A discussion of the new China Foreign Investment Law and the creation of an Expert Committee to produce template documents for in-house counsel. By Robert Lewis of docQbot, with an introduction by Patrick Dransfield of the In-House Community.
In July 1979, the People’s Republic of China promulgated the Equity Joint Venture Law (EJV Law). This was China’s first law on foreign investment, and was one of the earliest steps in China’s reform and opening up.
This was followed by the adoption of the Wholly Foreign-Owned Enterprise Law (WFOE Law) in 1986 and the Cooperative Joint Venture Law (CJV Law) in 1988.
Today, there are estimated to be more than 500,000 foreign investment enterprises (FIEs) in China — nearly 375,000 WFOEs and 125,000 Sino-foreign joint ventures, with EJVs outnumbering CJVs by more than 10-fold.
In March of this year, almost 40 years after the adoption of the EJV Law, China passed the new Foreign Investment Law (FIL), which will take effect on January 1, 2020, replacing the EJV Law, the CJV Law and the WFOE Law, all of which will be repealed as of the end of this year.
While the FIL was in large part passed to address several key issues in the context of the continuing Sino-US trade negotiations, for in-house counsel in foreign multinational companies with subsidiaries in China (as well as in-house counsel in domestic Chinese companies that have investments in Sino-foreign joint ventures) the most important legacy of the FIL will be that it represents a fundamental change in the legal basis for FIEs in China.
Going forward all new FIEs will be set up under and governed by the Company Law, and all 500,000-plus existing FIEs will need to convert into limited liability companies (LLCs) or other entities under the Company Law by the end of 2024. This will introduce a dramatic shift in the corporate governance for FIEs, creating both new opportunities and new challenges.
It is therefore no exaggeration to claim that when the new Foreign Investment Law takes effect on January 1, 2020, this will be an historic landmark in terms of China’s relationship with the rest of the world.
On a personal note, the adoption of the original joint venture agreements coincided with my own professional working life relating to China. In 1985 and 1986, I was living in Northern China and ended up with a teaching job at Beijing Normal University and also Newsweek. The best American burgers — the only American burgers — available in Beijing at the time could be found at the Jianguo Hotel. Copied in perfect detail from the Sheraton Palo Alto, the Jianguo Hotel was also one of the first JV contracts put together on China’s opening up to the world — by Vivian Bath, I believe, in 1982. The first JVs were cobbled together using German law and American precedents and emerged ad hoc — Levi Strauss and Dow Chemicals being some of the first protagonists.
One book brought many of these early practitioners together — Life & Death of a Joint Venture, published by Asia Law & Practice in 1994 (full disclosure, I ended up running this company for Euromoney from 1998 to 2000). The book was a legal guide in the form of a novel, which began at the conception and ended at the death of a JV agreement. It helped create the careers of a generation of American lawyers — and as a consequence quite a few legal fees. Despite the title, an optimism reigns through the book. While there are definitely local difficulties between AmWij Inc (the American party) and Shanghai Number One Widget Factory — the theoretical parties involved in this fictional legal saga — the book does not question the economic needs for the transaction per se. However, the publicity associated with the book used the phrase: “Same Bed, Different Dreams”: “Tong Chuang yi meng”.
It is to be hoped that with the introduction of the FIL, foreign investors and their Chinese counterparts will now experience shared dreams in a new bed, but challenges will undoubtedly remain.
In order to address some of the challenges presented by the new FIL, the In-House Community and Robert Lewis of legal-tech start-up docQbot have cooperated to form an Expert Committee of leading lawyers from the law departments of leading State Owned Enterprises and Multinational Companies as well as both international and domestic law firms.
Working under Robert’s direction, the Expert Committee has undertaken to prepare a suite of new sample base templates for FIEs in China that comply with the requirements of the Company Law. Drawing upon commentary from the members of the Expert Committee, Robert describes below some of the key practical implications of the FIL for FIEs in China and introduces the work of the Expert Committee.
When the EJV Law was passed in 1979, Deng Xiaoping was reported to have stated that it was more “a statement of political intent, rather than a piece of legislation”. That was a fitting description given that the EJV Law in its original form consisted of a mere 16 articles.
