China Passed the New Foreign Investment Law

Background
At the 13th National People’s Congress (NPC) on 15 March 2019, China passed its Foreign Investment Law (FIL). The FIL will come into effect on 1 January 2020, at which time the set of Chinese laws commonly known as the “Three Enterprise Laws” regulating the Foreign Invested Enterprises (FIEs), including Sino-foreign Equity Joint Ventures (EJV), Sino-foreign Contractual Joint Ventures (CJV)and Wholly Foreign-owned Enterprises (WFOE) will be replaced. The Company Law will be the governing law of all FIEs. 

Buren previously published an article named: Second Review on Chinese Draft Foreign Investment Law, which elaborated on the main provisions of the FIL and its implications for foreign investors in China after the second review. The final version of the FIL makes no significant changes to the second review draft, among which the most important change is that the confidentiality obligation of government authorities and their staff towards trade secrets of foreign investors and foreign-invested enterprises (FIEs) has been added under Article 23.

Please note that the FIL, partly due to its uncommonly fast approval, is comprehensive but not very detailed. More detailed instructions for its implementation are expected to be released before the end of this year. However, a clear timeline is set for FIEs to covert its organizational structure from the current status under the “Three Enterprise Laws” to the structure in compliance with Company Law. 

According to FIL, the existing FIEs may keep operating under their current organizational structures for 5 years after the implementation of the new law. That is, the existing FIEs will have to transform the company’s governance structure before 31 December 2025 to comply with the Company Law. Therefore, it is of importance for all foreign investors and FIEs to be aware of the current status of the regulations and upcoming changes, so they can take proactive steps towards compliance.

This article will provide an overview of some major differences between the Sino-foreign Equity Joint Venture Law (EJV Law) and the Company Law.

The Decision-making Organ
After the “Three Enterprise Laws” are abolished, one of the fundamental changes for EJVs is the fact that the highest decision-making organ will be the shareholders’ meeting, instead of the board of directors as is determined under the current laws.

According to the current EJV Law, there is no shareholders’ meeting set up within a EJV. The board of directors holds the power to decide on (i) amendments of the Articles of Association (AOA), (ii) increase or decrease of the registered capital, (iii) termination or dissolving the company, and (iv) merging or splitting the company. The aforementioned decisions require unanimous affirmative votes from the directors attending a board meeting.

Under the Company Law, shareholders’ meeting make decisions on (i) amendments of the company’s AOA, (ii) increasing or decreasing the registered capital, (iii) the merger, split, dissolution, or (iv) conversion of the company. Unlike the strict unanimous-approval requirement under the EJV Law, the foregoing decisions can be approved by shareholders representing more than two-thirds of the voting rights.

In addition to the matters described above, under the Company Law shareholders’ meetings are required to (i) determine operational and investment plans; (ii) appoint directors and supervisors who are not employee representatives and determine their remuneration; (iii) approve reports of board of directors, executive director, or supervisors; (iv) approve annual budgets and final financial positions; (v) approve any profit distribution or loss make-up plans; (vi) issue company bonds, etc.

Board of Directors
As the highest authority in a company provided under the EJV Law, the board of directors shall consist of at least 3 members. There is no option for appointment of an executive director in lieu of a board of directors. The term of each director is fixed as 4 years. Each party (shareholder) of an EJV shall have the right to appoint a director(s) and replace the director(s) it appointed. 

In a company incorporated in accordance with the Company Law, the board of directors is much less powerful than under the EJV Law and acts as an intermediary between the shareholder(s) and the management. As provided, a limited liability company with relatively few shareholders or of a relatively small size may appoint one executive director in place of a board of directors. The term of a director shall not exceed 3 years which may be renewed. Directors who are not employee representatives shall be appointed by shareholders’ meeting; as for employee representatives who sit on the board of directors, they shall be appointed by company employees via an employees' representative congress or employees' congress or other forms of democratic election.

Legal Representative
Under the EJV Law, only the chairman of the board can be the legal representative. However, the statutory candidates are more flexible under the Company Law, where the chairman of the board/the executive director or the general manager may be the legal representative.

Equity Transfer to Third Party
It is stipulated by the EJV Law that the transfer of one party's share of the registered capital shall be effective only with the unanimous consent of the other parties in an EJV. 

The Company Law requires the consent of over half of the other shareholders concerning equity transfer to a third party, unless otherwise provided by the articles of association. Moreover, where the shareholders reach a consensus to the proposed transfer, the other shareholders shall have pre-emptive right to acquire such equity on similar terms.

Statutory Funds
Under the EJV Law, an EJV is required to allocate a certain percentage of its after-tax profits to the reserve fund, enterprise expansion fund and employee incentive and benefit fund (Three Funds) with the percentage determined by the board of directors. Whereas, a limited liability company under the Company Law must allocate 10 percent of its annual after-tax profits to a statutory reserve fund until the amount of such statutory reserve fund reaches 50 percent of the registered capital of the company. After the company has accrued the statutory reserve fund, it may retain a discretionary reserve fund from its after-tax profits subject to a resolution of the shareholders’ meeting. 

It is still unclear whether and how the amount of Three Funds that has been collected by an EJV can be converted to the statutory reserve fund under the Company Law. 

Outlook for the future
The FIL was promulgated in an unprecedentedly short review and approval process. With the several broad principles and the goal of creating a more level playing field and improving the legal regime for foreign investors in China, more detailed implementing measures are expected to be published to facilitate the new FIL’s implementation. For now it at least seems that the current strict and inflexible rules on EJVs will be partially released under the FIL.

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