Years ago, we here at China Law Blog made clear our views on VIEs and nothing about those views has changed. For that reason, and becuase VIEs have little to nothing to do with most companies doing business in China, we stopped writing about them years ago. In a nutshell, we don’t like them, don’t trust them, and don’t do them. Quite frankly, our malpractice insurance just isn’t high enough for the massive risks we see in these investment vehicles. We simply believe that when push comes to shove, China’s courts simply won’t enforce the contractual agreements that are necessary to support such a structure.
Seems we are not alone in this assessment and we now have company from a Chinese court. Sue-Lin Wong just did a story on VIEs for the International Herald Tribune/New York Times and because both Steve Dickinson and I were quoted in it, I cannot resist retreading old ground here and again writing about VIEs.
The NYTimes story is entitled China Court Ruling Could Threaten Some Foreign-Invested Companies and it comes on the heels of a recent ruling by China’s Supreme People’s Court holding that “contracts used by non-Chinese citizens to gain access to sectors of the Chinese economy that are protected from foreign investment were invalid.” Ms. Wong nicely explains why V.I.E.’s exist at all:
Sectors the Chinese government considers sensitive, including finance, media, technology, the Internet and education, have long been largely off-limits to foreign investment. To get around that, some of the biggest companies in the country founded by Chinese people, including the Internet giants Baidu, Alibaba, Tencent and Sina, create variable interest entities, or V.I.E.’s, that give overseas investors de facto control over companies technically owned by their Chinese partners, as Neil reported. V.I.E.’s account for differing proportions of these companies’ income and assets, ranging from several percent to as much as 100 percent.
V.I.E.’s have for the most part worked just fine and this likely will not change, until there is a problem. And that itself is the problem. To make up a Yogi Berra quote, there is no problem with V.I.E.’s until there is a problem. Problems arise if the Chinese partners decide they don’t want to follow the contracts any longer because, for example, they already have the money and know-how they were seeking, as has happened in several instances. When that happens, the foreign party most likely has no legal recourse. China Law Blog’s own Steve Dickinson is quoted on the biggest problem with V.I.E.’s:
“Chinese law has a very clear provision. A contract written to avoid the requirements of Chinese law is void and the court will not enforce it,” said Steve Dickinson, a partner at Harris & Moure and a co-author of the China Law Blog.
In other words, they almost certainly are not legal. Though some are seeking to distinguish this recent Supreme Court case because it involved a type of company structure that predated V.I.E’s, Steve isn’t buying that:
“This group of people will distinguish the recent Supreme People’s Court ruling because it was an earlier set of documents, not entirely the same as the V.I.E. structure,” Mr. Dickinson predicted. “But what the court said is that any contract that is designed to avoid the clear requirements of Chinese law is void from the very first step. That is what the V.I.E. is.”
I then chime in to explain why despite the risks V.I.E formations just keep on coming:
“Accountants, lawyers and stock brokers make a ton of money off IPOs so they have no incentive to slow them down,” said Dan Harris, a China lawyer with Harris & Moure and a co-author of the China Law Blog. “They have every incentive to keep the V.I.E. structure going.”
Of course it is not just Steve and me who view V.I.E’s with such trepidation. Andrew Gilhom, head of Asia analysis at Control Risks describes them as a way for foreigners “to make some money for a few years but ultimately it’s kind of open season.”
Does this mean that all V.I.E’s are going to disappear or be sued out of existence? Absolutely not, because as the article rightly notes, it is “unlikely that the Chinese government wants to turn the V.I.E. structure into a huge issue”:
“They don’t want all the U.S.-listed stocks suddenly tumbling and companies failing and panic,” Mr. Gilholm said. “I don’t really see any signs that they are going to proactively go out and across the board say that all these structures have to be unwound.”
But what is to stop one or two at a time to encounter major problems? What do you think?
If you want to learn more about VIEs, I suggest you read the following China Law Blog posts:
- Variable Interest Entities (VIE) In China. What Would The Buddha (Steel) Say?
- China. Where Everything Is Local. Until It’s Not.
- Gigamedia And The Perils Of VIEs. Dude, Where’s My Chop?
- Thinking Clearly About Chinese Companies Listed On US Stock Exchanges. Or, If A Tree Falls In A Sino-Forest….
- China Law: Don’t Blame It On The Gray.
- Crouching Tiger, Hidden Fraud. Clear Speaking On VIEs.
- Who Owns China’s Internet? Why Even Ask That?
- China VIE Structures, The Podcast. Money….So Money.
- VIEs In China. The End Of A Flawed Strategy.
- China VIEs. The End Of A Flawed Strategy. An Update/Rebuttal.
And the following China Hearsay posts:
- The VIE Discussion Continues – 11/1/11 on G+
- The VIE Meta-Narrative: Illegal vs. Invalid
- A Post-holiday Update on VIE Chatter
- CSRC VIE Research Report Leaked to Media
- Today’s VIE Rumorfest – Update for 9/27
- A New Front Opens in the War on VIEs – Part I
- A New Front Opens in the War on VIEs – Part II
And the following China Accounting posts:
- New VIE IPOs and enhanced disclosures
- Cleaning up the VIE sector – Updated
- Are VIEs a going concern?
- Are VIEs a going concern – revisited
- Cash and VIE
- Statistics on VIE usage
- Emperor’s new suit: VIEs in China
- Explaining VIE structures
- PRC challenge to VIE structures
- Cleaning up the VIE sector
And the following China Finance posts:
- Consolidating Recent Opinions on VIEs
- The CSRC Research Paper and Its Possible Impact
- VIE News Today: More Risk or Government Approval?
- VIEs under IFRS, WFOEs With Variation
- GigaMedia’s VIE Lawsuit
- Who Owns What? Or, Aligning Incentives in VIE Organisations
If you read all of the above, you will probably know more about VIEs than anyone else alive. If you are going to read just one post, make it “Explaining VIE structures.” Oh, and just to give you more to read, I also recommend you read the Silicon Hutong post, “VIEs, The Long Resolution.” In that post, David Wolf talks of how the Chinese government likes to “boil its frogs slowly, not all at once,” and he then talks of how VIEs are on the wrong side of where China wants to be going. I could not agree more. I do not see VIEs disappearing overnight; instead, I see foreign companies involved with VIEs suffering a very long and very gradual squeeze out.
What do you think?