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China Joint Ventures Again. This Time We Blame The Victims.

Posted in Legal News

My co-blogger and fellow China Lawyer Dan Harris recently did an interview with AmCham on China joint ventures and a couple of follow up posts, entitled, Love The One You’re With. When China Joint Ventures Make Sense, and The China Joint Venture. It’s BACK!!!

We are writing about joint ventures so often these days because we are seeing a pronounced resurgence both in companies wanting to go into Chinese joint ventures and in companies coming to us needing legal assistance with their failed and failing joint ventures here in China. We have often expressed cautions about joint ventures in the past, and nothing we have seen recently causes us to change our mind.

In many cases we are not able to effectively assist the foreign party in a troubled JV because their original joint venture agreement has been so poorly drafted as to preclude any real assistance. We usually attribute this to the foreign company’s originally misinformed view that “China has no law” or that the “JV contract is not worth the paper it is written on.”

Based on these misguided views of Chinese law, the foreign joint venture participant failed to secure good legal representation when it went into the joint venture deal, leaving us with little or nothing to work with in terms of fixing the joint venture problems. The foreign joint venture participant has made basic mistakes that make it impossible to use the very effective Chinese laws and legal system to resolve the problems that have arisen in the JV. Though China’s courts do generally enforce foreign arbitral awards, the issues between joint venture partners more often hinge on issues relating to control and operations, which typically require a Chinese court ruling.

Some examples of the basic mistakes are:

1.  In order to resolve a joint venture dispute, the issue oftentimes must be resolved in China, either through litigation in the Chinese courts or through arbitration with CIETAC, BAC (Beijing Arbitration Commission), or some other legitimate Chinese arbitration body. Foreign partners often provide in the JV agreement, however, that litigation or arbitration must take place outside of China, either in the home country of the foreign partner or in some expensive and well known arbitration forum like Stockholm or London. This type of provision does little to nothing to protect the foreign partner and makes it impossible to resolve any disputes in China, where the problem exists.

By way of an example, many companies come to us complaining that the JV’s representative director has highjacked the operations of the China joint venture company and is operating without supervision and against the wishes of the board of directors. To effectively address this issue, it is imperative that we proceed in court in China directly against the rogue director. However, if the JV Agreement provides for jurisdiction outside of China, we are effectively precluded from taking such direct action.

2.  Our China lawyers are often called on to try to help foreign companies that are in deep trouble with their China JV for reasons stemming from their failure to hire their own independent legal and accounting advisor during the joint venture formation process. Instead of using their own independent counsel, these companies instead relied on the Chinese JV partner for all of the formation legal work. This is a guaranteed disaster. We have seen US companies that have put tens of millions of dollars into a Chinese joint venture, using no legal counsel at all, using the legal counsel of their joint venture partner, or using a local Chinese lawyer who has no experience with foreign joint ventures and no real incentive to protect their foreign client. We had one client who when he first came to us boasted of the great job his Chinese lawyer had done for only $600. When we pointed out how his joint venture so heavily favored the other side that his multi-million investment would likely never yield him a penny, we began to suspect he no longer thought of his counsel as such a bargain.

3.  Relying on a majority share interest to control the venture, rather than exercising effective control through the right to appoint the representative director and the general manager.

4.  Relying on a personal guarantee from the Chinese JV partner as a substitute for failing to properly document the project.

5.  Failing to provide clearly for protections for the foreign partner, assuming share ownership is sufficient to provide adequate protection.

6.  Failing to carefully monitor capital contributions and the use of contributions to capital, assuming that accounting reports will be adequate to reveal the fate of money contributed.

Though the above looks like a long list, I often see joint ventures where the foreign participant has made every single one of these mistakes and more that I have not mentioned. When this happens, we as China attorneys are severely constrained in terms of what we can do to help. But this is not because China has no law or because Chinese contracts are worth nothing. It is because the failure to properly form and manage the JV has made it impossible to proceed. The blame for this generally falls on the shoulders of the foreign JV partner, not on the Chinese side or the Chinese system.

Joint venture agreements are really no different from any other contract. The better the agreement, the less likely there will be problems and the more likely there will be a quick and inexpensive resolution to whatever problems arise.

