To go global, enterprises must be wise about legal risks

Foreign investment needs to conform to local laws on environment, taxation
By By HU XIAOXIA / 10-26-2016 / (Chinese Social Sciences Today)

Local employees work with a Chinese drilling crew member in Saudi Arabia. Some nations have legislated that foreign-invested enterprises must hire a certain proportion of local workers.


Overseas investment is a vital approach to realizing connectivity among all countries along the routes of the “Belt and Road” initiative. In addition to economic, political and cultural differences, China is distinct from the more than 60 other countries along the routes in terms of its legal traditions.

This creates legal risks for Chinese enterprises as they look to invest overseas. To maximally safeguard their local rights and interests, enterprises should fully recognize these legal risks while formulating rational strategies and making prompt responses.


Limited market access
The interests of China and other countries along the routes are not totally the same. Therefore, enterprises from China first face the risk of market access limitations when investing overseas.

For instance, some nations restrict investment in important industries, such as petrochemical engineering, national defense and infrastructure construction. Some prevent foreign entities from holding a majority share in a joint venture or require the government of the host country and its appointed organizations to participate in its operation. Others put forward strict restrictions and requirements on the scope and proportion of investment.

In the United Arab Emirates, the existing law stipulates that native capital shall not be less than 51 percent for enterprises established outside free-trade areas, but exceptions can be made contingent on approval from the cabinet after it negotiates with related ministers and departments. Even though there is no such provision in some other countries, the government often has veto power over major decisions of a joint venture.

In addition, some countries have raised specific requirements for cross-border mergers and acquisitions (M&A). Some have introduced non-transparent examination procedures, complicating cross-border mergers and acquisitions. Furthermore, Chinese enterprises may encounter anti-takeover obstruction from target enterprises as well as various challenges to the legitimacy of the M&A process.

Target enterprises may conceal guarantee problems and legal disputes they are involved in, which may ensnare Chinese enterprises in lawsuits after a merger.

To protect their own economy, countries and regions along the “Belt and Road” tend to lay down strict protectionist laws, setting up trade and investment barriers. Nations like Kazakhstan, Turkmenistan, Uzbekistan, Afghanistan, Azerbaijan, Bahrain, Iran, Iraq, Lebanon and Syria are not WTO members and therefore not bound by WTO legal systems. As a result, many laws, regulations and policies of these countries do not conform to WTO requirements, adding new legal barriers.

Kazakhstan bankruptcy law, revised in 2005, empowers the Ministry of Energy and Mineral Resource to refuse to grant permits when enterprises apply to transfer mineral exploitation rights or sell shares. At the same time, Kazakhstan has introduced special inspection procedures for specific products as part of technical regulations.

In international trade, China differs from its trade partners in the “Belt and Road” initiative in terms of commodity standards. The European Union has particularly strict standards for foodstuffs, while Central Asian countries adhere to a rigorous licensing system for trade in services. When exported to other countries, commodities consistent with Chinese standards may not meet local standards.


Local provisions
Also, Chinese enterprises should be aware of local legal provisions on labor employment. The proportion of local employees is explicitly stated in the labor law of some nations.

For instance, to raise its employment, the government of Saudi Arabia introduced a rating system in 2011 that calls on all enterprises to hire a certain percentage of local workers in proportion to different industries and operational scales. Enterprises that have achieved their goals will be given a series of incentives, while those that have failed will not have access to incentives and even face a series of punishments instead.

It should be noted that enterprises cannot ignore ethnic and gender issues when recruiting workers in the host country. Otherwise, they may imprudently violate laws on equality and discrimination, which could result in fines, lawsuits and other risks. When cutting jobs or making adjustments in acquired enterprises, Chinese enterprises should pay special attention to local provisions on reduction of employees and compensation. In addition, they should uphold the rights of labor unions in the host country to avoid running afoul of local labor laws.


Environmental protection
Moreover, overseas investment projects proposed in the “Belt and Road” initiative should also pay attention to environmental regulations. All countries around the world are setting up increasingly strict standards and laws for environmental protection. Some of these are so harsh that Chinese enterprises are struggling to adapt. Some nations have unveiled special protective legislation that restrains or prohibits foreign investors from undertaking projects that will wreak havoc on resources and the environment.

Chinese enterprises should abide by local laws and regulations on environmental protection even if it entails increased cost. Otherwise, they will face lawsuits or even be compelled to close down.

In response to political pressure over environmental issues, Sri Lanka in 2014 suspended China’s largest investment in the nation, the Colombo Port City Project, jeopardizing US$1.5 billion in financing. Chinese enterprises should learn from this experience and strive to conform to local standards—regardless of the cost—in order to avoid legal risks caused by destroying the ecological environment.


Corruption prohibited
Most Chinese enterprises that have invested overseas have established a system to manage legal affairs. However, some enterprises still have weak awareness of law and may encounter legal risks due to ignorance of local laws and regulations. An enterprise with no understanding of related laws and regulations in the host country may easily violate them in its daily operation and management.

At the same time, enterprises should be vigilant against corruption. European and other countries have introduced strict rules to combat corporate corruption. If an enterprise is found guilty of bribery, corruption or other misconduct, it will ruin its established brand and also face a severe lawsuit and sanctions.


Repeated taxation
In addition, taxation laws and policies vary between countries. Different sovereign states levy taxes on the same entity according to their laws. In overseas investment and operation, Chinese enterprises should report and pay tax to the Chinese government as well as the government of the host country. They should fully understand and abide by local laws on taxation to avoid legal issues in this regard.

Nonetheless, legislation in some countries along the “Belt and Road” still needs to be improved. There may be no laws governing Chinese enterprises investing overseas. In this context, once conflicts occur, the host country may choose to protect its own interests while subjecting Chinese enterprises to legal limitations.

Furthermore, the law on corporate operation of the host country may contradict international law or the Chinese law, forcing domestic enterprises into a dilemma in which abiding by one law means violating another.


Hu Xiaoxia is from the School of Law at Southwest University of Political Science and Law in Chongqing Municipality.