NOTES ON CROSS-BORDER INVESTMENT IN THE UK
Issue date：30 Oct 2017 Author：Partner Christina He,Legal Intern Kenrick Wong
The recent UK referendum decision to leave the EU has created fierce debate on the overall investment environment in the UK, especially over whether there will be a ‘Hard’ Brexit or a ‘Soft’ one. Despite the uncertainty over the UK’s future within the map of the EU, according to the UK government Chinese investment in the UK has not drastically decreased. The Chinese ambassador stated that China wants to do more business post-Brexit, which provides a basis for the argument that by leaving the EU with growing economic interdependence, the UK and China will be able to negotiate better trade agreements. Looking back to March 2015, it came as a prelude that the UK was the first Western nation to join the Asian Infrastructure Investment Bank (AIIB), despite strong opposition from the US, the UK’s traditional ally.
The United Kingdom is China’s top investment destination for Europe. China has invested £29 billion in the UK since 2005, with high interest in the property market. Chinese investment in business and infrastructure has risen by 500% since 2010. Indeed, the Financial Times reports that by 2025 China is set to invest £105 billion in the UK.
China’s rapid economic growth in the past three decades stems from its manufacturing and export industry. China is now actively looking for ways to innovate its own industries to satisfy a growing demand for better quality and highly innovative products and services. In contrast, the UK, as a historical nation of innovation, is a service-based economy with quality research base, and is well known for its strong rule of law and financial and legal services. The UK is globally ranked 6th on the Ease of Doing Business Index, and 1st within the EU. As such, one may note that the UK and China can actually complement each other’s economy.
Matters to Note
The UK has Chinese inward investors through a mix of direct investment, mergers and acquisitions, R&D partnering and joint venture business models. Investing can be a highly demanding and challenging business, even more so when one invests in a foreign country where he is less sophisticated about the laws of the land and local regulations. In the coming sections we have noted several important points of interest to Chinese investors that are likely to impact them and the success of their investment in the UK.
A. Understanding UK Law
It may be confusing to the Chinese investors when several concepts under the section of “the Governing Law” in the transaction documents are adopted at the same time: “the UK law”, “English law”, “the law of England”. The UK is comprised of 4 countries, England, Wales, Scotland, and Northern Ireland. The UK has a common law system, which means that other than legislation by Parliament, the UK also uses case law and general legal principles. The UK also implements EU law as well as human rights law under the European Convention of Human Rights.
Scotland and Northern Ireland have devolved parliaments and legislative powers in certain areas, so their relevant laws are different to those of England and Wales. England and Wales share the same laws, which are commonly referred to as English law. As such, it can be said that while there are major overlaps between the English, Scottish, and Northern Irish laws, there are some discrepancies between them. Within the overarching UK legal system there are three separate legal systems, of which English law is the most prominent. Investment flowing from China to the UK is subject to the laws of both countries. Thus the laws of both nations will regulate the transaction notwithstanding any overlaps between them, and depending on whether investment is made to a particular constituent country, there may be different laws and rules to abide by.
B. Investment Viability Checks
Foreign investment into the UK is subject to checks by the UK government agencies since protecting national security and maintaining an open investment regime are twin imperatives for the UK. Currently, the Secretary of State has the power to intervene in any mergers on certain public interest grounds, including national security.The intensity of the checks, however, depends on the sector or industry that the investment is going into. Generally, private company transactions in non-regulated industries do not require government approval, except for reviews by competition authorities. In regulated industries, such as transport, utilities, and weapon manufacturing, the checks are stringent. Investors will need to apply to the regulator for approval and the depth of information to be provided may exceed the expectations of the investors in many regards.
In the context of the Hinkley Point C nuclear station, which was forecast to contribute 13 percent of UK electricity by the early 2020s, the UK government has become increasingly concerned about foreign ownership of critical infrastructure and the national security implications of foreign control. China General Nuclear has 33% of the shares in Hinkley Point C. The project was originally granted approval by the UK in January 2008 when Gordon Brown was the Prime Minister. However the project was stalled repeatedly and even sparked an investigation from the EU level due to the fear of potential security risks caused by China’s involvement. Only until September 2016 has the UK government made its decision over the viability of the project; the project has been allowed to go ahead, after stringent checks on the parties involved amid concerns over national security. EDF, the French company with the remaining two-thirds of shares in the project had to compromise that the UK would be able to prevent them from selling their shares. The UK government has recently announced plans to introduce new foreign ownership rules that will include a national security requirement for the continuing government approval of the ownership and controls of critical infrastructure.
