Partnering up in a China Joint Venture – A wise decision?An R&P Publication on Chinese Law

and Legal Practice

Shanghai, 2012

www.rplawyers.com

C R&P China LawyersT +86 21 6173 8270E info@rplawyers.com

INTRODUCTION

• Restrictions on FDI / slow opening of China’s economy

JV was the compulsory structure especially in the 80’s/90’s

• China accession to WTO in 2001: gradual lifting of foreign direct investment (FDI) restrictions

• Today, new WFOE’s (wholly-owned subsidiaries) outnumber new JV’s (Chinese-foreign joint ventures) and the ratio shifts rapidly:

2008: 30% of all German companies in China were JV’s

2011: only 11% of German operations fall into JV’s

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INTRODUCTION

WFOEJoint Venture

Importance of Joint Ventures is sharply decreasing: When are JVs the right strategy?

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JV Structure: Key Points

• The basic idea: 2+ investors invest in and hold a third entity

i.e. the JV is NOT a merger of two existing companies!

• Both entities (A + B) continue to exist independently from JV

C:

Joint Venture

A: Foreign Investor

B: Chinese

Company

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JV Structure: Key Points (2)

• Two different Joint Venture types:

Equity Joint Venture / Cooperative Joint Venture

• Joint Investment: mutual capital contribution (cash, assets)

• Shared benefits – and shared risks

Principle for development of Chinese economy:

Foreign partner benefits from local knowledge and resources

Chinese partner acquires new technologies, know-how, insight in foreign management style and markets, cash contribution

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Reasons for Joint Venture Structure

• Benefits: local market knowledge, local resources, contacts, partner’s familiarity with culture and language

Cost

Legal

Benefit

• Legal restrictions: Partnering with Chinese company is still mandatory for certain industries determined in the Foreign Investment Catalogue:

E.g. car manufacturing, finance + insurance, telecommunications, media publishing, mining activities

• Minimizing costs: shared capital contribution, help with setting up cost-effective facilities under local conditions

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Equity Joint Venture

• Limited Liability Company + Chinese legal entity

Foreign Investor: Companies, individuals

Chinese Investor: Companies only

• Profits/dividends and risks proportionally shared

• Partners appoint legal representative/board of directors

• Capital contribution: cash, assets (e.g. machinery), intellectual property, land-use rights

• JV ends upon:

Expiration of agreed term (if not extended)

Mutual agreement between partners

Other reasons specified in JV contract ( exit strategies!)

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Cooperative/Contractual Joint Venture

• Can be established as Ltd. Co. OR as cooperation between separate legal entities with independent liabilities

• Capital contribution does not have to be of monetary value:

resources, services, licenses, market-access rights

• Investment return negotiable (dividend payment schedules, ownership of assets during and after the project)

not strictly linked to the party’s share (e.g. BOT projects)

• No binding system for voting rights (Board of Directors)

High flexibility in the JV organization, but complex, lengthy negotiations: suitable for certain projects

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The Advantages

• Shared risks and costs when expanding to Chinese market

• Market access: only way to invest in closed industries

• JV is a Chinese Ltd. Co.: higher chance in government procurement biddings

• Simplifies dealing with government authorities

• Benefits from Chinese partner’s network and local business practices (cost control)

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The Disadvantages

• Equity transfer requires government approval

• Difficult to control: Chinese partner may be involved in active management – who controls daily operations?

• High risk of dispute:

Different goals and expectations for the future direction?

Culture: different business/management mentalities

• Exposure of IPR and confidential information:

Who is the owner of the IPR when JV is closed?

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When Joint Ventures Fail…

• Common dangers for the foreign party:

Chinese partner may share land, machinery and employees where JV is located nearby Chinese investor

Contracts with relatives in unfavorable conditions

Secret (e.g. night shifts) manufacturing of own or competitive products to generate higher margins

Supplying relatives with IP and know-how to produce counterfeits

Conflicts of interest

Favoritism

Secret Manufacturing

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Minimizing Risks, Maximizing Chances

Establishment

Partnering

Due Diligence

Influence Control

JV Agreement

Intellectual Property

Confidentiality

Dispute Settlement

Exit Strategy

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Minimizing Risks, Maximizing Chances (2)

• Partnering: What are the roles of each partner in the JV?

Are individual interests/goals understood?

Focus on best-fitting partner, not the most obvious one!

• Due Diligence: check on partner’s finances, assets, business license, reputation, internal structure/decision-makers

• Influence Control: Not just a matter of majority share –optimal balance when appointing decision-makers

Key personnel like legal representative/GM important to control daily business operations

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Minimizing Risks, Maximizing Chances (3)

• Detailed Agreements (Articles of Association and JV Contract):

Intellectual Property: contractual rules regarding ownership, use, transfers and licensing of IPR

Confidentiality and anti-competition agreements

avoid exploitation of sensible information and IP

Dispute Settlement: how are disputes solved? Mediation?

Exit Strategy: rules on fair evaluation and sale of equity share in case the partners disagree on future direction

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When are JVs the Right Strategy?

If not, WFOE may be more suitable:

Easy set up without complex negotiations

100% Control over corporate management and operations

Control over IPR and confidential information

Straightforward exit: easy to close

• Foreign investor seeks entrance in restricted industry

Legal Restrictions

• Chinese partner’s market knowledge, capital contribution or other resources crucial to success

Resources

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Companies that want to do business in China may benefit from contact with a professional services firm such as R&P China Lawyers. If you would like a free-of-charge discussion on how we could assist you, please contact us:

Robin Tabbers (International clients)Email: tabbers@rplawers.com Mobile: +86 13641605259

Lukas Steinberg (International and German-speaking clients) Email: steinberg@rplawyers.com Mobile: +86 15221461321

It is always a good idea to gain a preliminary understanding of any legal issue before you seek professional advice, by reviewing materials such as introductions and articles which are free and easily available online. One convenient place to find more information on the legal aspects of doing business in China is www.rplawyers.com. Available titles include: ‘Guide on Establishing a Chinese Company’, ‘Dealing with Chinese Customers and Suppliers’, ‘Protecting Intellectual Property’, ‘Hiring Employees’, and ‘Dealing with Disputes’.

© R&P China Lawyers 2012

About R&P China Lawyers

Foreign-managed Chinese PRC Law Firm

Corporate / Investment Commercial Transactions Employment Intellectual Property Taxation / Forex / Customs Dispute Resolution

2011

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Good luck in your China venture!

Shanghai, 2012 www.rplawyers.com