The times they are a-changin’

How changes to China’s legal system have affected FDI

Butterfly metamorphosis_smallChina’s opening up in the late 70s necessitated an overhaul of its legal system. Significant events that have taken place since, such as the beginning of EU-China diplomatic relations and China’s accession to the World Trade Organisation (WTO), prompted further, large-scale changes. As China continues to assume a more dominant role in world affairs and becomes more integrated into the global economy, legislation is constantly being introduced and modified that impacts foreign-invested enterprises (FIEs) in different ways – for better and for worse. In the following article Dr Joachim Glatter highlights some of the areas affecting FIEs the most and outlines China’s challenges going forward.

Foreign direct investment

The very rudimentary Equity Joint Venture Law was passed in 1979, with laws permitting wholly foreign-owned enterprises (WFOEs) and contractual joint ventures following in 1986 and 1988 (the foreign investment laws). After the general Company Law was promulgated in 1993, the foreign investment laws still remained in effect and prevailed to the extent that they contained certain regulations different to those under the Company Law. To some degree FIEs are still regulated by a special set of corporate law rules, however, experiments in the China (Shanghai) Pilot Free Trade Zone (CSPFTZ) and revisions of the existing foreign investment laws—as well as the recently released draft Foreign Investment Law, which looks set to unify these three laws—indicate moves to harmonise corporate laws applicable to FIEs and domestic companies.

Initially, foreign investment was only permitted in China’s manufacturing sector. China’s accession to the WTO in 2001 represented a major breakthrough – China’s WTO commitments necessitated the passing of legislation permitting FIEs to trade, and the liberalisation of foreign investment in numerous sectors followed. Nevertheless, control of foreign investment still persists to this day and continues to cause substantial obstacles and delays to investment processes. For example, national treatment is not granted to foreign investors, as the incorporation and restructuring of FIEs still requires approval from the Ministry of Commerce (MOFCOM) or its local counterparts. It is encouraging that there has been some progress in this area: limiting approval processes to investment in certain restricted industries listed in the CSPFTZ’s Negative List—a move which has also been included in the draft Foreign Investment Law—is a major step forward. However, the positive effects of this will be nullified if more industries are added to the Negative List and other, stricter control instruments like a national security review are implemented.

Technology and IP

In many industries, technology transfer has been a precondition for granting market access to foreign companies. Related laws are still drafted in favour of the (Chinese) licensee of technology and foreign investors face pressure from Chinese authorities to make the latest know-how available as part of their investment in China, rather than letting business partners and the market determine the necessity to do so.

A major problem for foreign companies doing business in China was and continues to be the violation of their intellectual property rights (IPR). Over the last decades China has promulgated a comprehensive set of intellectual property (IP) legislation. Although this represents substantial progress, the main concern—for foreign and domestic IP owners alike—continues to be the efficient enforcement of IPR.

Other important legislative areas

A very important piece of basic legislation introduced in 1999 was the Contract Law, which regulates the basic principles of concluding, modifying, fulfilling and terminating contracts as the essential legal basis for business activities.

In 2008, the Anti-Monopoly Law (AML) was introduced and has had a huge impact on a number of business practices, which prior to the AML were largely unregulated or could be neglected by companies. For example, under the AML, mergers and acquisitions (including the establishment of joint ventures) are now increasingly subject to merger control. Also price fixing cartels, retail price maintenance agreements and the abuse of a dominant market position by a licensor (e.g. by charging unfairly high licence fees) are all practices that have come under increasing scrutiny from authorities and courts since the AML’s promulgation. The challenge now is for companies to adjust where necessary to ensure that they are fully complying with the AML.

China’s biggest challenge: rule of law

Although substantial work is still required legal developments in China over the last few decades have been impressive. The decisive test for any legal system, though, is ensuring that laws and regulations are abided by and properly enforced – this is undoubtedly China’s biggest challenge. The general attitude of ordinary people towards law appears to be slowly changing, at least in that there is an increased willingness to use legal regulations to raise claims and enforce rights with the help of the court system. Nonetheless, it will require a sustained effort by government authorities and the courts to build trust in China’s legal system. By focussing on the rule of law during the recent Fourth Plenum, the Chinese Government made it clear that it is aware of the necessity of creating a transparent and reliable legal environment and is willing to address current deficiencies. It is the hope of foreign business in China that in areas such as creating an independent judiciary and limiting government intervention substantial progress can be made.

Dr Joachim Glatter first came to China in 1986. Between 1990 and 1996 and from 2000 to 2001 he headed the Beijing and the Shanghai offices of a leading international law firm. His focus areas included the formation and restructuring of FIEs as well as arbitration. He is a nominated arbitrator of the panel of arbitrators of the China International Economic and Trade Arbitration Commission and of the Shanghai International Arbitration Centre. In 2002, he became a partner in Taylor Wessing’s Shanghai office where he remained until his retirement at the end of 2014.