Being a trusted advisor: practical considerations for lawyers advising on investment from China, Japan and Korea
Christopher Hewitt, Senior Associate
Australia has a long history of welcoming international investment. Australia’s limited domestic capital, abundant resources and comparatively stable economy has attracted investors from across the world for decades. Investment into Australia from East Asia is also not a new phenomenon, although recently it has attracted significant attention mostly as a result of the growth of Chinese investment into Australia. Quite rightly that recent attention has attracted Australian lawyers – lawyers have an essential part to play in international investment, from developing investment structures to regulatory compliance to contract preparation. However, as can sometimes occur in our profession, some Australian lawyers have been thrust into the position of giving international investment advice and representation without all of the necessary background and information.
Through the years there have been two mistakes that we have commonly seen from lawyers advising on international investment into Australia, and both are a problem. The first is the lawyer that entirely ignores the international element of a transaction and simply advises on the underlying domestic transaction. For example, the lawyer may advise on, and draft, a petroleum joint venture agreement for an international client without turning their mind to the international character of their client. This approach is easy to justify – “the international issues are not within my speciality or experience”. However, failing to turn your mind to the international character of your client may expose them to significant legal and commercial risk.
The second is the lawyer that wishes to be all things to all men, and so takes it upon themselves to learn – often via Google or Yahoo or WorldLII – the relevant laws of their client’s home jurisdiction. Based on that research, the lawyer will then advise the client on everything from regulatory compliance and investment structures all the way through to contract interpretation in the client’s home jurisdiction. The risks of this approach are obvious – especially if the client’s home jurisdiction is not English speaking or does not share Australia’s legal structure and traditions. The client will often joyfully seize the opportunity to instruct and pay only one lawyer; although that may not be in their best interests.
For lawyers that do not specialise in international investment, the best approach is often a middle- ground of understanding the concepts of international investment, being aware of the trigger points and then seeking advice, assistance or partnership from an specialist or lawyer in another jurisdiction.
This paper will seek to provide some background to international investment in Australia and provide non-specialist lawyers with some tips and trigger points. This paper will examine legal issues relating to investment from the perspective of both the international investor and the domestic investee. An Australian company that is receiving international investment or selling to an international purchaser often requires legal advice that is grounded in an understanding of international investment, or the laws of another jurisdiction. The discussion in this paper will take place against the backdrop of investment into Australia from three of the world’s most dynamic economies: Japan, the Republic of Korea (referred to in this paper as “Korea”) and the People’s Republic of China (referred to in this paper as “China”).
B The state of investment from Japan, Korea and China
The financial relationship and trends between Australia and Japan, Korea and China should be considered prior to going on to examine investment laws, regulations and policies.
In 2012, Japan accounted for 11.1%2 of Australia’s total inward foreign direct investment and 4% of Australia’s gross domestic product.3 Australia is currently Japan’s fourth most popular international destination for investment. Japan’s direct investment into Australia in 2012 was AUD61.2 billion, which towers over Australia’s direct investment into Japan at AUD220 million. Australia is Japan’s second biggest provider of goods and second biggest buyer of Japanese vehicles.4 Japan is the third largest foreign direct investor into Australia and is Australia’s second biggest trading partner.
