New Foreign State Immunity Law Opens Door for China to Target Foreign Businesses

“What makes you think we’re a German company?”

A Volkswagen AG executive was alleged to have asked this question at a recent private roundtable in the context of a discussion about de-risking the car manufacturer’s supply chain from China. The comment hints at the fact that around 25 percent of Volkswagen is owned by foreign institutional investors, and another 15 percent is owned by the sovereign wealth fund of Qatar. Of course, to some, the dismissive remark ignored the elephant in the room—that 25 percent of Volkswagen and 21 percent of the company’s voting shares remain in the hands of the German state of Lower Saxony.

Nearly half of Volkswagen’s annual earnings come from China, so the Lower Saxony government and its constituents could face significant negative consequences if Chinese laws stopped protecting their presumed rights. The problem isn’t hypothetical: China’s new Foreign State Immunity Law may end up intensifying de-risking discussions in the West.

Adopted on September 1 and scheduled to come into effect on January 1, 2024, the Foreign State Immunity Law broadly defines what constitutes a foreign state, and may result in the targeting of businesses linked to foreign states in the same way Vladimir Putin is currently targeting foreign companies operating in Russia.

Historically, China has avoided adopting laws similar to the United States’ Foreign Sovereign Immunities Act. Instead, China’s Civil Code mentions that actions against foreign individuals or entities shall observe such immunity “under relevant PRC [People’s Republic of China] laws and treaties.” Other than the Civil Code, one of the only other mentions of such immunity under Chinese law is the narrowly tailored Foreign Central Bank Assets Judicial Enforcement Exemption Law of 2005.

In four short provisions, the 2005 law afforded protection from Chinese judicial enforcement measures for the cash, securities, gold, and other assets held by foreign central banks. The government of the Hong Kong special administrative region (SAR) had reportedly lobbied for the 2005 law since 2000. Until the handover in 1997, Hong Kong had followed the United Kingdom’s State Immunity Act of 1978; doing so was important to Hong Kong’s financial stability.

It’s worth noting that the 2005 law provides limited protections for foreign central bank assets, but it does not cover any administrative actions and it makes clear that a foreign country which fails to provide the same protection to the assets of China’s Central Bank, or assets of the “financial administrative agencies” of China’s special administrative regions, will be treated with no more than reciprocity. Also, the 2005 law does not cover crypto assets, which have been illegal to trade in China since 2018, even though China has curiously encouraged Hong Kong institutions to promote them since early 2023.

Chinese officials have argued that the new Foreign State Immunity Law will bring China in line with other jurisdictions. Its Article 3 states that, by default, foreign countries and their assets are exempt from the jurisdiction of Chinese courts, but it provides exceptions.

When it comes to the definition of a “foreign state” under Article 2, the law chooses ambiguity over certainty for businesses, describing a foreign state as “any organizations or individuals authorized by a foreign sovereign state to exercise sovereign rights and conducting activities based on such authorization.” This raises more questions than it answers. In particular, it is not clear what the law means when it comes to exercising sovereign rights. For instance, would a nation’s sovereign wealth fund or a state-backed public pension fund’s investments in China fall under this definition? Or perhaps fully state-owned entities like France’s EDF, whose presence in China is significant?

What is apparent is that the Foreign State Immunity Law, like other Chinese laws, claims an excessive degree of extraterritorial power. Under its Article 7, the activities of foreign states (including individuals and organizations) will not be protected by immunity in Chinese courts when it comes to commercial transactions with entities anywhere in world, as long as the transactions have “direct effect within the territory of the PRC.”

Taken in isolation, businesses with links to foreign states may characterize this law as a Chinese “Foreign State Immunity Law” backed up with the teeth and political direction of the Chinese Communist Party. Taken together with the recently adopted Anti-Foreign Sanctions Law, Foreign Relations Law, and Counter-Espionage Law, the Foreign State Immunity Law represents one component of a growing toolbox of carefully crafted countermeasures available to China.

There is already evidence that this law is being considered in a retaliatory context. In an article published by the People’s Daily on September 4, in explaining the background of the Foreign State Immunity Law, the head of the Chinese Foreign Ministry’s Department of Treaty and Law complained that in recent years, certain foreign courts accepted “frivolous cases” filed by “anti-China forces,” “even calling for the forfeiture of the sovereign immunity which China is entitled to under international law.”

It appears that Chinese officials are already sharpening the regime’s counter-sanctions measures, which perhaps include the incitement of crypto-asset trade in Hong Kong, in the expectation that a planned invasion or embargo of Taiwan will lead to a fissure with the West. The strategy is to maximize the financial pain for Western democracies if they impose economic sanctions on China, including through the expropriation of foreign businesses and their assets in China and Hong Kong.

Vladimir Putin’s crackdown on foreign businesses and the expropriation of their assets in Russia should serve as a cautionary tale for businesses operating in China. On April 25, Putin signed Decree 302, giving himself the power to introduce external management over assets in Russia that are owned or controlled by legal entities and individuals from so-called “unfriendly countries.” These assets include shares in Russian companies, property, and property rights.

Since Russia’s invasion of Ukraine, more than 1,000 foreign businesses have left the country, with many accepting write-downs and financial losses in the hundreds of millions of dollars as the price of exiting Russia’s market. Others have been even less lucky: The Russian state in July took control of shares belonging to beer producer Carlsberg A/S and French agribusiness Danone SA.

The lesson here is that an unexpected shift in geopolitics and a sudden deterioration of relations between authoritarian powers and their neighbors can have disastrous consequences for foreign businesses operating in those countries.

China is not waiting around for tensions to escalate. It is already busy developing a toolbox for stripping entities—within the country and overseas—of their immunity in Chinese courts.

Whether the Lower Saxony government’s 20 percent stake in Volkswagen will be sufficient to provide the car manufacturer with immunity in Chinese courts is questionable. Likewise, it’s unclear how much weight China will give businesses with ownership linked to U.S. states. But the broad definition of this law, as well as the shifting mood in Beijing, means that foreign companies operating there should be planning for an eventuality where their assets may be seized.

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Benjamin Qiu is a partner with New York–based law firm Elliott Kwok Levine & Jaroslaw, where he specializes in China and Hong Kong-related cross-border disputes and transactions. He is a registered foreign lawyer in Hong Kong and registered arbitrator with the Shenzhen Court of International Arbitration.

Sam Goodman is a director at the China Strategic Risks Institute, the Director of Policy at Hong Kong Watch, and co-chair of the New Diplomacy Project.

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From: New York Law Journal