China’s new Foreign Investment Law (“FIL”) came into effect on January 1, 2020, marking a milestone for China’s Opening-up policy. As China makes efforts to attract new-comers from all over the world, it is also important for “old friends” to be aware of some major changes brought by the FIL to their foreign-invested enterprises (“FIEs”).
Changes for Joint Venture Companies (“JVCs”)
Under the FIL, FIEs’ governance structure will be organized according to the Company Law, Partnership Enterprise Law, and other applicable Laws. While wholly-owned foreign enterprises (“WOFEs”) have long been treated this way by registration authorities, JVCs will have to make more adjustments.
1.Change of Governance Structure
Prior to the FIL, the governance structure in JVCs had two layers, consisting only of the Board of Directors and Management. However, post-FIL, JVCs have three layers: a Shareholders Meeting, the Board of Directors, and Management.
Under the new governance scheme, important JVC matters such as capital increase, change of address, or merger will have to be resolved by shareholders. The Board of Directors will be responsible for implementation as opposed to overall decision-making.
2.Changes to Management Structure
Along with the adjustments to decision-making bodies of JVCs, the FIL grants more flexibility to JVCs’ management structure:
|Director/Board of Directors
|3-13 for limited liability company
Executive Director is allowed
|Service Term of Director
|Maximum 3 years
|Only Chairman of Board
|Chairman of Board, Executive Director or General Manager
3.Change of Dividends Distribution
Prior to the FIL, the standard for dividends distribution was limited to proportion of capital investment. Now that JVCs are under the purview of China’s Company Law, which encourages investors and shareholders to “make their own rules”, dividends distribution will no longer be so limited, and certain arrangements agreed upon by shareholders will be allowed.
4.Change of Equity Transfer
In addition, prior to the FIL, a transfer of equity to a third party was required to be approved by all investors of the JVC. Post-FIL the threshold has been lowered: approval by 50% or more shareholders will be enough for equity transfer to a third party.
Transition Period for FIEs
According to the FIL, there is a 5-year transition period for FIEs to adjust their governance structures. Although the FIL does not specify any enforcement measures or penalties for FIEs not making such changes within the stipulated period, foreign investors should note that there will be consequences:
According to the FIL Implementing Regulation, if FIEs do not change their governance structures by then, their failure to do so will be announced to the public by the market regulation authority. Furthermore, after the transition period, the competent market regulation authority will refuse to handle any registration matter applied for or submitted by non-compliant FIEs. This sort of indirect “penalty” will severely limit the ability of such FIEs to operate, and thus detrimentally impact the foreign investors.
So, it is important for currently operating FIEs to assess their current governance structure and make necessary adjustments within the time limit. This includes potentially time-consuming negotiation and modification of Articles of Association, Shareholder Agreements, Joint Venture Agreements, Appointment Letters of Directors or Management, and more.
Furthermore, for any ongoing FIE-related transactions such as equity transfer, mergers, and acquisitions, some key issues in the transaction documents will have to be re-evaluated and reviewed.
The bottom line is this: even if 5 years seems like plenty of time, we suggest acting quickly to avoid potentially drastic consequences. Consultation with management on when and how to bring up this topic with relevant partners should be take place early. In some cases, this may even entail drafting new Joint Venture Agreements.
Da Wo is here to help
DaWo’s domestic lawyers and international experts have handled foreign investment matters for numerous clients over the years. If you have any questions regarding the new Foreign Investment Law in China, do not hesitate to contact us!