Business law in China: evolutionary revolution.

Author:Duffy, Edmund C.
Position:Contemporary China: The Consequences of Change

Western investors in China are of two minds. They are at once frustrated by the lack of transparency and predictability in the Chinese legal process. Indeed they frequently see China as having no law in the Western sense, with guan xi (personal connections) taking precedence over any formal contracts and providing better (i.e. more politically sound legal protection.)(1) At the same time, Western investors often find that the Chinese laws most applicable to their projects inhibit their objectives to such an extent that they have to press their Chinese counterparts to ignore the rules, rules which stifle creativity and in themselves stall China's swift and sure rush toward a market economy. Law, in this sense, is equated with a numbing bureaucratic process, entangling sound business projects in endless review, overlapping government ministries with no evident purpose and endless opportunities for corruption and gratuities.

Like all facile observations, these insights are, at times, accurate. Certainly in the early days of foreign investment in China, and even today in smaller regional transactions, particularly those of the slash-and-burn variety, relationships did and still do carry significant weight. But as the pace and permanence of foreign investment in China quickens, and as the administrative process for creating and administering China's laws matures, the overriding importance of personal relationships as a substitute for carefully thought-out, fully negotiated contracts will significantly decline.(2)

Indeed, as is becoming clearer with each new law promulgated, there is now an extensive body of Chinese law governing foreign investment, one of increasing sophistication and transparency. The process of formulating and administering foreign investment law has been in place since the start of the new economic reform era, making it worthwhile to review its development and structure.

The list of new laws is extensive. Beijing began to develop legislation to attract foreign direct investment in 1979 with the People's Republic of China Law on Joint Ventures using Chinese and Foreign Investment, or the "Equity JV Law," which permitted Sino-foreign equity joint ventures with limited liability to be formed. Implementing regulations have been created since 1983, and various pieces of legislation have supplemented the Equity JV Law to regulate areas such as labor management, taxation, land use, foreign-exchange transactions and technology transfer by joint ventures.(3) The Law for Cooperative Enterprise, popularly referred to in China as Sino-foreign contractual joint ventures, was promulgated in 1986, with Detailed Rules for the Implementation of the Contractual JV Law being approved by the central government's State Council and promulgated by the Ministry of Foreign Trade and Economic Cooperation in August 1995. Options for foreign investment were expanded through legislation permitting wholly foreign-owned enterprises in April 1986, holding companies in April 1995 and the creation of foreign-invested share companies for which provisional regulations were issued in January 1995.(4) To address concerns about the transfer of state assets to joint ventures or other economic enterprises in which there was foreign ownership, the State Council promulgated the Administration of State Asset Valuation Procedures in 1991.(5)

In 1995 alone, we have seen the introduction of a law outlining the role of the People's Bank of China,(6) a commercial banking law,(7) a law governing the insurance industry in China(8) and a national law providing, for the first time, the legal structure for the creation of security interests in real estate and personal property.(9) Perhaps most significantly, the principal governmental organizations responsible for administering China's foreign investment laws - the State Planning Commission, the Ministry of Foreign Trade and Economic Cooperation and the State Economic and Trade Commission - promulgated Interim Provisions on Guiding Foreign Direct Investment (the "Investment Guidelines") in June 1995. These Investment Guidelines apply to all forms of foreign investment in China and, in a detailed catalogue, enumerate those sectors of foreign investment which are encouraged, restricted or prohibited. The significance of this is dramatic given the Investment Guidelines' comprehensive sweep and the insight which they provide into the administrative process in China.

The laws regarding foreign investment in China establish a multistage approval process. In creating a foreign invested enterprise with a Chinese partner, the first step is to enter into a letter of intent outlining the joint venture, in order to establish the basis for the review and approval process. The Chinese party will then be responsible for obtaining approval for the business from the industry bureau, which supervises the specific industry in which the project is involved. The industry bureau may then consult with the State Planning Commission, particularly for larger projects, to insure conformity with the appropriate annual and five-year plans. The Chinese and foreign parties will then prepare a joint feasibility study, which i s reviewed by the industry bureau and, for larger projects or those involving certain equipment, the State Planning Commission. The parties then enter into a joint venture contract or form a foreign invested enterprise, pursuant to documents approved by the Ministry of Foreign Trade and Economic Cooperation. Foreign-exchanee arrangements, as needed, must be made with the appropriate branch of the State Administration for Exchange Control. Thus a foreign-invested project receives certification of approval only if the proper "examination and approval authority" has reviewed and approved a formal application, feasibility study and organizational documents. Although the Ministry of Foreign Trade and Economic Cooperation and the State Planning Commission are permitted to delegate their examination and approval authority to relevant provincial and municipal counterparts, the delegation must not violate thresholds for specific provinces, municipalities and regions promulgated by the State Council in Beijing. In general, foreign-invested enterprises with total investment in excess of $30 million must be approved at the central government level.

Where specific aspects of a business transaction are addressed, China's legal structure seeks to require foreign parties to agree to contractrual provisions, which are clearly favorable to the Chinese side, while allowing deviations from the pro-Chinese norm only with approval of the appropriate authority. Take, for instance, the regulations promulgated by the State Council in 1985 and related implementing rules created by the Ministry of Foreign Trade and Economic Cooperation in 1988 to govern technology transfers, the "Technology Transfer Law."(10) This law requires that a licensor of technology warrants that the licensed intellectual property is suitable for the objective of the project and requires the licensor to be responsible for all infringement costs. Among other things, restrictions on the licensee's power to develop and improve the technology, on the licensee's ability to acquire similar technology from other sources and on the continued use of the technology after the contract's expiration all require special approval. Furthermore, the time limit for maintaining confidentiality generally may not exceed the duration of the contract unless the examining and approving authorities specifically permit otherwise. Such terms set forth in the Technology Transfer Law could effectively turn a licensing arrangement into a sale of technology.

There are several things which are quite clear from the record of law creation and the pattern of administration of China's laws on foreign investment. First, there is a definite policy in China that foreign investment should be strictly on Beijing's terms. Thus, certain industries, such as...

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