China’s Foreign Investment Law (FIL) came into effect on January 1st, 2020. In this article, we discuss what the Foreign Investment Law means for businesses and how this impacts both existing foreign-invested companies in China as well as companies seeking to enter the Chinese market.

Background to the Foreign Investment Law

Following China’s market reform and opening-up, the country adopted a law on equity joint ventures (JVs) in 1979, followed by the laws on wholly foreign-owned enterprises (WFOEs) and cooperative joint ventures in the 1980s. Since their implementation, these laws have provided the legal framework for foreign investors in China.

In an effort to provide more clarity and transparency, the government decided to work on a new legal framework. In 2015, the Ministry of Commerce of China (MOFCOM) released a draft of the PRC Foreign Investment Law, however, plans were put on hold until end of 2018. Subsequently, in a matter of months the Chinese government, on 15 March 2019, officially passed the new Foreign Investment Law. The extraordinary speed with which the new FIL was passed cannot be fully separated from geopolitical events such as the China-US Trade War and ongoing criticism about the country’s reform (See Peterson Institute for International Economics).

The Foreign Investment Law was introduced to tackle some of the largest concerns of foreign enterprises in China. The law aims to promote equal treatment of foreign and domestic enterprises, better protection of investors’ rights, and protection against forced technology transfers (See European Union Chamber of Commerce in China).

Overview of the Foreign Investment Law

The Foreign Investment Law is applicable to all foreign investment in the territory of Mainland China. Foreign investment is defined as investment activity directly or indirectly conducted by a foreign natural person, enterprise or other organization. These include the following circumstances:

A foreign investor establishes a foreign-invested enterprise within the territory of China, independently or jointly with any other investor;
A foreign investor acquires shares, equities, property shares or any other similar rights and interests of an enterprise within the territory of China;
A foreign investor makes an investment to initiate a new project within the territory of China, independently or jointly with any other investor; and
A foreign investor makes an investment in any other way stipulated by laws, administrative regulations or provisions of the State Council.

The Foreign Investment Law includes six different chapters covering general provisions, investment promotion, protection and management, legal liability and supplementary provisions.
The law aims to promote fair competition, equal application of policies in support of enterprise development to foreign-invested enterprises and equal participation in government procurement activities.
Moreover, investment protection is improved by limiting the state’s ability to expropriate investments made by foreign investors, improving the ease of remittances of funds in and out of the country, stronger intellectual property rights protection, and taking measures against forced technology transfers and trade secrets sharing.

It is important to note that foreign investment approval is done according to the principle of national treatment and the negative list. This means that foreign investors are not allowed to invest in the prohibited industries as specified by the negative list and have to conform to the investment conditions for restricted industries. Foreign investment should be given equal treatment to domestic (Chinese) investment in industries which are not prohibited or restricted.

The Foreign Investment Law came into effect on January 1st, 2020, and replaced the Laws of the People’s Republic of China on Sino-Foreign Equity Joint Ventures (EJV), Sino-Foreign Cooperative Joint Ventures (CJV) and Wholly Foreign-owned Enterprises (WFOE) (See National People’s Congress).
Foreign-invested enterprises, which were established in accordance with the aforementioned laws before the implementation of the new Foreign Investment Law, may retain their original organizational forms and other aspects for five years upon the implementation hereof. Subsequently, foreign-invested enterprises are subject to the Company Law, the Partnership Enterprise Law and other laws, meaning that they are now subject to the same laws as domestic enterprises.

Implications for Foreign-Invested Enterprises in China

As discussed above, companies will now have to abide by different laws. Companies looking to enter the Chinese market, will have to be established in accordance with the Foreign Investment Law. Whereas companies currently in the establishment phase are advised to discuss the effects of this change with their advisors.

On the other hand, companies which were incorporated under the EJV, CJV or WFOE laws had a five-year transition period to adjust to their structure in accordance with the Foreign Investment Law. Below we discuss how implementing the Foreign Investment Law impacts WFOEs and Joint Ventures.

Wholly Foreign-Owned Entities (WFOEs)

Because the existing WFOE law is already largely in line with the Company Law, there has been limited impact on existing WFOEs. We have elaborated on the impact for WFOEs below:

Under the Foreign Investment Law, WFOEs are no longer limited to being a limited liability company organizational form, but can also be a joint-stock company under the Company Law.
Moreover, under the WFOE law, foreign-invested enterprises are required to allocate at least 10% of the after-tax profit amount to a reserve fund and employee bonus and welfare funds, up until the total of 50% of the registered capital. Under the Company Law, companies must allocate 10% of their after-tax profits to their statutory, common reserve. However, they are not required to contribute to the employee bonus and welfare funds, where this is up to the discretion of the shareholders.
Lastly, in case of a liquidation, the liquidation committee no longer has to include the legal representative, but will be formed according to the decision of the shareholders or be determined via the general meeting of shareholders.

Joint Ventures (JVs)

On the other hand, the impact of the Foreign Investment Law is larger for Joint Ventures. Among others, existing Joint Ventures should consider the following:

According to EJV and CJV law the board of directors was the highest authority, which shall decide all major issues concerning the joint venture. Under the Company Law, the board of shareholders is the highest authority.
Moreover, under Company Law, amendments to the articles of association of the company (including among others an increase or reduction of the registered capital and merger, division, dissolution or change of corporate form) will be adopted by majority vote (two thirds) of the shareholders, whereas under the previous JV laws this required unanimous agreement of the members of the Board of Directors.
As a consequence of the above, the Joint Venture agreements of existing JVs had to be renegotiated.

Category	Before FIL (Old JV/WFOE Laws)	After FIL (2020–Present)
Governing Law	Governed by separate EJV, CJV, and WFOE Laws	All FIEs governed under Company Law + FIL
Organizational Form	WFOEs limited to LLC structure	WFOEs may adopt LLC or joint-stock company forms
Corporate Governance	JVs: Board of Directors is highest authority	Shareholders’ Meeting is highest authority
Voting Requirements	Unanimous board approval for major matters	Two-thirds shareholder approval for major matters
Profit Reserve Requirements	Mandatory reserves + employee welfare funds	Only statutory reserve fund (10%) required
Transition Deadline	Five-year adjustment period	Transition must be completed by Jan 1, 2025

End of the Transition Period — 1 January 2025

Under the transitional provisions of China’s Foreign Investment Law, foreign-invested enterprises established under the old legal framework had a five-year grace period starting from January 1, 2020, to bring their operations into compliance. This means that WFOEs and other previously established foreign entities needed to adapt their organizational structures, governance, and operational documents to meet the requirements of the new law by January 1, 2025.

If you are unsure whether your WFOE is in full compliance, please get in contact with us.

The Foreign Investment Law introduced negative-list systems that initially seemed to simplify approval but actually shifted discretion to sector regulators who now evaluate “national interest” on deal-by-deal basis. Certainty decreased despite apparent simplification. China company setup under the new law requires early engagement with relevant sector regulators. MSA Asia guides approval navigation. Speak with our team about investment approval strategy.