Highlights:

From October 1, 2016, a new FDI administration system will be launched in China.  Under the new system, MOFCOM approval will not be required for incorporation or acquisition of a foreign invested enterprise (“FIE”), unless its business is on the Nationwide Negative List released by the State Council.  This will increase efficiency for incorporation of and acquisitions involving FIEs, reduce the uncertainty inherent in interactions with Chinese government authorities, and ease the government’s control over FDI and M&A activities.

Main Article:

Significant Changes in FDI Laws

On September 3, 2016, the Standing Committee of the People’s Congress of the PRC amended the three major legislations on foreign direct investment (“FDI”) applied to FIEs, i.e. the Sino-Foreign Equity Joint Venture Law, the Sino-Foreign Cooperative Joint Venture Law, and Wholly Foreign Owned Enterprise Law (the “Amendments”). FIEs include Sino-foreign equity joint ventures, Sino-foreign cooperative joint ventures and wholly foreign owned enterprises.  The Amendments will be effective from October 1, 2016, pending the release of the nationwide negative list on administration of foreign investment by the State Council (the “Nationwide Negative List”).

As contemplated by the Amendments, certain corporate matters of FIEs (such as incorporation, dissolution, capital increase/decrease, equity transfer, renewal of company term, etc., the “Relevant Corporate Matters”), the joint venture contract and articles of association (including the amendments thereto), will no longer require approval by the Ministry of Commerce of the PRC or its local counterparts (“MOFCOM”). Instead, a filing with MOFCOM will suffice, unless the business of the FIE falls under the Nationwide Negative List.  MOFCOM has issued draft regulations for soliciting comments, which address the filing requirements in greater detail.

For clarity, the Amendments have no impact on the approval of the Anti-Monopoly Bureau of the PRC Ministry of Commerce on the concentration of undertakings required under PRC Anti-Monopoly Law.

Background

• Current FDI Legal Regime

Since the three major laws on FDI were first enacted in 1979, 1986 and 1988 respectively, the Relevant Corporate Matters of FIEs, including the joint venture contract and articles of association, have required approval from MOFCOM, regardless of substance of the matter.  In practice, MOFCOM would perform a substantial review of the terms of transaction documents, and sometime challenge the terms that appear unusual to them even if they are compliant with the relevant laws.  In some cases, local MOFCOM may even require the transaction documents to be prepared based on their standard simple form.  It would typically take 3-5 weeks to complete the MOFCOM approval process, and the process may even be prolonged if additional time is needed to address MOFCOM’s comments.

• Pilot Reform in Free Trade Zones

The concept of “negative list” was first introduced into China’s legal system in 2013 when it was implemented into the Shanghai Free Trade Zone before the pilot program later expanded to three other free trade zones in Guangdong, Tianjin and Fujian.  Under the “negative list” based FDI administration system, most foreign invested companies would be allowed to set up in the same manner as domestic companies, unless listed in the “negative list”. This approach signifies a long leap for foreign investment administration in China, from having a requirement of obtaining government authorities’ approval on each foreign-invested project/entity to a procedure that applies equally to both domestic and foreign investors (unless the foreign investment is on the negative list).

One of the centerpieces of the reform is that, if the contemplated business is not on the negative list, MOFCOM approval will no longer be required, and a filing with MOFCOM will suffice.  The filing process only requires the submission of minimal documents and limited information – MOFCOM will not review transaction documents such as the joint venture contract, articles of association and share purchase agreement; and the filing can be completed in few days.  This increases efficiency for FIEs by saving them substantial time and effort, and reduces the uncertainty inherent in the interaction with Chinese government authorities.

The above negative list based FDI administration system was implemented on a pilot basis for a short term expiring on September 30, 2016 and only in four free trade zones.  With the Amendments and the Nationwide Negative List put in place, the benefits will be extended to the rest of China.

Eased Control over FDI and M&A

Generally, the Amendments convey a positive message to foreign investors: foreign investment is welcomed by China and the Chinese government is making progress to ease control over FDI and mergers and acquisitions (“M&A”) activities.  Essentially, the procedure and timeline for the Relevant Corporate Matters of an FIE and a domestic company will be the same.

With respect to M&A activities, in addition to the shorter timeline and simplified process discussed above, the main benefits arising from the reform under the Amendments include the following:

1. Price Adjustment Mechanism – Where MOFCOM approval is required for a purchase agreement, as a matter of practice, in most cases, MOFCOM will not approve a purchase agreement with a price adjustment mechanism, or will indicate a fixed price on its approval letter regardless of the price adjustment mechanism provided in the purchase agreement. As a result, if a transaction contemplates cross border payment, the agency in charge of foreign exchange control, i.e. the State Administration of Foreign Exchange (“SAFE”), will only approve payment of the fixed price specified on the MOFCOM approval letter.  As MOFCOM approval is no longer required for purchase agreements, we expect that parties will have more liberty to agree on and adopt a price adjustment mechanism, something that is commonplace and desirable for most transactions.
2. Enforcement of Certain Rights – Certain shareholder’s rights such as call option, put option, tag along, drag along and anti-dilution rights are commonly seen in transaction documents for an FIE, but they generally have enforcement difficulties because the equity transfer or issuance for exercising such rights is subject to MOFCOM approval. Said approval would be withheld if the parties cannot submit an equity transfer agreement, board resolutions and other documents required by MOFCOM. This means that it would be very difficult for a party to exercise such rights without the cooperation of the other party in signing and delivering the additional documents. Since MOFCOM approval is not required under the Amendments for the equity transfer or issuance, it would likely be much easier to enforce such rights by completing the MOFCOM filing process – a formality in nature and therefore will not have to be a closing condition.
3. Method of Payment. In the context of M&A, although PRC law does not specify the form or method of payment, in practice, MOFCOM would usually require that the consideration be paid in cash.  Under the Amendments, the purchase agreement will not be subject to MOFCOM approval and it will therefore be possible for parties to agree on alternative forms of consideration, including non-cash payment.

Things to Expect

1. Nationwide Negative List. The Nationwide Negative List has yet to be seen but we expect that it will be prepared based on the existing negative list that has been adopted by the four free trade zones.
2. Other Agencies. It is uncertain how soon the other agencies (e.g. SAFE) will change their administration systems and practices to accommodate the changes contemplated under the Amendments.  It is also possible that it may take local provinces and cities (particularly those in remote areas) a longer time to follow this national reform, and there will have to be a transition period.
3. M&A Rules. It remains to be seen if and to what extent the major legislation on cross boarder M&A, i.e. the Regulations on Mergers and Acquisitions of Domestic Enterprise by Foreign Investor, will be amended in light of the Amendments.  It is likely that MOFCOM approval will remain required for such acquisitions of domestic enterprise by foreign investor.
4. Foreign Investment Law. At the beginning of 2015, a draft version of the Foreign Investment Law was released to the public for feedback.  The Foreign Investment Law, if enacted, will replace the above-mentioned three major legislations on foreign direct investment, and contemplates an overhaul of China’s FDI legal regime.  The negative list based FDI administration system is a part of the major reforms provided in the draft Foreign Investment Law, and has been implemented while the other intended reforms are still being debated.  Following the major progress under the Amendments, we anticipate that the legislation process for the Foreign Investment Law will be expedited.