What’s the context?
China’s new foreign investment law, which
targets the incorporation and governance of foreign investment
enterprises (FIEs), will come into effect on January 1 2020.
The law, which was passed at the 2019 National
People’s Congress, the annual meeting of
China’s legislature, is a move welcomed by foreign
The framework for foreign investment in China has been
governed by the Wholly Foreign-Owned Enterprises law, the
Sino-Foreign Equity Joint Ventures law, and the Sino-Foreign
Contractual Joint Ventures Law. These three laws do not provide
specific protection for trade secrets or forced technology
transfer. The new law aims to streamline the existing
legislation into a single law that will make China friendlier
to foreign investment.
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There are provisions that state specifically that Chinese
joint ventures (JV) are prohibited from stealing intellectual
property and commercial secrets from their foreign partners
(Article 22). In addition, there are strict prohibitions on
government officials using administrative measures to pursue
forced technology transfers and the disclosure of trade secrets
(Articles 22 and 23), and such actions may attract criminal
liability (Article 39).
What concerns do existing FIEs have?
Under the existing regime, there are three types of joint
ventures, namely, the WFOE (wholly foreign-owned enterprise),
the EJV (equity joint venture), and the CJV (cooperative joint
venture). The question of fiduciary duty has been unclear
with respect to EJVs and CJVs in particular, because although
the directors of EJVs and CJVs are subject to fiduciary duty
rules, these may be waived under contracts.
One concern is that FIEs will need to reorganise their
corporate form to reflect the new law. This won’t
be a big issue where a foreign company owns 100% of the FIE and
the shareholder of a WFOE will at most need to sign restated
articles of association. "Where a foreign investor has a JV
with a partner, the partner could make the process difficult
and painful by trying to renegotiate the JV terms," said Paul
McKenzie, managing partner, Morrison & Foerster in
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McKenzie said that if the JV was set up as a CJV, then there
may be tricky technical issues conforming the
entity’s capital structure to the more restrictive
requirements of the PRC Company Law. The details of how
all this will be implemented have not been spelled out yet.
"The fiduciary duty of directors of the equity joint
ventures matters to many foreign investors in China, and more
importantly, to the foreign directors sitting on the boards of
foreign-invested companies in China," said Yang Wang, partner
"With the new law taking effect, it is now clear that
directors of EJVs and CJVs owe a fiduciary duty to the joint
venture and they are subject to duty of loyalty when
sharing information and business opportunities with the
shareholders appointing them," said Wang. A waiver
provision in their EJV and CJV contracts, if any, may not be
valid nor enforceable anymore.
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In the context of fiduciary duty, the EJV and CJV contracts
need to be reviewed and revised. Directors may need to be
changed due to concerns over personal liability, and
discussions may be held regarding directors and
officers’ insurance. "However, this may be
difficult where the joint venture parties are already in
dispute, because one party can use this proposed change as an
opportunity to leverage and ask another party for other changes
in irrelevant provisions," said Wang.
According to Betty Louie, partner at Orrick, due to some
greater flexibility and potential ambiguity in the new law, new
terms may be introduced in the contractual re-negotiation
process. For instance, under the existing regime, Chinese
natural persons are prohibited as shareholders of a foreign
equity JV. Under the new law, the language is silent on
this aspect. Currently, foreign shareholders should customarily
contribute no less than 25% of the equity JV but the new law is
also silent on this issue.
Louie said the existing law stipulates that certain matters
require the unanimous approval of all directors present at a
board meeting but would only require an approval of two to
three of the shareholders with voting rights under the new
What legal uncertainties remain?
According to the European Chamber of Commerce in China,
Article 40 of the new law is of particular concern as it allows
for political issues to influence investor-state relations. It
gives China the power to take unilateral action against trading
and investment partners based on a principle of perceived
negative reciprocity. Rather than having this legal
uncertainty, conflicts should be handled through established
multilateral institutions such as the WTO. "More than anything
else, foreign companies want equal treatment and
opportunities," said Mats Harborn, president of the EU Chamber
of Commerce in China.
What will happen next?
The new law is very broadly-drafted, and implementing
regulations are needed. The Ministry of Finance and Commerce
(Mofcom) is developing ancillary regulations and policies.
While there is technically a five-year transition period, the
challenge in implementation will be in the details.
2019 M&A Report: China