Beware the Ides of March? China’s New Foreign Investment Law Passed on March 15, 2018

Categories: Blog, Business In China, China Business Ventures, Foreign Direct Investments | By Peter Pang

By Peter Pang*

Foreign investment is big business in China. According to China’s state news agency, Xinhua, as of October 2018, nearly a million foreign-invested companies were registered to do business in China – and these are not shell companies either. Total foreign investment in China exceeds a staggering $2 trillion, larger than the annual GDP of all but eight of the world’s nations.

US investment accounts for around ten percent of this total. So far, however, the massive scale of the economic interdependence between the US and China has not been able to alleviate the concerns that have sparked a burgeoning trade war between the world’s two largest economies. China’s new Foreign Investment Law seems to have been triggered at least in part by some of these tensions.

What Happens Next

The 2018 Draft Foreign Investment Law was released on December 26, 2018. Normally, it would have been expected to spend 2019 awaiting formal approval. In the current political climate however, the bill was rushed through, and was passed on March 15, 2019, fourteen days after the expiration of the Trump administration’s “hard deadline” for a trade deal with China. The law will take effect on January 1, 2020.

Primary Features

By general consensus, the most important features of the Foreign Investment Law include:

  • Protection of the intellectual property rights of foreign investors
  • Prohibition of forced technology transfers
  • National treatment of foreign-invested enterprises
  • Equal treatment in government procurement
  • A last-minute change imposing criminal penalties for sharing sensitive foreign company information

Please see below for a more detailed commentary on these features.

Prohibition of Forced Technology Transfer by Administrative Means

Article 22 of the Foreign Investment Law prohibits the “forced” (强制) transfer of the technology of foreign investors by administrative means. Under an optimistic interpretation of this provision, an administrative entity, with the power to approve or reject an application for foreign investment, would not be permitted to condition its approval of such an application upon the transfer of technology by the foreign investor.

The concern here is that the Chinese government itself has characterized the practices, that foreign investors refer to as “forced technology transfers,” as negotiated outcomes in which foreign investors willingly agree to transfer their technology in exchange for access to the lucrative Chinese market.

Whether Article 22 operates effectively might well depend on the PRC government’s interpretation of the word “forced.” Nevertheless, effective legal representation can help prevent administrative authorities from asserting an unrelated (in other words, concocted) justification for rejecting the application of a foreign investor who refuses to transfer technology. 

National Treatment of Foreign Investors

The Foreign Investment Law guarantees foreign investors national treatment (equal treatment with domestic enterprises) on “the principle of consistency between domestic and foreign investment” (Article 27). An exception applies to the government’s “negative list,” which restricts foreign investment in certain sectors. The reference to the negative list is not as discouraging as it might sound, since the 2018 version included 48 sectors – down from 63 sectors in 2017.

Doubts remain, however, about:

  • The exclusion of the financial sector from national treatment (due to its presence on the negative list).
  • The extent to which foreign investors and invested enterprises will be able to compete on an equal playing field with state-owned and state-influenced enterprises that represent a large slice of China’s economy, yet are exempt from some restrictions of the Anti-Monopoly Law.
  • Article 6’s vague prohibition against foreign investors and foreign-invested enterprises “endangering China’s national security or harming public interests.” China’s previous enforcement of this prohibition should be instructive here.
  • Article 20, which states that the government will not expropriate foreign investments except under “special circumstances” justified by “public interest”. The concern here, of course, is that “special circumstances” and “public interests” could turn out to be the twin exceptions that swallow the rule.

Equal Treatment in Government Procurement Processes for Products Produced in China by Foreign Investors

Articles 15 and 16 guarantee foreign investors national treatment in government procurement – at least with respect to products produced in China. Foreign investors are also guaranteed the right to participate equally in the formulation of mandatory standards. Doubts remain, however, regarding the practical ability of foreign investors to compete with state-owned enterprises with strong government connections in either of these two areas. This is especially true in light of the restrictions imposed by the Multi-Level Protection Scheme, an information security regime that often works to the competitive disadvantage of foreign investors.

The Devil’s in the Details…

Some overseas commentators are pessimistic about the Foreign Investment Law. Scott Kennedy, Director of the Project on Chinese Business and Political Economy at the Center for Strategic and International Studies, is one of them. “The draft is so full of vague statements and holes that passing the law would make absolutely no difference to the experience of foreign companies in China and actually could leave them worse off than they are today,” he asserts.

Yao Xinchao, Professor at the University of International Business and Economics in Beijing, sees things from a different perspective: “China will make concessions but won’t do everything at one go, and some issues, like the business environment, just can’t be changed in a short period of time.”

Focusing the Lens, One Step at a Time

Viewed from a historical perspective, there is nothing unusual about the ambiguities present in the Foreign Investment Law at this point in the PRC legislative process. Although it is typical for new legislation to be vaguely worded, it is always followed by implementing regulations that clear up the muddy waters – at least to some extent.

Even after implementing regulations have been released, however, certain ambiguities are bound to remain. A clear picture will emerge only after the implementing regulations have been in place long enough to generate an enforcement history that will justify drawing generalized conclusions about their effectiveness. Experienced legal counsel will know how to interpret this enforcement history in a manner that does not rely on unfounded assumptions.

The Bottom Line

Put simply, the final verdict on the probable effectiveness of the latest draft of the Foreign Investment Law is… (drum roll please) …too early to tell. That might not be the most satisfying answer, but it is almost certainly the most realistic one. Notwithstanding this unavoidable uncertainty, experienced legal representation can help investors determine the magnitude of the legal risks involved at each stage of the legislative reform process.

*Peter Pang is the Chairman and Managing Partner of IPO PANG XINGPU LAW FIRM, a premier international law firm founded in the early 1990’s and is headquartered in Shanghai, PRC. The firm’s primary practice focuses on assisting foreign companies in doing business in China and has legal expertise in Intellectual Property, Foreign Direct Investments, including equity joint ventures, employment and labor laws and mergers and acquisitions. Mr. Pang has studied both in the US and China, and is a frequently speaker and contributor to topics such as US China trade, franchising and protection of intellectual property and trade secrets. He is the author of a number of articles and chapters in books on the same topics, including transfer of technology.

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