Korea has not traditionally been a high value investor into Australia, although that has changed in recent years. In 2012, Korea’s direct investment into Australia was AUD12.8 billion, which accounted for approximately half of Korea’s total foreign direct investment.5 Korea is Australia’s fourth-largest overall trading partner and total two-way trade was worth approximately AUD30.5 billion in 2012 to 2013, which is equal to about 5% of all of Australia’s international trade.6
Chinese investment into Australia continues to increase. China is the ninth largest foreign direct investor into Australia7 and is Australia’s biggest trading partner.8 In 2012, China’s investment in Australia totalled approximately AUD22.9 billion and AUD16.7 billion of this was foreign direct investment.9 China has been ranked in the top three sources of proposed investment, behind the US and UK, for the past three consecutive years. China is Australia’s largest two-way trading partner in goods and services, valued at an amazing AUD125.1 billion in 2012.10
C Investment regulations: domestic and international
Domestic: Australia investment regulations11
There is significant commentary available on the requirements and future of the Australian Foreign Investment Review Board (“FIRB”) and the Foreign Acquisitions and Takeovers Act 1975 (Cth) (“FATA”). This paper will not revisit those requirements, process and procedures, except to say that it is imperative that Australian lawyers representing an international investor or an Australian investee be aware of the requirements and practical ramifications. Applying for and receiving approval from FIRB will effect timeframes for negotiation and execution of contracts, conditions precedent and settlement of a transaction. Not applying for FIRB approval can also have fairly salutary effects!
As outlined by other commentators at length, FIRB may approve or reject an application under FATA outright, or may approve an application with conditions. Australian lawyers should consider FIRB’s powers, policies and processes when negotiating and drafting any contract that forms part of an international investment. For example, it is usually advisable for a sale and purchase agreement to contain a condition precedent to settlement that approval from FIRB be obtained on conditions suitable to the international investor. If you are representing the domestic investee (seller) you will presumably seek certainty around what constitutes a “suitable” condition from FIRB. Conversely, if representing the international investor (purchaser) you may seek to preserve discretion for your client.
A few tips that we can provide is first to make it clear to the investor what’s about to happen. Too often the level of disclosure required, and the need for a full and frank explanation of the investment and the investing entity, are a surprise for an investor. Secondly, it is important to be mindful of the diverse and sometimes complicated ownership structures in many Japanese, Korean and Chinese corporations, to the extent that a corporation that initially appears to be 100% privately owned may turn out to have an ownership structure that comes within the foreign government requirements of FATA.12
International investment regulations from the investor’s home jurisdiction
Australia’s inward investment regulations are only half the story as many countries have varying levels of restrictions on outbound investments. Investments from certain countries into Australia will be subject to notification and approval from investment regulators in the investor’s home jurisdiction. Australian lawyers should be aware of the existence of these international investment notification and approval requirements in order to provide for them in certain contracts. For example, sale and purchase contracts involving an investor from China will often require a settlement condition allowing for Chinese Government approval of the investment.
Historically, there have been significant restrictions imposed on outward investment by Japanese and Korean investors. Those restrictions have been progressively reduced and eliminated by the Japanese and Korean Governments, in order to liberalise, deregulate, stimulate and encourage outbound investments. China still retains a significant outbound investment approvals mechanism that will affect many investments into Australia by Chinese investors. We will now examine the current state of outbound investment regulations in each country.
Despite significant liberalisation, outbound direct investment approval may still be required for Japanese investors under the Foreign Exchange and Foreign Trade Act (“the FE Act“).13 Notification to, and approval from, the Minister of Finance (“the Minister”) must be obtained in some limited circumstances, and the Minister has the power to require modifications to, or even the discontinuance of, an outbound direct investment.