So what can we say about the new Foreign Investment Law passed in March of this year? It was longer than the original EJV Law but still quite brief — it was less than a quarter of the length of the original 2015 draft of the FIL. It was also passed in record time — while the 2015 draft of the FIL had lain dormant for almost four years, the new version was adopted in under three months after the most recent revised drafts had initially been circulated for comment.
As such, it was apparent to most commentators that the new FIL was adopted primarily to address several points which were (and remain) under negotiation as part of the Sino-US trade negotiations, including strengthening of intellectual property rights (IPR) protections, elimination of non-tariff trade barriers, discontinuance of mandatory transfers of technology in exchange for market access, etc.
The FIL also enshrines the principle of national treatment into law. When coupled with the negative list system presaged in the 2015 draft of the FIL and separately implemented in 2017, this sets out a system of pre-establishment national treatment, which means that unless specifically restricted on the negative list, all other sectors are open to foreign investment subject only to record filing requirements. This also conforms to international practice in bilateral investment treaties.
USHERING IN A NEW ERA FOR FOREIGN INVESTMENT IN CHINA
All of these trade and investment negotiation points in the FIL (and many others which are beyond the scope of this article) are of significant importance, but these have not been the primary focus of lawyers engaged in foreign direct investment (FDI) work in China.
The key provisions of the FIL for this group comprised only a few brief lines at the end of the already very brief FIL. Specifically:
- The EJV Law, the CJV Law and the WFOE Law (collectively, the Three FIE Laws) are to be repealed at the end of this year.
- Once the FIL takes effect on January 1, 2020, all new FIEs will be subject to the provisions of the Company Law going forward.
- More significantly, the FIL also provides that by the end of 2024 all 500,000-plus existing FIEs will be required to restructure to conform to the requirements of the Company Law.
The FIL thus will usher in a new era for foreign investment in China, overturning the old legal system which has governed FDI in China for 40 years. Both the corporate governance and the corporate documentation for FIEs will need to change under the Company Law.
This will be good news in many respects. The corporate governance provisions under the Company Law, while not yet fully up to international standards in all respects, are in general superior to the rules under the Three FIE Laws.
The Company Law provides that the highest authority in the company is the shareholders meeting, while the EJV Law does not provide for a shareholders meeting and designates the board of directors as the highest authority in the joint venture company. In the context of a Sino-foreign joint venture, which typically has a limited number of investors, this likely will be a matter of form over substance, and most FIEs (like most of their domestic non-listed LLC counterparts) will conduct the business of the shareholders meeting on paper only without holding an actual meeting.
However, in addition, the Company Law provides super-majority shareholders with a higher level of control than permitted under the EJV Law. For example, certain matters which now require unanimous board approval under the EJV Law, now will only require two-thirds majority approval at the shareholders meeting level. In addition, there are scores of other changes that will need to ripple through the various clauses of the joint venture documentation. This change in governance provisions alone will present significant challenges to both Chinese and foreign investors in joint ventures in China.
Under the Company Law, the nature of the corporate documentation for FIEs will also change dramatically, more especially for joint ventures. The joint venture contracts which have been in use since the opening up of China to foreign investment had been drafted to reflect the requirements set out in the EJV Law, many of which reflected government policies, administrative procedures and market conditions which no longer apply.
Under the Company Law, domestic LLCs commonly adopt a simpler set of articles of association (AoA) and then separately enter into a shareholders’ agreement (SHA) as appropriate. Sino-foreign joint ventures are now expected to follow suit and as such will no longer be required to use the traditional legacy joint venture contract and will now have greater flexibility to adopt an SHA or a joint venture agreement (JVA) that is more consistent with international practice. (See below.)
Expert commentary on the implications of the FIL
“During the five-year transition period from January 1, 2020, Sino-foreign joint ventures are required to reform their corporate governance structures” (including decision-making mechanism, voting, quorum, management nomination and share transfer) in order to comply with the PRC Company Law requirements. This would likely open the gate for re-negotiation between the joint venture partners and have a major impact on the dynamics of their relationship. Joint venture partners should weigh their positions in the joint venture and get themselves ready for the changing landscape.” Nanda Lau, partner, Herbert Smith Freehills, Shanghai.
