled by Chinese nationals on the ground that the CFIUS process violated the investors’ due process rights.
National security reviews are generally excluded from the “national treatment” requirements of bilateral investment treaties.
Information filing obligations
As under the draft, most of the foreign investment will no longer be subject to the approval of MOFCOM, thus MOFCOM needs a new mechanism to collect information regarding foreign investments. As a result, the draft imposes information filing obligations on foreign investors/foreign invested enterprises. According to the draft, certain information in connection with foreign investment should be filed to the local MOFCOM. Such filings are categorized into: (1) filing of new investment; (2) filing of change of investment; and (3) periodic information filing.
The Three Foreign Investment Laws will be abolished by the draft, and currently there is some inconsistency regarding the corporate governance between the three Foreign Investment Laws and the PRC Company Law. The draft expressly requires that, within three years of implementation, all the foreign-invested companies must adjust their corporate governance structures to make them consistent with the Company Law.
Variable Interest Entity (“VIE”)
The draft, for the first time under the Chinese law, provides the solution to the VIE structures, which is popular in China for foreign investment in industries not yet open to foreign investors, such as the value-added telecommunication industry.
The draft: (1) includes VIE in the scope of foreign investment, and (2) allows that the existing VIEs may continue their operation on the condition that they apply to the Chinese authorities and prove themselves to be ultimately controlled by Chinese investors. The draft implies, but does not expressly state, that if the existing VIEs are not ultimately controlled by Chinese investors, then they may be forced to terminate the contract and divest their controlled companies.
Relevant reforms corresponding to the draft
As the draft completely changes the system for regulating foreign investment, there are several other relevant laws and regulations, in addition to the Three Foreign Investment Laws, which may also need to be amended or repealed.
For example, as there will be no MOFCOM approval under the draft for most of the foreign investments, the concept of “total investment,” which currently is reviewed and approved by the MOFCOM upon the incorporation of foreign invested companies, may no longer be applicable. Currently, any foreign invested company may borrow foreign debt only up to the amount by which its total investment exceeds its registered capital. Given that the concept of total investment will no longer be used, the law makers must also change relevant foreign exchange rules to adapt to the draft.
To summarize, the draft is a significant reform to the existing foreign investment regulatory environment, and a major step in implementing the economic reform plans announced by the Chinese government at the Strategic & Economic Dialogue held in Washington, D.C., in the summer of 2013. However, there are still some open questions related to the draft, which hopefully will be clarified in the final version, or result in the update of other relevant laws and regulations.