  • Tony

    From reading this blog, I gather that China does have an effective legal system. Yet it seems to be overly ridden with technicalities and catch-22s.
    I believe it was a past posting where the contract stated the correct forum was in the U.S. But the U.S. judgment won’t be enforced in China. Then if you try to bring suit in China, it will be dismissed because the contract states the correct forum is in the U.S.
    This seems utterly absurd to me. Why would the court enforce a forum selection clause if it won’t enforce the judgment of that forum? Seems like there should be some equity and common sense involved. I guess it’s the foreign companies fault for picking a forum where the other side has no assets. But maybe I’m misreading this.
    Same thing seems to go for Chinese labor law. Follow it to a tee or you are completely screwed. I guess that can be good for the workers, but on the other hand, it seems impossible to start a business in China without legal counsel. While that’s no problem for international companies coming to China, it could be a problem for small startups without much money. But then again, if you are Chinese you can probably hire a Chinese lawyer who doesn’t charge very much.

  • Wallice Chai

    Tony
    One thing needing to be made clear is that it’s very LIKELY a foreign judgement will NOT be enforced in China, but it’s very UNLIKELY the verdict made by a foreign arbitration entity will NOT be enforced in China. This is the key point. China is a member of New York Convention and the Supreme Court of China made it difficult to deny the verdict made by a foreign arbitration entity. If a middle court does not want to enforce a verdict made by a foreign arbitration entity, it needs to get approval from the Supreme Court. Anyway, we should have some confidence in the Supreme Court that its decision is made on the basis of law.
    The other thing is that as far as I know some small American businesses have a good business here in China. There are many ways to get affordable Chinese legal services for the foreign small startups.

  • Falen

    If you are Chinese chances are you won’t need to do a JV and can open a regular business easily and cheaply, with no hassle and no lawyer.
    And to be fair, operating a business with a partner is itself a difficult prospect anywhere, requiring careful deliberation on a whole range of business issues beside the legal ones.

  • http://www.chinaprimer.com Carson

    My understanding comports with Wallice’s: That foreign arbitration awards are almost always enforceable in China. That an award from HKIAC has the same force as one from CIETAC.
    Dan wrote that the opposite is true: That the HKIAC (or other jurisdiction) award is (significantly?) less likely to be enforced in China.
    The example described above of the rogue director calls for injunctive relief. My understanding is that it’s a gray area whether a court would enforce an arbitration award for injunctive relief – regardless of where the panel sat.
    Dan, can you comment on whether a dispute resolution clause that calls for arbitration outside of mainland for monetary damages, and mainland court for injunctive relief, makes sense?
    Thanks.

  • http://www.chinalawblog.com Steve

    1. To clarify: Chinese courts do generally enforce foreign arbitral awards.
    2. Chinese courts will generally not enforce arbitration awards that call for injunctive relief. As a practical matter, only arbitration awards that call for payment of monetary damages will be enforced in China. This is a major weakness with a foreign arbitration as it relates to joint ventures.
    3. I used to think that that the split provision you suggest was a good idea. However, this is not practical. The Chinese courts usually reject any arbitration provision that is not exclusive. If it is not exclusive, they throw the whole thing out, with extremely uncertain consequences. You really have to make a decision: arbitration or court action: you cannot have it both ways. Since the need for injunctive type relief is so common in the joint venture matters with which I usually deal, I find that arbitration is often not a practical alternative. To give two examples: 1) arbitration is not appropriate when you will need to seek injunctive relief to stop product infringement and 2) arbitration is not appropriate when you will need to seek court action to deal with management issues within a joint venture or a WFOE.
    4. Having said all this in #3, in country China arbitral bodies, such as CIETAC and BAC have taken to referring out injunctive matters to China’s courts and China’s courts are ruling on those matters. This is a reason for perhaps agreeing to arbitration within China as opposed to trying to negotiate one outside China.
    At this point, if you are going to do a joint venture in China, our advice would generally be to have disputes handled either by China’s courts or by a Chinese arbitral body. Stockholm or London usually do not make sense.