“We expect foreign investors will welcome many of the innovations of the FIL, including establishment of foreign-invested enterprises under the structure and governance provisions of the Company Law instead of under separate laws, as well as the FIL’s enumeration of certain rights, protections, and access to be enjoyed by foreign-invested entities, including equal opportunity to participate in the formulation of standards (Article 15), equal treatment in government procurement for their products which are produced within China (Article 16), access according to law to China’s capital markets (Article 17), IP protection (Article 22), and others. Undoubtedly, there will be great interest among foreign investors in seeing how such provisions will be given full effect as China continues to work to promote foreign investment and “create a stable, transparent, and foreseeable investment environment” (Article 3).” Walker Wallace, managing partner, O’Melveny & Myers, Shanghai
“Sino-foreign joint ventures will become a much more attractive option under the FIL, allowing foreign investors to tap into the burgeoning Chinese market by partnering with well-established Chinese partners. Thanks to removal of many prior rigid restrictions, foreign investors will be able to use more sophisticated offshore joint venture terms and techniques which they are familiar (and comfortable) with.” Jin Xiong, international partner, King & Wood Mallesons, Beijing
“In addition to an improved corporate governance framework under the Company Law, the transition from the old FDI laws will also do away with the current “thin capital” rules and should also open up downstream investments by FIEs which have continued to be artificially constrained as a practical matter under the legacy legal regime. This will allow a significant opportunity for foreign investors to regularise their capital and corporate structures for their entities in China.” Scott Yu, partner, Zhong Lun, Beijing
MAPPING OUT THE ROAD AHEAD
Up to this point, the EJV Law has provided a structure for Sino-foreign joint venture contracts, and most joint venture contract forms in China all have derived from a common original base developed in the earlier stages of FDI in China, so there has been a common touchstone for the market. However, the Company Law imposes much fewer requirements on the form of an SHA or JVA, and since these foundational documents will no longer be subject to government review and approval, the parties will now have a broad scope to agree both the form and content of these agreements.
This threatens to create a vacuum in the market, which could result in the creation of a proliferation of multiple competing forms, some excellent, some substandard, and all mutually inconsistent. This in turn would engender a battle of the forms each time the parties undertook a new foreign investment project and — perhaps even more daunting — each time an existing Sino-foreign joint venture was to convert to an LLC under the Company Law. This would inevitably result in an excessive misallocation of time and money.
As I and some colleagues presented these issues at a workshop at the Beijing In-House Congress event at the end of March of this year just after the formal adoption of the FIL, I suggested that a working group of senior lawyers from leading domestic and international law firms, as well as law departments in major Chinese and international corporations, be formed to create a new set of FIE templates to reflect the pending legal changes. I underscored that as part of any such initiative it would be necessary to discard certain legacy provisions in old-style joint venture contracts, import all of the Company Law corporate governance provisions and incorporate international best practices so as to take proper advantage of this unique opportunity to set a new standard template for common reference and use. This proposal received enthusiastic support from the attendees.
I approached the In-House Community shortly after the event to discuss how we might work together on this proposed template project. The In-House Community was keen to support this initiative as they saw that this would make an important contribution to their members working in corporations with investment activities in China. (See below.) We set an ambitious target to complete the principal drafting for the set of templates by the end of August 2019, so that the templates could be finalised for presentation and discussion at the In-House Congress events in Hong Kong on (October 3) and in Shanghai on (October 30, 2019).
Empowering in-house counsel through thought leadership
“When Robert Lewis invited the In-House Community to be a part of the Foreign Investment Law Expert Committee, we immediately agreed as it felt very much a part of our DNA and fitted the platform we deliver. The mission of the In-House Community is to empower in-house counsel and to strengthen legal and ethical compliance for the benefit of all. It is a community of practice and what better way to manifest that than by helping to assemble a group of expert lawyers and business people from diverse backgrounds and perspectives to create a dynamic thinktank to provide input regarding the drafting of this new and crucial law that will fundamentally change Chinese-foreign relations positively — and also to provide the oxygen of discussion through the In-House Congresses in Hong Kong (October 3) and Shanghai (October 30, 2019).”
