The Fake China Joint Venture, Made Real Through Marriage?
Just got this email, which is not too dissimilar from other emails and phone calls I have previously received:
Like I said before, I'm really enjoying your series on China Law Blog on starting a business in China. It's something I might try myself someday.I'd be really interested in hearing about a foreigner starting a local Chinese company through a Chinese spouse. I know this is fairly common (I know of several people who have done it this way), but I'm curious about the details. I hear the registered capital must be of a certain amount, or else it doesn't make sense for the Chinese company to "hire" the foreigner to run the business. And, of course, there are also visa considerations. Then, I guess there's the ugly possibility of what divorce means to the company... but I think that's pretty clear. (If partnerships become possible in the future, will foreign management hires be able to become full partners in this kind of business?)
I'd really love to see a blog post on this angle. Please keep my request anonymous, though... no need to make my employer nervous! :)
Great questions.
Earlier this year, we wrote on what we call the fake China joint venture, which is really nothing more than someone wanting to set up an illegal business arrangement as a way of avoiding the fees and costs involved in forming a real joint venture or Wholly Foreign Owned Entity (WFOE). In that post, we talked about the following as a typical situation:
Caller: I've got this great website and it is exactly what China wants/needs. And I've been working on developing it with some Chinese tech friends of mine and we want to take it legal so we can start getting VC (venture capital) funding for it. Here's our plan. Now I know that the old/truly legal/expected/usual way to do this is for me to form my own company and then form a joint venture with my Chinese partners, but I also know that will cost a lot of money. So our plan is for the Chinese company to own the website and then we will have an oral agreement (or a written agreement) that I really own half of it.
Me: Listen, my firm has been contacted at least twenty times after these situations have gone bad and I am aware of at least another twenty times where the same thing has happened, and let me tell you, these arrangements (it is NOT proper to call these joint ventures) virtually always end the same way. They end with the Chinese company booting you out completely and leaving you with no recourse. Protecting foreign companies in legitimate joint ventures is difficult enough, but it is pretty much impossible under the scenario you are describing. We had a guy who paid us a lot of money once for us to do everything we could to try to get "his" multi-million dollar business back. Guess what, we could not even come close to getting it back. Every Chinese lawyer we talked to about suing to get it back told us we had no chance of winning at all. I mean, just listen to the argument we would need to make to the judge:
Your honor, my client knew that China's laws are very clear on what foreign companies must do to operate legally in China, but he thought these very clear laws should not apply to him because, well because he is an American tech company and he was just too smart/too poor to bother to comply with the very clear laws. So instead, he had this great method for completely circumventing China's very clear laws. His idea was to not form a company, but rather, have his Chinese friends form the company and he would have a little side deal with that company. Well, that side deal has now gone bad and my client wants you to go against China's very clear public policy on how foreign business is to be done in China and enforce this unwritten side deal.
What do you think of that argument?
Caller: (long pause) I understand things could go wrong with that kind of arrangement, but would you be willing to draft the contract between me and the Chinese company?
Me: No. I can't do that. I can't draft a contract that I know will never work. I just can't. Give me a call if you ever want to do this legally, in a way where you actually have a chance of profiting from your work down the road.
We then referred readers to the following:
For more on this, check out "China SMEs, Own If You Want To Own." To get a feel for how difficult it can be even with a fully legal joint venture, check out this article by Steve Dickinson in China Brief, entitled, "Avoiding Mistakes in Chinese Joint Ventures." and this Wall Street Journal article I wrote, entitled, "Joint Venture Jeopardy."
UPDATE: In, "Private Equity, Venture Capital and ‘Fake’ China Joint Ventures," China Hearsay very nicely maps out the way these deals are typically done (using an offshore holding company) and notes that you might have legal recourse in the rare instances where your Chinese partner has "huge assets offshore" in a country in which you can sue and win:
You can tie up the Chinese founders in 100 different contractual knots, but unless those founders have huge assets offshore (real assets, not equity in the holding company) that you can go after in a dispute, they can always tell you to piss off and kick your ass out of the business.
But back to the email and what can happen to a business started through/with a Chinese spouse?
Here are some thoughts:
1. If the marriage works and the business works, then it is all good.
2. If the marriage works and the business fails, the business fails.
3. Because my firm does not represent Chinese nationals seeking to form Chinese domestic businesses (it would not make any sense for them to retain us for this sort of thing), we are not very knowledgeable about this and so I do not know what sort of minimum capital would be required for such a business to hire a foreigner.