C. Due Diligence
Due diligence is an issue of priority for most Chinese investors. Chinese investors must pay greater attention when performing due diligence in the UK. It is not enough to abide by regulations and treaties during business operations by the Chinese themselves. They should make sure that their business partners in the UK and elsewhere are abiding by their respective domestic legislation and regulations. In this regards the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises shall be one of the key legislations that Chinese investors can’t afford to ignore. A breach by either side can lead to negative publicity and devastating blows to the reputation of Chinese investors, in addition to substantial economic losses.
In 2007 the Zijin Mining Group purchased the UK-owned Monterrico Metals for nearly £100 million and took over their Rio Blanco mining project in Peru. There were no competitors bidding over the project, and Zijin quickly obtained mining rights in the area. The problem was that Zijin had failed to perform a thorough due diligence, and therefore failed to find out before the purchase that there were many problems with the mining project. The local situation was dire; the local community believed that if the project went ahead, there would be severe environmental consequences, such as landscape damage, soil contamination, loss of vegetation, pollution, and so forth. The locals held demonstrations, refused to work, and even set fire to buildings owned by the mine. Zijin also incurred high costs on legal counsel to defend UK civil proceedings brought by those tortured at the mine. The case and lesson learned well illustrates how crucial it is to perform detailed due diligence in a UK-related investment.
D. Employment Issues
UK employment law has a strong focus on the protection of employees. During the course of employment, employers must not discriminate against employees based on race, religion, gender, sexual orientation, disability, and age. EU anti-discrimination directives to the UK also make discrimination unlawful, and there may be severe financial penalties to employers. Further examples of employees’ rights in law include a restriction on working hours, paid leave, minimum time of notice of redundancy, and the national minimum wage. Any imported labour will share the benefits of the rights accorded to employees under the law of the UK.
In the UK the procedure to make workers redundant is more flexible than other neighbouring countries, but it is important to know so as to avoid possible claims against employers. If the notice of redundancy is not communicated beforehand, the employer will be liable for breach of contract, and any restrictive covenants in the employment contract against the employee will be ineffective.
E. Tax Issues
The UK has low barriers to investment, with some of the lowest major tax rates within the G7 and G20, including the corporation tax rate for company profits, which is at just 20%, with an expectation to be lowered to 17% within 5 years since 2016. The UK does not generally impose withholding tax on dividends, nor does it impose tax on capital gains for non-UK residents. Moreover, there are interest deductions on loans financing foreign equity investments. This makes the UK a competitive destination for investment compared to other countries within the EU.
The new double tax agreement (New DTA) between China and the UK entered into force on December 13th, 2013. The New DTA provides further benefits for the Chinese investors with respect to lower levels of dividend and royalty withholding tax, and the exclusion of certain capital gains on minority shareholdings from capital gains tax. The New DTA applies to: (i) income tax in China, arising in any tax year beginning on or after January1st, 2014; and (ii) income tax and capital gains tax in the UK, for any year of assessment beginning on or after April 6th, 2014, and corporation tax in the UK, for any financial year beginning on or after April 1st, 2014.
F. Dispute Resolution through Arbitration in the UK
The UK is a contracting member of several arbitral conventions. These conventions mean that UK courts enforce arbitral awards even if they are decided in tribunals outside the UK. The UK’s common law also, in principle, intends that the UK enforce a valid arbitral award made in most countries. When Chinese firms contract with UK firms, a detailed arbitration clause is strongly recommended to be included to reduce future complexities if the partnership falls apart. To balance the interest of forum shopping, the contracting parties may consider choosing a prestigious arbitration organization located in a neutral jurisdiction, if the London Court of International Arbitration (LCIA)is not a favourable choice.
The points of concern noted above are not exhaustive, but do give an idea about some of the main legal matters a Chinese investor will want to know about. In short, Chinese investors will want to be sure of the various legal jurisdictional differences of the UK, the various checks and inspections the investment will be subject to, the need to do proper due diligence, local labour laws, tax issues, and the arbitration centers to go to should any disputes arise. In particularly, we would stress the importance of due diligence, as this is one of the first steps in determining whether an investment or strategic move should go ahead, and is arguably one of the factors that may have a large impact on the success of the investment. In any case, however, investors should seek legal advice from a solicitor to be completely sure about the legal soundness of their investment and any future dealings in the UK.