Patrick Dransfield, co-director, In-House Community
FORMING THE EXPERT COMMITTEE
Since the objective of the proposed initiative was to produce an authoritative set of high-quality base standard templates for the China legal market, it was critical that we assemble a top-shelf team of legal experts to form the drafting committee. This could not be the product of a single lawyer or even a single law firm — it was imperative that this be a group effort involving experienced lawyers from multiple law firms and corporate law departments in order to produce templates which would set the new standard for the entire China legal market.
Patrick Dransfield, co-director of the In-House Community, coordinated the efforts to extend invitations to a select group of leading lawyers. We were very pleased with the quick affirmative responses to the invitations extended and with the final composition of the Expert Committee. (See below.)
Key members of the Expert Committee
Robert Lewis (chief expert)
Adam Channer (VP product development)
Sara Yu (VP product development & strategic partnerships)
Zhou Zimin (senior manager product development)
Patrick Dransfield (co-director)
LAW FIRM PARTICIPANTS
Herbert Smith Freehills:
Nanda Lau (partner)
Angela Zhao (senior associate)
Alizee Zheng (senior associate)
King & Wood Mallesons:
Jin Xiong (international partner)
Luo Hai (foreign legal consultant)
Latham & Watkins:
Frank Sun (partner)
O’Melveny & Myers:
Walker Wallace (managing partner, Shanghai office)
Zhong Lun Law Firm:
Scott Yu (partner)
Scott Guan (partner)
Rachel Li (partner)
Aaron Yu (partner)
LAW DEPT PARTICIPANTS
Accenture, Greater China:
Andy See (former managing director, Asia Pacific)
Zhiyong Yan (senior counsel, Greater China)
Max Zhang (head of law corporate)
Xi Zhang (head of LPC (VP))
Li Ge (deputy group general counsel)
Yvonne Yao (senior group legal counsel)
Li Chi (legal counsel, contract management division)
All of the core members of the Expert Committee are highly experienced in both inbound and outbound investment projects. Collectively, the members of the group have worked on literally thousands of joint venture and WFOE projects in China over the last three decades. Our work also benefited greatly from the fact that we have had a good balance between Chinese and foreign lawyers, in-house lawyers and law firm lawyers.
The in-house members of the working group played a particularly important role. Li Ge, deputy group general counsel for China Resources, had the most unusual backstory in connection with his participation on the new FIL templates initiative. Not long after the Expert Committee commenced its work, I was invited to make a presentation to a group of in-house counsel from all of the first-tier subsidiaries of China Resources, and as part of my presentation I mentioned the work we were doing on this new FIL forms project. After my presentation Li Ge sought me out to ask how China Resources could join the Expert Committee, explaining that since China Resources is headquartered in Hong Kong, all of its entities in China are WFOEs or joint ventures. Moreover, he had a personal interest in this initiative since he had previously worked for the Ministry of Commerce and had been responsible in the early days for review and approval of joint venture contracts, so he was keen to participate in the development of the new templates for this new era of FDI in China. Obviously, I was happy to confirm the participation of China Resources on the spot, and Li Ge assigned one of his top lieutenants, senior group legal counsel, Yvonne Yao, to join him on the Expert Committee. They jointly made very valuable comments on how to address issues involving SOEs in the templates.
Andy See, managing director of the Accenture Asia Pacific law department, learned of the work of the Expert Committee when he attended a presentation I made at another In-House Community event in Shenzhen. He similarly accepted the invitation to contribute to the initiative without hesitation. (See below.) Andy and his colleagues not only invested substantial time to contributing to the new FIL templates, but Andy also took a keen interest in the broader docQbot ecosystem into which the new templates would be integrated. (Andy left Accenture at the end of August 2019, but because the core work of the Expert Committee had concluded by that point, Andy is still listed above in his former capacity at Accenture, where he was during the applicable periods of time.)
Going back in time
Perspectives of the law firm participants
Angela Zhao, senior associate with Herbert Smith Freehills in Shanghai, noted: “The FIL will have a profound impact on foreign investors in China. Many of our clients are already preparing for this change. We believe that what the Expert Committee has been able to produce will prove to be extremely useful for the entire legal community in China. It is a great honour and privilege to be part of this important initiative.”
