To ensure the effective implementation of the new Foreign Investment Law (the FIL) as well as to clarify the issues not clearly addressed in the FIL and to better protect the legitimate rights and interests of foreign investors, the State Council of China published the Implementing Regulations for the Foreign Investment Law of the People’s Republic of China (the FIL Implementing Regulations) on December 31, 2019. The FIL Implementing Regulations came into force a day later on January 1, 2020.
Some of the most notable highlights of the FIL Implementing Regulations are as follows:
Enforceability of the Investment Agreement With the Government
The FIL sets out the principle that “local government at all levels shall fulfill the policy commitments made to foreign investors and foreign-invested enterprises (the FIEs) and all types of contracts executed pursuant to the law.” Likewise, Article 27 of the FIL Implementing Regulations defines “policy commitments” as commitments made by local government at all levels to provide preferential treatment and other support to attract foreign investment within their legal authority. In addition, Article 28 further provides that local government at all levels and relevant authorities shall not unilaterally alter policy commitments or contractual agreements unless national interest and public interest are at stake, nor shall they violate or breach any contract on the grounds of administrative area adjustment, reelection, organizational or functional adjustments or change of head of governing body. Fair and reasonable compensation shall be provided to foreign investors in case of any unilateral changes to such agreements for the purpose of national or public interest.
New Regulatory Stage for Foreign Investment
The FIL Implementing Regulations make it clear that the National Development and Reform Commission (NDRC) will retain its function to approve or maintain record filing of foreign investment projects, while industry authorities will retain their power to issue industry-specific licenses. State Administration for Market Regulation (SAMR, formerly State Administration of Industry & Commerce) and its local counterparts are responsible for the registration of foreign-invested enterprises. It is worth noting that the new mechanism has taken away the power of the Ministry of Commerce (MOFCOM) to review the establishment of foreign investment entities. As such, MOFCOM will only monitor foreign investment through its information reporting system. This means no approval or record filing will be required from MOFCOM for incorporation of an FIE, neither will joint venture contracts be subject to its review or approval.
In addition, Article 35 of the FIL Implementing Regulations provides that in case any FIEs apply for any industry-specific licenses, the relevant authorities shall apply the criteria and procedures that are applicable to domestic entities. This seemingly will let foreign investment receive national treatment as domestic entities after entry into the China market. In practice, a number of industry-specific rules and regulations impose various restrictions on foreign investment. These restrictions are often broader than those enumerated in the Special Administrative Measures (Negative List) for the Access of Foreign Investment, including special requirements applicable to foreign investors in shareholder qualification, industry experience and registered capital. Article 35 of the FIL Implementing Regulations only recognizes that laws and administrative regulations (issued by People’s Congress and State Council, respectively) may set out special requirements for FIEs, that would mean the industry-specific regulations and departmental rules issued by the various ministries will become abolished for FIEs.
Protection of Intellectual Property Rights
The concept of punitive damages has been introduced in the recently amended Trademark Law of the People’s Republic of China (PRC), which is also reflected in the draft Civil Code and draft amendment to the Patent Law of the PRC, and is targeted to combat the malicious trademark and patent registrations and litigations. The maximum amount of statutory compensation for malicious infringement of trademark rights has been raised to RMB 5 million. As such, Article 23 of the FIL Implementing Regulations provides for a severe punishment mechanism for intellectual property infringement. It can be expected that the introduction of punitive damages will provide more legal basis to improve intellectual property protection in China. The Economic and Trade Agreement recently signed between the Chinese government and the U.S. government also provides a strong foundation for China to protect intellectual property rights more effectively.
