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China's New Foreign Investment Law: What U.S. Businesses Need to Know Right Now

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On March 15, 2019, the Chinese National People's Congress (China's legislative body) passed the new China Foreign Investment Law. The new law, a version of which was first released for comment in 2015, is intended to level the playing field between Chinese companies and foreign companies doing business in China by affording foreign companies the same treatment provided to domestic Chinese companies. However, the new foreign investment law does not go into effect until January 1, 2020 and is quite vague on details, including specifics addressing its implementation and enforcement. As a result, only time will tell whether the law actually will improve conditions for foreign companies operating in China. Regardless, it is important that those companies understand the changes now and how they may impact their business.

Key Changes:

1. Replacement of Three Foreign-Invested Enterprise Laws and National Security Reviews

The new foreign investment law will repeal the existing Sino-Foreign Equity Joint Venture Law, Sino-Foreign Contractual Joint Venture Law and the Law on Foreign-Capital Enterprises which currently apply to and regulate foreign-invested enterprises in China. After the effective date of the new foreign investment law, foreign-invested companies will be governed by Chinese Company Law and Chinese Partnership Enterprises Law – the same laws that regulate domestic Chinese businesses. The stated intent is for foreign companies, including U.S. companies, to no longer be subject to a different regulatory regime, but instead to receive the same privileges and treatment under the law as domestic Chinese companies. However, foreign companies will remain prohibited from investing in certain industries that are listed on the negative list published by State Council of China. Another limiting factor is the requirement that any foreign investment that affects or may affect national security must undergo a security review. Coupled with the law's rather open-ended requirement that foreign investors shall not harm national security or public interest, the new foreign investment law provides the Chinese government with broad powers to block or limit foreign investment activity in any sector that may be considered politically sensitive.

The new law may upend and dramatically alter current business operations for foreign companies that are already doing business in China. By requiring foreign businesses to comply with Chinese Company Law/Chinese Partnership Law, it is likely that U.S. companies will need to reexamine their existing joint venture agreements and consider the strong possibility that they will be required to renegotiate and enter into new contracts with their Chinese joint venture partners or to restructure their existing Wholly Foreign-Owned Enterprises (WFOE).

2. IP Protection

The new foreign investment law eliminates the requirement for foreign enterprises to transfer IP to Chinese joint venture partners and prohibits the Chinese government from forcing technology transfers through any administrative measures. However, the Chinese government regularly denies that such forced transfers occur. In addition, most coercion and regulation that forces the technology transfer occurs at the local level. Therefore, unless the implementation and enforcement regulations include structural changes and objective enforcement mechanisms, the new law is unlikely to result in significant improvements for foreign enterprises on the ground.

3. Retaliation

Most likely in response to more stringent reviews of Chinse investments in the United States by the Committee on Foreign Investment in the United States and stepped-up enforcement actions against Chinese companies and citizens for alleged violations of U.S. trade sanctions and other laws (i.e., Huawei and Meng Wanzhou and other Chinese nationals), the new foreign investment law also provides a mechanism for the Chinese government to take action in response to prohibitive or restrictive investment practices by a foreign country. Thus, U.S. businesses and their executives may face an increased risk of retaliatory action imposed by the Chinese government in response to what it perceives as unfair treatment at the hands of the U.S. government.

4. New Implementation and Enforcement Regulations

Because the new foreign investment law will not go into effect until January 1, 2020, Chinese government ministries and agencies will use the next nine months to develop new guidelines and rules for implementation and enforcement. Questions that remain unanswered for the moment include: (i) whether the vague protections set out in the new law will be overridden by more specific guidelines or rules that continue to disadvantage foreign enterprises and (ii) the impact a resolution of (or a failure to resolve) the continuing trade war between the U.S. and China and/or the Huawei/Meng Wanzhou saga will have on the development of the guidelines and the rules.

Key Takeaways:

  • The devil is in the details. Due to the uncertainty regarding how the new foreign investment law will be executed, it is important for U.S. businesses to keep an eye on the rollout of the rules and guidelines for the implementation and enforcement of the new law. These new regulations will highlight important requirements for U.S. businesses to comply with the new law and also should provide insight into whether the new foreign investment law will substantively improve the environment for U.S. companies operating in China or if the deck will remain stacked against them.
     
  • Is your business currently in compliance with Chinese law? It is highly recommended that U.S. companies engage a legal professional with China experience to audit their current compliance. In our experience, many China operations were not established correctly under Chinese law, and many other U.S. businesses are not operating lawfully (i.e., employing both Chinese and foreign workers improperly, not paying taxes, or not registered at all, to name a few). As the U.S./China trade war remains unresolved and the Huawei saga continues to unfold, it is likely that enforcement of current Chinese law and regulations against U.S. companies will increase. The potential of being shut down or having executives barred from doing business in China or even imprisoned likely will increase.
     
  • For those U.S. companies with existing joint ventures or wholly foreign-owned enterprises operating in China, it is recommended that they have a conversation with a legal professional with China experience to discuss what steps may be required in order to reorganize and convert your entity in China to comply with the Chinese Company Law or Chinese Partnership Enterprises Law as required by the new Chinese foreign investment law. Unfortunately, until such time as the rules and regulations are adopted, it will be difficult to discern a clear strategy to ensure compliance.

If you have any questions about China's new Foreign Investment Law and how it will affect your business, please contact John Scannapieco or Frank Xue.

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