The circumstances where notification and approval are required are limited and the FE Act is relatively non-interventionist. The stated purpose of the FE Act is to enable:
“…proper expansion of foreign transactions and the maintenance of peace and security in Japan and in the international community through the minimum necessary control or coordination of foreign transactions”.14
In keeping with those liberal sentiments, Japanese natural persons and corporations are only required to notify the Minister in advance of the intended international investment if the investment is likely to result in:
- significant adverse effects being brought to the smooth management of the Japanese economy; or
- international peace and security being impaired, or the maintenance of public order being disturbed.15While the circumstances giving rise to a notification obligation under the FE Act may be limited, if triggered the notification process can potentially result in delays and disruption to an international investment. Once a notification is received the Minister may recommend changing the content, or even discontinuing the outbound direct investment altogether. An outbound investment pertaining to a notification must not occur until 20 days after receiving the Minister’s recommendation. An investor may refuse to accept the recommendation, in which case the Minister does retain the power – although seldom used – to block an outbound investment. In certain circumstances when representing a Japanese investor it may be prudent to provide for outward investment notification in contract documents. Our experience with legal matters involving government officials in Japan is that there is an incredible amount of diffidence and adherence towards them and their decisions. An investor may refuse to accept the recommendation of the Minister, and the Minister does retain the power to block an outbound investment – but it very rarely needs to be used.Korea The Korean Government has transformed from a regulator to a facilitator of outbound investment. The Government has lifted many of the previously required approvals and notification obligations to encourage internationalisation. After becoming a member of the Organisation for Economic Co-operation and Development in 1997, the Korean Government made substantial efforts to deregulate, liberalise, and integrate with the global economy, including transferring authority, responsibility and discretion for international investment to the private sector. Since that time, the Korean Government has encouraged Korean businesses to invest abroad through simplifying the foreign investment process.16
Compared to Japan and Korea, China has an onerous outbound investment approvals regime potentially involving various government ministries and multiple levels of approval. The Chinese outbound investment approvals regime has been subject to significant changes in recent years, including dramatic changes in 2013. Prior to 13 December 2013, all international outbound investments required prior approval from the National Development and Reform Commission (“the NDRC”), the Ministry of Commerce (“MOFCOM”) and the State Administration of Foreign Exchange (“SAFE”).17 This approval was (and potentially still is) required at either local, provincial or national levels, depending on the value of the investment. Investments by State Owned Enterprises also potentially require approval by the State Owned Assets Supervision and Administration Commission. For many years Chinese investors have complained that China’s outbound investment regulations have limited their competitiveness in the global marketplace. Because of these constraints, sellers in other countries, such as in Australia, have dismissed Chinese bidders, required protective measures for sellers or added the so-called China premium.
In December 2013 the State Council of China promulgated the Catalogue of Investment Projects Subject to Governmental Verifications 2013 (“the 2013 Catalogue”).18 The 2013 Catalogue is seen as a significant, albeit inconclusive, step towards deregulating outbound investment and empowering Chinese enterprises. Under the 2013 Catalogue prior approval by the NDRC (or equivalent) will only be required for “special projects”, being investments in “sensitive countries and regions”, in “sensitive industries” or for investment of over USD1 billion.19 Other investments should only be subject to post transaction filing with the State Council. The terms “special projects” and “sensitive countries and regions” are not defined in the 2013 Catalogue, although certain NDRC implementing rules indicate that:
- “Special projects” will include media, energy, land development, telecommunications and the exploration and exploitation of water resources.
- “Sensitive countries or regions” will include countries:
- without diplomatic relations with China;
- subject to international sanctions; or
- at war or subject to political unrest.
However, doubt remains about the operation of the new investment regulation regime. The 2013 Catalogue is not clear on the approval and notification requirements for all investments, and does not provide absolute clarity on the how the approval regimes of MOFCOM and SAFE will be affected. We anticipate that MOFCOM and SAFE will issue measures to clarify the rules and requirements for outbound investments, which should provide even greater liberalisation for Chinese investors into Australia. Notwithstanding these encouraging developments, lawyers should continue to act as though investment approval from the Chinese Government may apply to an investment into Australia, in at least some form.
As a lawyer advising Chinese investors you need to be aware of the existence of approval requirements that may affect, delay or even prevent an investment transaction. Australian lawyers involved in Chinese investment transactions should, at a minimum, ensure that all transaction documents make provision for Chinese Government notification and approval processes. It would not be prudent or appropriate for a non-specialist Australian lawyer to attempt to determine what approvals are required under the 2013 Catalogue and NDRC implementation notices. Investment specialists and Chinese lawyers will be able to provide advice on the specific requirements. If you are representing an Australian investee or seller you should be mindful that Chinese notification and approval processes do still exist and may affect negotiations and settlement. Seller protection measures, including deposits, should be considered – although as a practical issue those deposits may potentially be subject to SAFE approval themselves.