Foreign Investment Information Reporting System
Currently, FIEs can submit registration and enterprise information through two channels: (i) the MOFCOM foreign investment information system and (ii) the SAMR company registration system and enterprise credit information disclosure database. The FIL proposes a unified foreign investment information reporting system combining the above two channels in order to lessen the reporting burden on FIEs. The scope and content of the information FIEs are required to submit are limited to those deemed necessary by laws and regulations. Articles 38 and 39 of the FIL Implementing Regulations reiterate the foregoing principle and grant MOFCOM and SAMR the authority to draft specific rules for foreign investment information reporting. On December 31, 2019, MOFCOM and SAMR jointly issued the Measures for the Foreign Investment Information Reporting under which FIEs are required to submit information such as the initial report, change report, dissolution report and annual report. However, they are explicitly exempted from separate submission of information which can be obtained via information sharing between different governmental bodies, such as information regarding deregistration and domestic investment. On the same day, MOFCOM issued Notice on Matters Related to Foreign Investment Information Reporting, providing detailed practice guidance and specific content of information reports. Information already submitted to SAMR by FIEs will be shared with MOFCOM and does not need to be separately submitted again by FIEs or foreign investors in information reports. Furthermore, annual reports will take the approach of “integrating multiple reports into one,” meaning that FIEs simply need to add specific information required by MOFCOM and the State Administration of Foreign Exchange to the annual report already being prepared for SAMR. This will avoid repetitive submission of the same information and effectively reduce the reporting burden on FIEs and foreign investors.
Five-Year Transitional Period
The FIL came into effect on January 1, 2020 and replaced the Laws on Sino-Foreign Equity Joint Ventures, Sino-Foreign Cooperative Enterprises and Wholly Foreign-Owned Enterprises (Former FIE Laws). FIL allows the corporate governance and organizational structure of existing FIEs to continue for a five-year transitional period, but changes need to be made to comply with the FIL by January 1, 2025. What concerns every existing FIE is the question of what happens if it to some degree fails to adapt to the changes before the transitional period expires (such as the parties of a joint venture cannot reach agreement in time). Article 44 of the FIL Implementing Regulations provides that if adaptation is not completed within the transitional period, SAMR will not process other registration matters for such company and may disclose such noncompliance in the credit information disclosure database. The penalty provided under Article 44 is pragmatic as it would not jeopardize the existence and operation of existing FIEs. But it still leaves many related questions unanswered, such as whether the original joint venture contracts and articles of association will remain valid, and whether decisions made by FIEs’ governing bodies will be valid, which will need to be tested in practice.
In addition, Article 46 of the FIL Implementing Regulations provides that some arrangements between shareholders such as distribution of profits and remaining assets among FIE shareholders may remain valid after the necessary changes for the governance and organizational structure have been made. For major changes in the organization form and organizational framework of Sino-foreign equity joint ventures, Sino-foreign cooperative joint ventures and wholly foreign-owned enterprises after the abolition of Former FIE Laws, please refer to the chart linked below.
MOFCOM, NDRC, SAMR and other authorities have formulated a large number of implementing regulations and rules in the past several decades. With the abolition of the Former FIE Laws, a large number of regulations and rules also need to be abolished or amended. Article 49 of the FIL Implementing Regulations provides that the FIL and the FIL Implementing Regulations shall prevail in case of any discrepancy (related to foreign investment regulation) between them and any other regulations or rules issued prior to January 1, 2020. Admittedly, there may still be problems in practice without proper housekeeping methods for existing foreign investment regulations and rules. At the current stage, relevant authorities such as MOFCOM and NDRC are all in the process of cleaning up and updating existing regulations and rules. Within the last week of 2019, the Supreme Court, MOFCOM and SAMR issued FIL-related judicial interpretations or ancillary rules. MOFCOM, in particular, issued two notices regarding the clean-up of existing rules, but a large number of regulations and rules still remain to be dealt with. Foreign investors shall seek legal counsel to make changes in these areas. With respect to joint ventures in China, foreign investors shall start evaluating their overall business strategies in China and their relationships with their Chinese business partners, then make necessary adjustments in these areas depending on their available leverage.
The goals and missions of the FIL Implementing Regulations are to provide implementing guidance for the FIL and to help facilitate transition into the new foreign investment regime. Given the complexity of the existing foreign investment regime and relevant rules created in the past several decades, the transition may be challenging. Questions left unanswered by the FIL Implementing Regulations need to be further clarified and addressed by the Chinese government in the future.