Scott Guan, a partner in the Shanghai office of Zhong Lun, similarly commented: “We have had an unprecedented number of responses from clients to our updates on the new FIL, and many have already instructed us to help guide them through the practical implications. We anticipate that once the FIL implementation regulations are issued, there will be another significant uptick in requests from our clients for FIL-related guidance. This is a major reason that we were so keen to join this initiative. We wanted to be on the cutting edge of all the practical aspects of this new change in law.”
All of the participants also saw the value proposition this initiative in broader market terms. Walker Wallace, managing partner of the Shanghai office of O’Melveny & Myers, expressed similar sentiments as follows: “This has been a very worthwhile project. I think that the work of the Expert Committee will result in a product that is truly valuable to the Chinese legal community on many different levels. We were pleased to be invited and happy to make a contribution.”
THE WORK PROCESS AND THE WORK PRODUCT
This FIL templates project was ambitious in its scope and as such demanded a substantial investment of time over a period of three months. In all, more than 1,000 hours of professional time have been invested by the members of the Expert Committee, principally by the docQbot team, which took the labouring oar.
This was a multi-stage process. The initial joint venture template drafts were developed on an international base incorporating best practices drawn from more than a dozen publicly available templates from multiple jurisdictions around the world.
We then identified various legacy provisions which were required under the EJV Law but which were no longer required under the Company Law, were not consistent with international best practices and, in the opinion of the Expert Committee, no longer served a legitimate purpose. These were intentionally omitted.
We then layered in the corporate governance provisions required under the Company Law. This was a pains-taking exercise as scores of related changes had to be made throughout the base template. This exercise was central to the overall initiative and is hoped will prove to be a valuable guide for FDI practitioners and investors inside and outside China.
Members of the Expert Committee then compared these international templates against best practices in connection with both legacy Sino-foreign joint venture contracts as well as representative shareholder agreement templates for domestic Chinese companies in order to ensure that these new JV templates are consistent with local market expectations as well. Accordingly, the sample templates are intended to reflect the best of both international and domestic best practices.
The group determined that it would not be feasible to create a set of base templates that would be suitable for use in connection with the full range of common FDI transactions. Accordingly, the decision was taken to prepare sample templates to reflect the terms of representative hypothetical base case scenarios.
The templates then passed through multiple rounds of drafts and comments in order to achieve, where possible, a consensus view of the Expert Committee members. In the early rounds it became apparent that there were divergent views on various key topics. To be able to reflect the range of views of the members of the Expert Committee, it was decided that we also produce annotations to the sample templates.
This added a significant amount of work to what was already a major undertaking. However, this also provided a very valuable and unique platform on which we could present different views of the group as well as alternative approaches that ultimately were not incorporated into the sample templates.
Moreover, for the corporate governance provisions required under the Company Law, we have provided references in the annotations to the specific articles of the Company Law for ease of reference. However, the annotations cover not only points of law but also related practical considerations to be taken into account as the templates are used. We are of the view that these annotations, and particularly those which set out the divergent views of the group, form another key part of the overall value proposition of this initiative. (See below.)
The value proposition of the annotations
Zhiyong Yan, senior counsel for Accenture Greater China, who was particularly active in reviewing and commenting on the draft templates, had a very expansive view of the value proposition of this template project generally and the annotations specifically. He noted that “The detailed annotations to the templates can be used as a valuable reference guide to the applicable provisions of the Company Law, while at the same time also provide practical guidance on alternative clauses. We will be able to use these annotations as a guide for possible alternative positions we can take in negotiations.”
|Sample Joint Venture Agreement (JVA) (EN & CH)|
|Sample Articles of Association for Sino-foreign Joint Venture (JV AoA) (EN & CH)|
|Annotations to JVA and JV AoA (EN & CH)|
|Sample WFOE Articles of Association (WFOE AoA) (EN & CH)|
|Annotation to WFOE AoA (EN & CH)|
THE WAY FORWARD
We wish to thank the In-House Community for their leadership on this new FIL sample templates initiative, and we welcome the input from all the members on the platform. Working together we can create a valuable shared foundation to move forward in this new era of FDI in China.
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