Queensland specific investment regulation
For international investments into Queensland, a further regulatory consideration is registration with the Queensland Foreign Land Registry (“the Registry”). Queensland is the only state in Australia that maintains a register to monitor foreign ownership of land, under the Foreign Ownership of Land Register Act 1988 (Qld) (“the Foreign Ownership Register Act”).21 The Foreign Ownership Register Act requires notification if a foreign person acquires an interest in land.
A “foreign person” includes:
- a foreign natural person;
- a foreign corporation; or
- a corporation in which a foreign natural person or a foreign corporation holds a controllinginterest or in which two or more foreign natural persons or foreign corporations hold an aggregate controlling interest.
The notification requirements under the Foreign Ownership Register Act are not extensive – a one page Foreign Ownership Information form filed at the same time that a transfer of land is registered with the Queensland Land Registry. The information required includes the property details, details of the foreign purchaser, country of origin of the purchaser, intended use of the land and any development plans. The Registry is publicly searchable, including obtaining particulars of the information recorded on the Registry.24 Penalties are imposed for non-compliance and if a foreign person is convicted of an offence in respect of land, the land may be forfeited to the State of Queensland.
The new Commonwealth Government has proposed introducing a national register of foreign ownership in all land, similar to the Registry. The Coalition’s Discussion Paper on Foreign Investment in Australia states:
“There is no database capable of tracking acquisitions of land across Australia to inform public debate or policy. To rectify this unsatisfactory situation, the Coalition will establish such a database or databases, as an up to date public register.”
Additionally, the Commonwealth Government has proposed that the Australian Securities and Investment Commission establish and maintain a national register of foreign ownership in businesses valued above a certain threshold of, say, AUD15 million.27 The national register has been proposed as a post-acquisition recording system to operate independently of the FIRB investment approval process.
D Contractual provisions – confidentiality and disclosure
As with most commercial transactions, confidentiality and disclosure obligations are often critical to an international investment. It is possible that your client will either require, or be required to agree to, a confidentiality and non-disclosure agreement during negotiations. Most transactional documents will include a confidentiality provision of some nature protecting the ongoing confidentiality of the parties. If representing an international investor, prior to advising on confidentiality agreements or provisions it is worth considering whether your client may be bound by continuous disclosure regulations from your client’s home jurisdiction or a third jurisdiction. The ownership structure of an international investor may be such that it has continuous disclosure obligations that you may not be aware of – it is important to conduct further enquiries with your client before advising on confidentiality and disclosure provisions.
While continuous disclosure obligations are common to the Australian Stock Exchange, Tokyo Stock Exchange, Shanghai Stock Exchange and Korea Exchange, the specific requirements of continuous disclosure may differ between jurisdictions. In respect of the Shanghai Stock Exchange, for example, the occurrence of a major event that may have considerable effect on the share trading price of a listed company requires an immediate provisional report to the China Securities Regulatory Commission. 28 Under the Law of the People’s Republic of China on Securities, the report must include an explanation of the causes, status and possible legal effects of the event.29 The assessment of whether a continuous disclosure obligation has arisen will depend on the Chinese securities law, administrative regulations released by the China Securities Regulatory Commission30 and even judicial interpretations from the Supreme People’s Court. It is obviously not within the expertise of most Australian lawyers to advise clients on continuous disclosure on the Shanghai Stock Exchange. However, you may be able to sculpt confidentiality and disclosure provisions that preserve the necessary flexibility for your international client to comply with its disclosure obligations, wherever they may arise.
E Contractual provisions – dispute resolution
When representing an Australian party entering into an agreement with a foreign entity or individual you need to give consideration to a dispute resolution strategy, especially in the context that the foreign investor may have limited assets in Australia. It may be in your client’s interest to be in a position to take legal action that can be enforced against the assets of a foreign entity or individual in their home country.