4. If the marriage fails and the business works, what happens? This is the key question and I do not know the answer. The business belongs solely to the Chinese spouse, so the question then becomes a Chinese family law issue. What happens under Chinese divorce laws to something that can legally be owned only by the Chinese spouse?
5. What about China's new laws on the "Establishment of Partnerships within China by Foreign Enterprises and Foreign Individuals," set to go into effect on March 1, 2010? These new measures will allow foreign enterprises and individuals to form partnerships with Chinese enterprises and individuals, but it is very hard to say at this point what impact those new laws will have. But, my hunch is that the fees and costs of setting up one of these partnerships legitimately will be roughly the equivalent of setting up a WFOE or a Joint Venture, so I do not see them solving the problem of the foreigner who wants to set up a China business on a shoestring.
Comments (19)
Read through and enter the discussion by using the form at the endSarahplusone - December 21, 2009 8:47 AM
All I can say as someone who, through little foresight of her own and less start up capital, ended up closing down my SME when I shut down my marriage, is be smarter than I was. Its not that I think every marriage is bound to fail, its that long term you're going to need that JV or WOFE anyway. Sure, it'll cost you more upfront, but you'll be saving yourself months of struggle with "getting legal," arranging financing, even visa agents, if you do it right the first time.
I got out without losing everything. It was nothing short of a miracle that I was able to find someone to take over my company, and get my initial investment back. But it would have been worth a lot more if I had the legal structure in place. And more still if I had been able to keep it going through my divorce.
Your Chinese spouse is probably having a small fit about a) the amount of money this will cost, and b) the fact that you are now counting on divorce. Take your spouse out to a really nice dinner to apologize and then get your WOFE set up. Its the smart business option.
Sarah
Jay - December 21, 2009 10:02 PM
Since this was (I think) my idea, here's my answer to Q4/5: If the marriage fails, then I'm screwed anyway, and the 'company' is the least of my worries. I would resign from my wife's company, which then folds (unless she finds somebody else with my set of skills who can take over the work), and she can re-coup whatever cash is left over after liquidation. Depending on how messy the divorce is, she either keeps half or all of it. But all of that is theoretical and unlikely -- my marriage is rock-solid. If this mechanism is legal -- I don't see why not, I'm currently also legally employed by a wholly Chinese owned company -- it remains an attractive option for me in my situation. A practical alternative is for me to quit and go work some place else, but this has two draw-backs:
1) I actually like the work I do, only would like to get paid better and do less (unpaid O.T.) hours of it, not want to do something else, and
2) at another company I might just run into the same problem all over again (expected to work hard but getting paid fairly is a constant struggle), unless I go work for a foreign company (draw-back 1).
As for Q5, how do I find out about this new law, or about any existing laws for that matter? I'm not trying to make a fast buck, avoid paying tax or any other such thing, but finding out about the rules, the law (existing and new) is not easy. My village does not have a library, let alone that they keep printed copies of law books there, even if I would be able to read/understand those (I speak the language, but reading is another matter entirely). I'm sure the various laws are on the net somewhere, but google hasn't yet told me where for all but a few, and these laws seem to be completely ignored by all relevant parties anyhow. Asking around (gov't offices) so far has gotten me mostly "illegal to sell peanut-butter in China" answers. In my experience, unfortunately, asking a Chinese lawyer about the law is less effective than setting fire to my cash (which at least lets one warm one's hands for a minute or two). Asking a foreign lawyer about Chinese law might be an option though... Anybody?
Don Clarke - December 22, 2009 2:22 AM
Re what happens if the business succeeds but the marriage fails: I'm not an expert on Chinese marriage/divorce law and practice, but what I do know suggests there would be no insuperable obstacles to a court doing the right thing if it wanted to. China has a community property regime, so the wealth represented by the business belongs to the community, no matter whose name it's in. Assume that an even split would be the fair solution. Although the business itself can't be split upon divorce, there's no reason why a court couldn't give more of *other* assets to the foreign spouse while giving the business to the Chinese spouse. If the other assets aren't enough to give the foreign spouse a fair deal, a court could require the Chinese spouse to pay something extra to the foreign spouse, or perhaps even to sell the business and split the proceeds. This is, I repeat, premised on the assumption that an even split of assets would be fair in the circumstances AND that the court wants to be fair. The point is just that the restriction of ownership to Chinese nationals need not be an obstacle unless a court wants to make it one.
uk visa - December 22, 2009 3:30 AM
Hi Dan
I just wanted to say thank you for your regular - and regularly fascinating - posts of 2009.
May I wish you and yours very Happy Holidays.
