How to deal with the Foreign Investment Law

According to Article 42, foreign-invested enterprises established in accordance with Three Enterprises Laws may continue to retain the original organization form within five years after the implementation of this Law. Although a five-year transition period is stipulated, the new law does not have a clear definition on how the “original organizational form” could be retained during the transition period. As a result, adjustment of corporate institutions in accordance with the provisions of the PRC Company Law will inevitably have a profound impact on the existing organization.

1.Organization Structure

Under the Three Enterprise Laws structure, the board of directors or the joint management committee is appointed by shareholders, as the highest decision-making mechanism, and shareholders’ meeting is not a necessary. However according to the PRC Company Law, shareholders’ meeting is the executive body as well as the highest authority in the company, which means that organizational structure of foreign-invested enterprises need to be changed, and the cooperation contracts and articles of association needs to be modified.

2.Organizational Form

Limited liability company is the basic form of foreign-funded enterprises, as it written in Articles: according to Article 4 of the Law on Sino-foreign Joint Ventures, “the form of a joint venture is a limited liability company”. Article 14 of the “Implementation Rules for the Law of the Chinese-Foreign Cooperative Enterprises” stipulates that “a cooperative enterprise shall be a limited liability company if it obtains the qualification of a Chinese legal person according to law.” However, Article 2 of PRC Company Law indicates that the company's organizational form refers to the “limited liability company” and “company limited company”, meanwhile, the Foreign Investment Law also takes partnerships established by foreign investors under the Partnership Enterprise Law of the People's Republic of China into consideration.

3.Profit Distribution

According to the Three Enterprise Laws, “the joint venture parties share profits and risks according to the proportion of registered capital; the parties to the Chinese-foreign contractual joint ventures may distribute the proceeds according to the contract, and may also agree that the foreign partners shall first advance during the cooperation period”. According to Article 31 of FIL, “the organization form, and activity standards of foreign-invested enterprises shall be governed by PRC Company Law and the PRC Partnership Enterprise Law”.

As articles above do not make a clear agreement on how to distribute the benefits, we will pay close attention to whether investors can directly apply the Company Law and other relevant provisions to modify the existing distribution method after 1st January 2020.

The implementation of the FIL provides space for innovative investment and transaction arrangements. At the same time, the structures and terms can be more in line with market practices. Since all parties will face a new round of negotiations, then how to use the new law to implement the conditions for cooperation that is both beneficial to the party and promote the long-term development of the enterprise will be the primary consideration for every foreign investor who has or will enter the Chinese market.

In summary, FIL is going to simplify the administrative burden of foreign-invested enterprises, expand the field of foreign investment, and resolve the conflicts in practice. We understand that the current provisions in the FIL are generally principles. Compared with the Foreign Investment Law (draft), the content of FIL has been greatly reduced, then how effective the FIL can be in practice as it expects largely depend on how the detailed implementation rules and even the attitudes of local governments will be.