State of flux: 40 years of change to China’s legal landscape

A look at some of the key factors that have shaped Chinese law over the last 40 years.

Legal landscape_smallIn the following article, Omar Puertas and Conchi Bargalló of law firm Cuatrecasas, Gonçalves Pereirareflect on 40 years of change in China’s legal landscape. They look at some of the key factors that have influenced the development of Chinese law and identify areas that need to improve if China is to create a sustainable investment environment and maintain its increasingly dominant position in the global economy.

Over the past 40 years China has been through several different stages of development, changes to its investment models—both inbound and outbound—and levels of economic growth that have determined and shaped its legal landscape. Forty years ago China’s legal system was not fully developed according to Western standards. It was not until Deng Xiaoping’s rise to power in 1978 that China began the process of opening its economy and gradually shifting from a centrally-planned economic system to a more market-orientated one. It was this economic paradigm that necessitated the updating of China’s legal system.

The legal system that China has created since is based in part on Continental Europe’s civil law system and several principles taken from Anglo-Saxon common law, a practical approach that has provided a degree of adaptability when sculpting their legal landscape. The primary source of Chinese law, however, is statutory law, developed mostly through regulation – case law is not binding in China.

China stepped up the process of updating its legal system following its accession to the World Trade Organisation (WTO) in 2001. This earned China the benefit of international recognition for abiding by its rules and offered a channel to make public and promote its concerns and demands regarding the equal treatment of developing countries. Joining the WTO also led to China making several changes to its trade regulations (in order for it to conform to the organisation’s standards), gradually opening up several economic sectors and certain industries to foreign investment, and the liberalisation of its foreign exchange market.

Being a member of the WTO, as well as working with other international institutions such as the World Bank (or more recently, the Organisation for Economic Cooperation and Development—of which China is not actually a member—to fight aggressive tax planning, base erosion and profit shifting internationally), has enabled Chinese lawmakers and the country’s business community to become more au fait with international standards of law. However, because of what the Chinese leadership consider to be special characteristics of the country and the areas they feel still need close monitoring, China has been reluctant to completely adopt those standards.

So China’s legal system is still very much a work in progress: laws and regulations have gaps and ambiguities that cannot be handled through unified interpretation as long as case law remains unbinding. The different local authorities follow diverse practical approaches and interpretations, and the continuous, rapid policy changes weaken legal certainty and have a negative impact on foreign investors’ perceptions of the commercial opportunities in the Chinese market.

The three main drivers of China’s economy and the subsequent rise in gross domestic product (GDP) that have made China’s the second largest economy in the world are exports, domestic consumption and foreign investment. Therefore, legal efforts, policies and developments have traditionally focused on regulating trade and the financial and foreign investment sectors. However, the scope has recently expanded to ensure legal institutions’ independence, professionalism and reliability, and to tackle local challenges such as environmental issues, intellectual property rights, contractual rights and consumer protection.

To reinforce its status and influence as an international player and to continue to attract foreign investment, China is working towards establishing trust, easier processes and transparency. But there are still certain issues that Chinese lawmakers must improve for the legal system to reach maturity and ensure steady development:

  • The rule of statutory law must be strengthened and legal certainty reinforced by setting out clearer law-making policies. When planning their business in China, both local and foreign investors need legal predictability, a clear legal enforceability timeframe and timely access to laws and regulations through an official publication system.
  • Regarding the application of law, and also to reinforce legal certainty and transparency, nationwide implementation of laws and regulations must be guaranteed and consultation channels enabled to grant reliable public access to judgements and relevant cases, even if they are not binding. A tax ruling system must be implemented as a way of ascertaining the tax treatment of relevant transactions (which we believe would result in cost reductions and a boost in efficiency for Chinese tax authorities in terms of resources and time).
  • Unfair discrimination against foreign investment must be avoided by granting foreign investors reciprocal treatment to that of Chinese individuals and businesses overseas (e.g. revising the application rules of double tax treaties that, in practice, imply that double tax treaty reliefs or benefits are not recognised).

China’s continuous changes in legal practices directly impact the way lawyers understand their profession and present constant challenges. Inbound investment was the focus of legal services in the past, but outbound investment has become more and more important recently, almost reaching the levels of inbound investment in the past year.

Despite being one of the countries with most foreign lawyers, there are many regulatory constraints that, in practice, imply that foreign law firms cannot compete on equal terms with local firms. Some improvements have recently been made in this area with the approval of the first joint operation between a Chinese law firm and a foreign law firm in the China (Shanghai) Pilot Free Trade Zone. However, not liberalising the legal services sector further will only serve to maintain discrimination against foreign investors who may not have a complete understanding of the Chinese legal system and the procedures they must undergo if—in addition to the services they may receive from local advisors—they are denied full assistance from law firms from their own legal systems that can channel their legal advice, and share and balance their needs in the different jurisdictions in which they are present.

Cuatrecasas, Gonçalves Pereira is a leading law firm in Spain and Portugal. Its 25 offices worldwide (including Shanghai since 2007) and over 950 lawyers offer added-value legal advice on all areas of business law. With a multidisciplinary team of Chinese, Spanish and Portuguese lawyers and first-hand understanding of China’s legal system, business world and culture, it has been supporting and accompanying Chinese companies investing in Spain, Portugal, Latin America and Africa for the last two decades, as well as European and Latin American companies on their investments in China and Asia.