China: Positive Developments Contained In China's New Draft Foreign Investment Law

China released a new draft Foreign Investment Law ("Draft Law") soliciting public comments. The Draft Law further liberalises the Chinese economy to foreign investments and primarily provides broad principles governing foreign investment activities in China. The successful implementation of the Draft Law would depend in part on subsequent supporting regulations, smoothly harmonising existing rules and adjusting certain practices. This alert highlights some of the positive developments contained in the Draft Law.

Salient elements of the Draft Law

Abolishing foreign invested companies as a formal investment vehicle

The Draft Law would be a unifying law enshrining the principle rules governing foreign investments in China through repealing three existing legislations and their implementation rules governing companies wholly owned, and joint ventures invested, by foreign investors. This means, among others:

  • foreign invested companies as formal investment vehicles will no longer exist and foreign investors investing in Chinese companies would be treated as an ordinary shareholder under China's Company Law like any domestic Chinese investor, subject to other rules applicable to foreign investments;
  • no more foreign investment threshold as the capital contribution in any business ventures with Chinese entities, other than specific shareholding percentage requirement as per the "negative lists" (see details in the next paragraph); and
  • foreign parties would be allowed for the first time to establish a company with a Chinese natural person.

Continued liberalisation of the Chinese economy

The Draft Law reiterates China's commitment to open up more sectors of its economy to foreign investments as the Draft Law reaffirms the negative list regime for access by foreign capital in specific sectors of the economy. Essentially, China publishes a list annually stipulating what industries are prohibited and restricted to foreign investors. Restrictions such as foreign ownerships are imposed on foreign investors in the listed industries and any industry not prohibited or restricted on the list is open to foreign investment without conditions. The latest list sets out 48 prohibitions and restrictions on foreign investors involving 34 industries. There is a separate and slightly less restrictive list for foreign inevstors investing in the eleven pilot free trade zones across China with 45 prohibitions and restrictions in 32 industries. The 2019 lists are predicted to reduce restrictions even further.

Protecting foreign investments

State expropriation

The Draft Law states that during exceptional circumstances where foreign investments are expropriated by the state for "public interest", fair compensation must be given to foreign investors. China's highest court has defined "pubic interest" narrowly in cases involving requests to recognise foreign arbitral awards. Specifically, China's Supreme People's Court has confined the scope of "public interest" to cases implicating state sovereignty, fundamental public safety, national security and other matters of the highest state priority. Therefore there is legal basis in China for the state or courts to interfere in the name of public interest only when national interests or analogous grounds are involved.

Mandatory technology transfer

The Draft Law tries to address a major source of complaint from some foreign investors about "forced technology transfer" by including some high level language banning mandatory technology transfer by foreign investors. However, the investment structure in China in respect of foreign investors is such that it creates the impression or effect of forced technology transfer through requiring the formation of joint ventures in order for foreign investors to participate in certain restricted sectors of the Chinese economy. This is often regarded as an unavoidable cost of doing business in China in order to gain access to such a significant market.

Government breach of contract or policy commitment

The Draft Law states where there is a change in contractual terms or government policy commitments for state or public interests, compensation must be made to foreign investors or foreign invested companies which has suffered as a result. Although China's Contract Law may provide a basis for a party to seek compensation in similar circumstances, enshrining this principle into law may prove useful for foreign parties in the appropriate circumstances to seek compensation from the Chinese government at any level.

Managing foreign investments

The Draft Law calls for the following reforms to more effectively manage foreign investments in China:

  • a more equitable process in reviewing applications for business permits and licenses through applying one standard applicable to Chinese and foreign investments;
  • where multiple department approvals are required, one department should be tasked with handling all application submissions of foreign investors and coordinating with all other departments involved to stream compliance requirements;
  • a disclosure obligation on foreign invested companies and any information already provided to the government which could be shared among government departments need not to be disclosed again; and
  • a national security review for applicable foreign investment projects and such review decision would be final and binding with no appeals which could broaden the scope of review beyond the currently required merger and acquisition review.

The recent news about British Telecom obtaining the relevant licence in China to operate as a telecom operator, the entry of Standard and Poor into the Chinese credit evaluation market have been encouraging for foreign investors as they are able to enter more sectors of the Chinese economy which were prohibited or restricted to foreign investors in the past.

Although the Draft Law primarily addresses principles governing foreign investment activities in China, whether the Draft Law can effectively further improve the openness, fairness and competitiveness of the Chinese economy depends largely on the subsequent implementing of rules, enforcement at all levels of government, and the sustained efforts from foreign investors and others to communicate their concerns to the relevant authorities. However, the Draft Law supports the position that the Chinese government is attempting to create a landscape to attract foreign investors to invest in China.

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