Kind regards
V
glebester. - December 22, 2009 4:22 AM
Hi -
As with the posts on setting up a WFOE, this is a very interesting and potentially relevant post for me. Thanks. I am looking forward very much to your post on setting up a RO, as this is something that I am contemplating doing.
My situation is as follows. I have a number of business contacts in China through my wife, who I met and have lived with in the UK for the last three years. I have been endlessly hassled to go into business with these contacts, which I have resisted until now. However, I am now dealing with the threat of being made redundant here in the UK, so it is an avenue I am exploring further.
What I would like to do is set up an agency, based here in the UK, selling consultancy services to Chinese businesses looking for information on the UK market and seeking business partners in the UK. I might then expand the business to sell similar services to UK businesses, if it proves successful.
Until now I have not really thought about how the mechanics of the operation would work - The arrangement I had set up was that I would operate in
China on tourist visas and keep the money in my wife's family. But reading through the posts here I get the sense that this is a bad way to operate and sets a bad precedent for the future development of the business, not to mention the family problems that might ensue, particularly if large sums of money are likely to be involved.
Instead I would rather operate in China legally and get money out of China legally as well. I am trying to work out whether I can do this in a cost efficient way. The solution that I had established was to set up a company here (with my business partner), and then a RO in China, albeit not one that was actually staffed on a permanent basis.
I realise that this might seem like a ridiculously cautious approach to setting up what is basically a small business and next to zero capital is involved. Apologies if I am coming across as being naive. But I'm just scoping out the options at this stage.
Sarahplusone - December 22, 2009 4:25 AM
Re: What happens under Chinese divorce laws to something that can legally be owned only by the Chinese spouse?
The spouse who does not legally own the business is entitled to 50% of the business owner's share. This should be paid out in a cash settlement. Ownership shares cannot be transferred to a non-Chinese national. In reality, these payments are rarely made. My ex quickly took his mother on as a 1/3 partner as a way of protecting controlling interest and minimizing the assets I was entitled to in the divorce. This is also very common strategy.
No matter how it is settled, the non-Chinese spouse isn't going to end up with a legal, functioning business at the end of this process. It's legally impossible under the existing combination of family law and company structures available. And odds are high that if you make it clear you want to keep the business going and your divorce is at all bitter, it'll be liquidated or sold or run into the ground by the time you reach divorce court.
HM - December 22, 2009 4:27 AM
A Sino-Italian pizza cafe marital 'joint venture' in a well known Yunnan tourist town ended very much in the way you warned your caller. Business good, marriage suddenly terminated ... you can guess the rest.
Dan - December 22, 2009 2:59 PM
Sarahplusone,
Thanks for both of your comments. I must say I learned a ton from them as I have yet to have had any involvement in a matter involving a marriage that went bad while the Chinese business was doing well. What you say makes complete sense and is not the kind of thing one can learn from the law textbooks.
Dan - December 22, 2009 3:07 PM
Jay,
It was NOT you who spurred the question, but it just goes to show how widely applicable it is.
Generally, the best way to find out about a Chinese law is to read it in Chinese and discuss it with those who enforce it and with those who operate under it. Laws standing alone usually do not tell you everything you need to know. This is true everywhere, but particularly true in China where laws come out lacking regulations on the nitty gritty of their enforcement and so much of what is considered law is oftentimes just how a law is interpreted or enforced.
I have been very hesitant to write about this new law because the law itself only says so much and I am certain that the real bones of it will not be clear for quite some time.
Dan - December 22, 2009 3:29 PM
Don,
What you say makes complete sense.
Dan - December 22, 2009 3:31 PM
ukvisa/V,
Why thank you so much and the very same to you!
Dan - December 22, 2009 3:32 PM
glebester,
It is the opposite of "naive" to seek answers to very complicated questions.
Dan - December 22, 2009 3:34 PM
HM,
I can guess the rest, but I have to admit my guess is not being made with a whole lot of confidence so I for one would love for you to tell us "the rest." I'm guessing the poor foreigner ended up leaving China with no more assets he or she had than before he or she went in and created a very successful business.
Arthur Borges - December 23, 2009 10:01 PM
The problem in China is the same as everywhere: in the presence of bad faith or degraded interpersonal relationships, the most tightly written contract is worthless.
Westerners often lack the interpersonal sensitivity and psychological flexibility to function intelligently and smoothly in Chinese society, e.g. if you get confrontational, it may secure a tactical victory, but you have just set yourself up for payback time.
