26 Jan 2016

Legal Considerations of Chinese Joint Ventures

Doing business in China is notoriously difficult and hazardous and as a result, many western multi-nationals opt for a joint venture with a local Chinese company.

A joint venture (JV) is a specific business arrangement where the parties combine, usually under contract, to create a new business entity or share resources and responsibilities for a new business venture.

In China, the authorities tend to encourage foreign investors to enter into JVs, and they can be the only way to do business in China in certain sectors.

Although there are pitfalls associated with JV arrangements, it is still possible to get favourable outcomes under JVs provided you can get the legal and contractual arrangements right.

You’ll no doubt have heard plenty of horror stories about Chinese JVs that have gone spectacularly wrong for the foreign investor. In some of these stories, a lack of due diligence on the part of the overseas investor meant that they didn’t realise their Chinese business partner’s entire organisation was just the fabrication of a single fraudster.

In another common story, the foreign entity fails to register its trademark locally and finds its products being sold at a lower price by its own business partner. Although these tales are hair-raising, there are ways to avoid many of the common difficulties if you can get a sound legal team with the experience working in China.

Make relationships favourable for both parties

The most successful business partnerships are formed when the interests of both parties are aligned. Put simply, if your partner finds it beneficial to meet the terms of the JV agreement then it’s likely they will comply with it. You should also ensure there are enforceable legal penalties in place in case they do not fulfil the terms of the agreement. A conflict of interest may arise if the other party has other priorities.

For example, if your partner has strong ties to government then there may be other considerations besides profitability. They may consider local job creation or tax income generation to be more important than pursuing profits from your investment. The more your interests are aligned with that of your partner, the more successful the partnership is likely to be.

Successful joint ventures require all parties to have a realistic set of expectations.

Browbeating your potential partner into terms that are unfavourable to them may be counterproductive. If the terms of your agreement make it difficult for your partner to benefit from the arrangement, for example if the margins are too tight for them to make a decent profit, they have little incentive not to renege on the deal.

You may obtain better results by making the arrangement more attractive for your partner, even if that means accepting lower profitability. It also means your relationship with them is more durable as they have less incentive to cut and run if a better offer comes along.

It’s difficult to assess the reliability and integrity of a potential JV partner. You should obviously respect your instincts and insist on face-to-face meetings with the key personnel in your partner’s organisation.

You should also visit their premises. Whilst your partner may not be deliberately deceitful, they may be tempted to over-exaggerate their capabilities or resources in order to impress you and seal the deal. Seeing their capabilities (such as the scale of their operations) close up is one way to gauge how realistic their claims and ambitions are.

You also need to conduct a full program of due diligence. Remember that saving face is very important in China so you need to tread sensitively if any of your investigations are potentially intrusive. Finding a go-between that understands the local culture may be the right way to do this without causing friction.

Retain control

Having 51% ownership of the JV does not automatically give you full power over it. It’s important that your side retains the power to appoint and dismiss the Legal Representative and General Manager, even if they are in practice appointed by your local partner. Simply having majority ownership does not guarantee full control of the board in a Chinese legal environment.

You should also retain control of the company seal, also known informally as the “chop.” This is the official seal used to give an organisation’s “signature” on things such as documents and bank arrangements. It gives the power to make binding legal contracts on behalf of the JV. If you lose control of the seal, then you can get shut out of bank accounts and contracts with key service providers.

Protect your copyright and trademark

Ensure your trademark and copyright is protected to ensure your partner does not have free reign to produce your product or use your brand without authorisation. This trademark/copyright must be valid in China, not just in your home market.

Draw up local language contracts

Contracts are usually more enforceable if they are written in Chinese. Make sure the terms are detailed and legally enforceable by Chinese law. Any penalties for breach of contract need to be explicitly stated in the contract.

Successful JVs take time

Remember that it takes time to find the right partner and enter into a successful JV. There needs to be an appropriate period of ‘courtship’ and relationship building in the run up to reaching agreement. Conducting due diligence will also take a certain amount of time. Successful joint ventures are not rushed.

You’ll find the most benefits are obtained from long-term partnerships. Your partner has a particular incentive to invest in a relationship that will deliver long-term benefits or future profits, and less incentive if it’s a short-term, one-off deal that’s unlikely to continue.

Don’t be deterred

You’ll hear plenty of scare stories about JVs that have gone wrong but there really are benefits available via the JV system that are hard to access otherwise.

A good JV can bring access to government and business contacts, support and licensing, as well as resources including land, distributor and supply networks, and access to qualified and reliable workers. Get the right advice, including a legal team with JV experience in China, and the JV structure can yield benefits for you.


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