Japan and Australia have a reciprocal relationship for the enforcement of superior and inferior court judgements.31 This allows for an Australian court judgement to be enforced directly against a Japanese entity or individual through the Japanese District Court without the substantive dispute being re- examined. All that is required is that the Australian court judgement meet the following conditions:
- the jurisdiction of the foreign court is sustainable under international civil jurisdiction rules of Japanese law, ordinance or a treaty;
- the defeated defendant has been properly served with a summons, or has appeared and presented the merits of the case;
- the contents of the judgment, and the procedure in which the judgment is rendered, are not contrary to the “public order” or “good morals” of Japan; and
- there is a reciprocal “guarantee”.32
Usefully, the Japanese District Court has established that foreign judgements from the Supreme Court of Queensland relating to business activities will satisfy the reciprocity requirements of the Code of Civil Procedure.33 The jurisdictional requirement under (a) above may generally be satisfied with properly constructed choice of court and choice of law provisions that establish the jurisdiction of the courts and laws of the State of Queensland.Accordingly, an agreement prepared on behalf of an Australian company with a Japanese individual or entity can generally rely on court based dispute resolution remedies. Similarly, the courts of Korea provide for direct enforcement of Australian court judgements, subject to equivalent procedural requirements.34
China does not have a reciprocal relationship with Australia for the enforcement of foreign court judgements. Courts in China do not generally accept the jurisdiction of Australian courts over Chinese nationals, companies or assets, and will not directly enforce an Australian court judgement.35 Therefore, even if an Australian business does obtain a judgement against a Chinese company in, say, the Supreme Court of Queensland, the judgement will most likely be unenforceable in China. The Australian company will be forced to restart the court proceedings in China, or worse still be barred from taking any action at all in China if the choice of court clause provides exclusive jurisdiction to an Australian court.
Thankfully, in 1987 China became a signatory to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958 (known as the “New York Convention”). Under the New York Convention a properly constituted arbitral award (not a court judgement) from another convention country, including Australia, may be enforced by a Chinese court. The process for enforcing a foreign arbitral award takes about six months, and must be commenced within two years of the date of the underlying award. A more efficient process for enforcement within China can be a “foreign-related’ arbitral award from a select Chinese arbitration body, which may be enforced in the same manner as a domestic award.36 The strategic down side of this option is that the arbitration must take place within China.
In practice, the dispute resolution clause in a contract involving a Chinese party investing in Australia should:
- provide that all disputes be resolved through arbitration;
- stipulate the jurisdiction where the arbitration will take place;
- identify the language of the arbitration;37 and
- identify the rules that will govern the arbitration and the arbitral body.
In the absence of agreement to an arbitral procedure, we have recommended to clients – much to their initial shock and concern – that the jurisdiction of Chinese courts over an agreement should be accepted and expressly recognised. Western companies are finding that the rule of law does exist in China, and that they can get a fair hearing and a judgement under the laws of China which is ultimately more effective than an Australian one.
F Free trade agreements
Current developments in free trade agreements
Free trade agreements may be relevant to investments into Australia in a number of direct and in-direct ways. Australia is a party to a growing number of free trade agreements, and is in negotiation for a number of new free trade agreements that could be strategically important to Australian businesses. Korea and Australia reached agreement regarding a new Korea-Australia Free Trade Agreement (known as “KAFTA”) in December 2013. Australia is currently in the process of negotiating free trade agreements with both Japan and China. The new Australian Government is making all the right noises about finalising negotiations and signing agreements with both countries. As an interested party we remain hopeful, but not expectant, about the finalisation of the Japan and China free trade agreements. When it comes to negotiating free trade agreements nothing happens quickly.
Typically, there are three key elements of a free trade agreement that may potentially effect investment into Australia:
- trade costs;
- national treatment and most favoured nation; and
- investor state dispute mechanisms.