Confrontation and display of anger flag you as a infant having a temper tantrum and they are embarrassed as hell to be seen hanging out with such a jerk. You also come across as ungrateful for the opportunity they invested time and effort in setting up. Ever since the difference between you arose, your Chinese partner had been sending out signals but through a mix of your cultural inexperience and limits on language skills on both sides, most msssages got lost, missed or miscontrued. Suddenly you're out in the cold feeling all bitter because they are all "two-faced".
Um, not necessarily although here, as elsewhere, you will run into individuals of most moderate honesty.
All else being equal, natives perfectly at home in their own country will have little incentive to do things in any manner they find foreign, unnatural or counterintuitive.
If you are going to be an off-the-record partner, then you had better create such an incentive by holding an irreplaceable skill or asset. That failing, it is entirely up to you, the foreigner, to kiss up to the local culture and do things the native way.
Which is what you would expect of foreigners operating in your native land.
Otherwise, once your partners have determined you aren't playing ball, they will figure out how to operate the business without you.
Andrew Li - January 19, 2010 8:35 PM
Being a PRC attorney, I suggest, for that man who mentioned "So our plan is for the Chinese company to own the website and then we will have an oral agreement (or a written agreement) that I really own half of it", that in the provision of Resolution & Dispute in a written agreement between you and your Chinese company an arbitration should be executed on Hong Kong International Arbitration Center.
In Hong Kong the arbitral award is likely in favor of that man. Then he can apply for enforcement of such a decision in the Mainland. Finally, he can retrieve his property.
Gary Roulette - March 5, 2010 6:39 AM
Exactly what you describe happened to me and I have since learned of a couple of other people who this also happened to. I wish I had read this post before I went into the deal, though honestly, I probably would have done it anyway, since like everyone else, I believed mine would be different and the people who cheated me were my friends. You have completely called it.
Jay (same as above) - March 18, 2010 7:38 PM
The plot thickens. Having found out that I got screwed by my Chinese employer even more than I thought (apparently, they only have to comply with Chinese laws when those prevent paying me, not when they mandate paying me), I've packed-in my job and plan to go at it alone. My Chinese spouse has registered a company with another relative (need 30K RMB in the bank for two owners, 100K for a single owner) and the authorities were very helpful, if not keen, with a fairly quick and painless process by any standard. The only glitch was that the company name could not include 'high tech' unless she/they had 3000K RMB in the bank. Hiring a foreigner to run the place is apparently no problem at all, as long as there's some expert skills that are not (easily) found in China. Check. The trick is now to find out what tax rules apply (nobody seems to know or care) and whether what we've been told so far is correct (although nobody except me seems to care about that either).
Matthew - March 19, 2010 1:40 AM
Jay,
What do you mean, what tax rules apply? This seems like a very simple scenario from a tax perspective. What is the issue causing problems?
Matthew
Jay (same as above) - March 20, 2010 1:24 AM
Matthew,
I'm sure you have the answers, but we don't. Not a tax-lawyer myself, just an ordinary wage-slave, and I'm the edumecated one in our family:)
I've tried to find out what the rules are but failed. I've found rules applying to 'enterprises', but these state that these rules do not apply to a simple one or two person company -- which is what we've got, although even that is not clear, at least to me. Being not after dodging tax/laws and wanting to be safe rather than sorry, I have requested my wife should find out what the rules are. She's the jingli, after all...
A trip to the tax office didn't result in a nice colorful brochure like you would expect to get at the ATO for example, but some vague comments like "well, it depends... let's see what to do when the time comes...", meaning that maybe my wife asked the wrong tax official, who didn't know but didn't want to admit that. A call to a CPA resulted in a flood of words (so much that I couldn't follow) but in summary all it was was "send us lots of cash first...", which is not an option at this time (30K RMB capital doesn't go very far). Now, inquiries have moved on to girlfriends who also run companies and the consensus seems to be that if-and-only-if customers *want* a fapiao then you get one from the tax office, at say 5% of the total, and that's that. I'm pretty sure it's not, so I'll be continuing to push for answers, but I've been living in China now for eight years (and not in an expat bubble) so I'm not getting my hopes up. From what I've seen sofar, the whole notion of paying tax and keeping any sort of records at all is completely unheard of in your average mom-and-pop operation, while even the larger Chinese 'enterprises' (who I'm pretty sure ought to comply with EITL/order-63 etc) seem to have a lot of scope to be 'creative' in their accounting, with no apparent supervision (i.e. pay "some" tax and the gov't peeps are already very happy -- as evidenced by the hollow look on their face when they stamp the forms before they go back to sleep). Maybe it is different in Beijing?