Impact of Foreign Investment Law on M&A in China

By Catherine Shen, Commerce & Finance Law Offices
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on 1 January 2020, with the effectiveness of the Foreign Investment Law, the Foreign Investment Law Implementation Regulations and the associated department rules and judicial interpretation, China has entered into a completely new era of foreign investment administration and regulation.

Catherine Shen Commerce & Finance Law Offices Foreign Investment Law
Catherine Shen
Partner
Commerce & Finance Law Offices

As the most significant legal development in the past 40 years in the area of foreign investment, the Foreign Investment Law and its associated regulations have brought fundamental and systematic changes to the way the central government manages and supervises foreign investment activities in China. This article highlights a few important practical changes brought by the new foreign investment legal regime, and their impact on foreign investors doing M&A in China.

Information reporting system

Since the promulgation of the Sino-Foreign Equity Joint Ventures Law in 1979, the establishment of foreign invested enterprises (FIEs) or the acquisition of equity interest of Chinese companies by foreign investors had required approval from the Ministry of Commerce (MOFCOM) or its predecessor, the authority in charge of foreign investment activities in China. Since 2016, with the issuance of the foreign investment negative lists, the single foreign investment approval system was changed into a parallel approval and filing system – foreign investment projects that fell within the negative lists required approval from MOFCOM, while for foreign investment projects that fell outside of the negative lists, a filing with MOFCOM sufficed.

This parallel approval and filing system was abolished under the new foreign investment legal regime. According to the Foreign Investment Law and the associated MOFCOM regulations, any direct or indirect investments made by foreign investors in the form of greenfield investments or acquisitions (within the negative list or outside of the negative list) now require online reporting to MOFCOM only, which can be completed in the same day of the submission of the reporting forms.

No transaction documents – such as joint venture agreement, share purchase agreement, capital increase subscription agreement, and even articles of association of the FIE concerned – are required to be submitted as part of the initial report. MOFCOM no longer reviews or examines any transaction documents.

Such a simplified reporting system has greatly reduced uncertainties for foreign investors doing M&A in China, as they no longer need to worry whether their projects will be approved by MOFCOM (assuming such projects fall within the negative lists), and whether their agreed commercial arrangements – e.g., adjustment of valuation, conditions and timeline for payment of consideration – will be acceptable to MOFCOM or not, due to lack of precedents or unfamiliarities of MOFCOM with such arrangements. The parties can agree on their co-operation and transaction terms purely based on their commercial needs and intention, subject to no violation of mandatory PRC legal requirements.

JVs with Chinese individuals

Another practical change is that foreign investors can now directly set up joint ventures (JVs) with Chinese individuals. Under the previous laws, this was not allowed unless Chinese individuals had been shareholders of the target company for at least one year before the acquisition of such target company by foreign investors. Under the new legal regime, this restriction has been abolished and Chinese individuals no longer need to set up a legal entity in order to form a Sino-foreign JV.

Unified corporate governance

With the abolishment of the three basic laws governing them, FIEs to be set up under the Foreign Investment Law will have the same corporate legal form and governance structure as domestic legal entities. A Sino-foreign equity or contractual JV is no longer a separate legal vehicle, and the Company Law or the Partnership Enterprise Law will apply, depending on the legal form of the legal entity to be set up by Chinese or foreign investors.

For existing Sino-foreign equity or contractual JVs, the Foreign Investment Law has granted a five-year transitional period from when the Foreign Investment Law came into effect (until 31 December 2024) for the parties to revise the JV agreements and articles of association to be in line with the corporate governance structure provided under the Company Law, failing which the State Administration for Market Regulation (SAMR) will not handle any registration applications of such FIEs, and will also publicly announce such non-compliance.

Due to the substantive differences in corporate goverance structure between Sino-foreign equity or contractual JVs and limited liability companies, such adjustment of corporate government structure will involve changes concerning, among others, the highest decision making body of the company, the methods of appointment of directors, terms of directors, quorums for board meetings, voting mechanisms for important matters at shareholder and board level, restrictions on equity transfer, etc. Most of these required changes are critical, and may involve a new round of bargaining and negotiation among Chinese and foreign shareholders in order to have agreement on the required changes.

Conclusion

The Foreign Investment Law has been widely recognized as a legislative milestone in China’s legal history. It aims to create a level playing field for FIEs and domestic companies, and to safeguard foreign investors’ interests in China. So far, the MOFCOM has abolished 62 department notices, regulations and rules in various areas concerning the administration of foreign investment and FIEs. It is expected that more changes will come to help foster and build up a more transparent and predictable administrative system for foreign investment.

Catherine Shen is a partner at Commerce & Finance Law Offices. She can be contacted on +86 10 6569 3471 or by email at shenxiaolin@tongshang.com