Using the soon to be signed KAFTA, we will briefly examine these investment issues in free trade agreements. We note that another investment issue related to free trade agreements is the setting of special thresholds for FIRB notification and approval, which we have not examined in this paper.
Free trade agreements: trade costs
Many investments into Australia from Korea, China and Japan are made for the predominant purpose of achieving security of supply for a commercial operation in the home jurisdiction. For example, there has been recent growth in agribusiness investments in Australia from China designed to secure supplies for Chinese businesses. A classic example is investment in Australian red meat resources for the purposes of securing supply for Chinese hot-pot restaurants. In this context the trade and investment nexus is critical as Australia’s tariff levels, export controls, export licensing and other trade measures will directly impact the profitability of the investment. Securing supply from Australia may appear less attractive to a Korean investor if trade expenses and barriers significantly expand the cost of that supply. A key cost of trade is tariffs, and typically the cornerstone to each free trade agreement is the reduction and elimination of certain tariffs on key goods and services. For example, under KAFTA Korea has agreed to eliminate its 40% tariff on Australia beef in equal annual stages. The inequalities in treatment of countries inside the FTA to those outside can cause huge shifts in investment and competition, with the preferences enjoyed by one international car maker under the Thailand-Australia Free Trade Agreement being touted as one of the factors that has led to the demise of the Australian vehicle manufacturing industry.
Free trade agreements: the investment chapter
Most free trade agreements include an investment chapter that describes the treatment that each nation will give to direct investments from the other country. For example, Chapter 11 of KAFTA includes provisions to facilitate more direct investment into Australia from Korea, and vice versa. Thus, KAFTA will provide enhanced protections and certainty for Korean investors in Australia with provisions to ensure non-discrimination, protection and security for investments.38
KAFTA requires Australia to treat investors from Korea in the same manner that it treats Australian investors in like circumstances – this is known as national treatment.39 National treatment is designed to ensure competitive equality in the market for national and foreign investors. KAFTA also requires Australia to treat investors from Korea in the same way as it does investors from any third country – this is known as most favoured nation.40 Most favoured nation is designed to ensure competitive equality between all international investors. National treatment and most favoured nation are relevant to a range of issues relating to international investors and businesses, including treatment by Commonwealth, State and Territory government agencies.
Free trade agreements: investor state dispute mechanisms
Arguably the most important provisions in the investment chapter of a free trade agreement are those which – if included – protect the investor against government actions. These are very controversial. An investor state dispute mechanism is a system whereby international investors may directly initiate dispute settlement proceedings against a foreign government in certain circumstances. Free trade agreements, such as KAFTA, often include substantive protections for investors that are guaranteed by the host country. For example, KAFTA includes a commitment by Australia and Korea that they will not expropriate or nationalise a covered investment either directly or indirectly except:
- for a public purpose;
- in a non-discriminatory manner;
- on prompt payment of adequate compensation; and
- in accordance of due process under international law.41
There are a significant number of moderating exceptions under KAFTA, dealing with public health, safety and the environment (including legitimate resource retention).
If a dispute arises between the investor and Australia, the investor state dispute mechanism in KAFTA allows the investor to initiate international arbitration directly with Australia.42 This would generally be seen as more advantageous for an international investor than initiating proceedings against the Australian Government in an Australian court. KAFTA sets out the detailed process for an arbitration, including enforcement of an arbitral award under the New York Convention.43
Investment law is not a discrete area of law and does not stand alone. International investment transactions are a team effort that involve lawyers and advisors with different skills, knowledge and experience. Lawyers that are new to international investment or are representing non-Australian clients should be mindful of the various investment-specific obligations and rights of their clients. In this paper we have provided a brief summary of some of those rights and obligations, though this is by no means comprehensive and Australian lawyers should always be open to seeking specialist assistance.44