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China Joint Ventures. Can Things Get Any Worse?

Posted in Legal News

My 11 year old daughter is always asking me whether I can drive any slower. I usually respond by proving that I can. Seems almost as though China is now doing the same thing to me in response to my constantly harping on the dangers of China joint ventures.
When I was just starting out as a lawyer, I negotiated what I thought was a great settlement for my client. The amount it would pay would be far less than we were expecting it would take to settle, and the other side would be giving us a more complete release than we were expecting. As part of this agreement though, my client, a Fortune 50 company, would have to allow the opposing party to pursue a third party in litigation, under my client’s name. Legally, I thought that a very small price to pay for what I thought was a great settlement. I took this to the senior partner with whom I was working on the case, expecting nothing but kudos.
He hated the deal.
He agreed I had set things up to save our client millions of dollars, but he would not recommend it to our client and he was convinced our client would reject it. The client did reject it and the reason it gave was that it would “never” allow some other company to use [and possibly] abuse its name.
They were absolutely right and I was dead wrong.
That case came to mind recently in light of the Sanlu baby formula scandal. CLB’s own Steve Dickinson was recently interviewed by the Dominion Post about the New Zealand company’s (Fonterra) handling of the tainted baby formula. Steve pointed out how as a minority owner of a Chinese joint venture, Fonterra had virtually no say on anything:

Steve Dickinson, a partner at law firm Harris Moure, was surprised, however, that Fonterra learned what was going on as early as it did. Mr Dickinson, who has been based in China since the 1980s, is heavily involved in its food industry.
“If you’re a 43 per cent shareholder in a joint venture in China, you don’t have any power. And the fact that Fonterra even found out means that they’re far more involved than a typical 43 per cent joint venture partner. It just shows you the problems of being a minority owner of a Chinese company. You’re not really aware of what’s going on.”

Hong Kong’s Media Magazine just came out with a very interesting article on Danone’s China public relations problems stemming from its longstanding dispute with Wahaha. The article is entitled, “‘Hegemonic’ Danone loses PR battle” and subtitled, “When the People’s Daily newspaper starts referring to your brand as ‘hegemonic’ and calls on your local joint venture partners to rise up against you, it is probably safe to say that you have a serious PR problem in China.”
Media interviews David Wolf of Silicon Hutong who views joint ventures as potentially deadly for the brand and just plain bad news:

Wolf agrees that Danone sacrificed goodwill by “running to its own courts”. He also points to a deeper problem that other MNCs would do well to avoid: the temptation to sling mud in an environment where brand awareness is evolving rapidly. Wahaha founder Zong Qinghou, for example, compared Danone’s tactics to the Western powers that bullied China a century ago. “Danone was baited into a public war of words, but, in retrospect, it won nothing by doing so. It should have portrayed it as a purely legal matter, and focused on its consumers.”
* * * *
Brands experienced in foreign expansion such as Disney, Coca-Cola and McDonald’s remain well protected in China, although for some others that assertion is arguable. “Brand ownership has to be completely clear,” says Wolf. “In Danone’s case it was left up in the air. Given China’s relatively immature IP regime for protecting brands, you cannot rely on sophisticated legal agreements.”
Where, then, does the collapse leave that most storied of Chinese structures, the joint venture?
Wolf believes they are obsolete. “The strategy should be to build your company from the ground up. The other option is acquisition”. Coca-Cola, presumably, is listening closely.

I agree with David Wolf, but with a few exceptions. There are still some industries in China where foreign companies can enter only by joint venture. There are also some instances where a Chinese company can contribute so much as to warrant a joint venture, though usually in those instances, there are legal workarounds that can take advantage of what the Chinese company can offer, without need for a joint venture.
For additional reading on joint ventures in China, check out the following:
Chinese Joint Ventures — The Information The Chinese Government Does Not Want You To Know
WFOE v. JV
China’s Joint Venture Jeopardy” (this post is on an article I wrote for the Wall Street Journal on the same subject.
China — Damn The Joint Venture
Beware The China Joint Venture
Beware The China Joint Venture, But Do Not Ignore It Completely
China SMEs: Own If You Want To Own.
UPDATE: A reader just pointed out this very interesting blog post, entitled, “Lessons for foreign investors from the Sanlu scandal,” over at the Chinese Law Prof Blog, discussing what foreign participants in Chinese joint ventures can do to protect themselves.
UPDATE: Just saw that the Off The Record Blog talks about the risks of being a “passive” investor in China, in its post, “Time for new China game plan.

  • http://www.foarp.blogspot.com FOARP

    But Dan, surely you are forgetting the way in which JVs deliver over the pre-existing logistics chain and access to clients that is essential for success in the mysterious east. The China market is such a wild environment that you need the kind of links with local government (I believe the Chinese call this ‘guanxi’ – pronounced ‘gwansy’) that a JV can deliver. There is such a minefield of complex regulations out there waiting to trip up unsuspecting foreigners trying to set up in China that you need local nous and connections to get along. Cases like Danone, Sanlu, etc. are aberrations in an otherwise very successful story.

  • douglas

    FOARP, remember one thing. Your local partner’s guanxi is always theirs. A foreign investor has to start somewhere. It is not easy to learn to the tricks of the trade unless you do it yourself.

  • http://www.foarp.blogspot.com FOARP

    @Douglas – But surely you can smooth the path if you get a consultant who has operated in China for a long time and has plenty of connections with the local government to do your due diligence etc. first?

  • http://twofish.wordpress.com/ Twofish

    @FOARP – But surely you can smooth the path if you get a consultant who has operated in China for a long time and has plenty of connections with the local government to do your due diligence etc. first?
    The problem then is how do you trust the consultant. The fact that they have plenty of connections with the local government and have operated in China for a long time means that their interests may not be yours. Due diligence is something that you can’t easily outsource.
    Also always remember the local government needs you as much (or maybe more) than you need them, and that if you can’t find one local government that will work with you, you can find another one.

  • Tim

    FOARP is being sarcastic.
    I liked that assistance with pronouncing Gaunxi.

  • http://www.foarp.blogspot.com FOARP

    @Tim – Alright man, you got me, I should have known that the ‘Gwansy’ bit was over-egging the pudding. I have to say though, as a mere dis-interested observer it is satisfying to see that my own views on this correspond so closely to those of experienced China pundits like Twofish, Douglas and Dan. Whenever I hear people try to make out that there are mysteries in doing business in China that require more than detailed knowledge of your own field and the ability to learn, then I hear BS.
    Yes, JVs bring definite advantages and should be considered, but not much more so than when doing business in your home country. People who try to make out that there are special circumstances in China above and beyond the legal requirements in some sectors are peddling expensive nonsense.