Header graphic for print
China Law Blog China Law for Business

Yahoo/Alibaba/Alipay/Jack Ma/Carol Bratz: What Really Happened And What It All Means.

Posted in China Business, Legal News

The media has been doing a thorough job of covering the Yahoo/Alibaba/Alipay so I am only going to summarize the situation in the briefest terms. Yahoo (along with Softbank) owns a large portion of Alibaba, which in turn, owned Alipay. Alipay is in the online payment business, which, according to Chinese law, means it cannot be foreign owned. A few weeks ago, Yahoo alleges it just recently learned that Alibaba had transferred ownership of Alipay to a fully domestic Chinese entity. Alibaba is saying it did that so as to bring Alipay in line with the laws prohibiting foreign ownership of an online payment company.

Financial advisory services and investment banks frequently call me when something like the above story breaks. Typically, they are calling because they want to know what to advice their own clients (usually either investors or investment firms). In most cases, I spend 1-2 hours reading the news regarding the latest story on which I am to opine and then I draft up a quick analysis and then we talk.

This Yahoo/Alibaba/Alipay story was different. I spent nearly a full day reading just about every story on it (this was a few weeks ago so it is possible something has changed since then, but my quick perusal of the news today did not turn up anything) and even then I still felt that I was lacking sufficient facts. Nonetheless, I went ahead and answered a bunch of questions from various Wall Street firms, consisting mostly of the following:

  1. Was what Alibaba/Alipay did ilegal?
  2. What can Yahoo do about it?
  3. Why did Alibaba/Alipay do what it did?
  4. Is it possible Yahoo really did not know about it until just recently?
  5. What is the Chinese government going to do?
  6. Is this sort of thing unprecedented?
  7. Will this lead to a decline in foreign investment into China?
  8. Are we going to hear more stories like this in the future?

Here again are the questions, this time with answers to the best of my ability:

Was what Alibaba/Alipay did legal?  I do not know and I cannot answer that without having access to Alibaba’s and/or Alipay’s corporate documents. China does not protect minority shareholders nearly to the same extent as the United States. Alibaba’s or Alipay’s corporate documents may very well have given a small group within the company authority to do exactly what was done here. I have not seen anyone from Yahoo claim what happened was illegal, which makes me think that it may have been perfectly legal. In other words, it is quite possible that Alibaba/Alipay had every legal right to do what they did.

At which point, the advisers asked me if it was possible that Yahoo would have agreed to such a  corporate structure and I responded by saying that was possible and I had in fact been involved in many cases where foreign companies had, usually without knowing, put themselves in similar situations.

What can Yahoo do about it? I do not know as it so much depends on whether Alibaba/Alipay acted legally or not. Yahoo has essentially three options: legal, economic, and political. I do not know what sort of strength they have in any of these three arenas vis a vis Alibaba/Alipay. I do not even know in what forum it would be best to fight on any of these fronts (United States, Mainland China, Hong Kong, British Virgin Islands?).

Why did Alibaba/Alipay do what it did? Do what? Make the ownership transfer or do it allegedly without telling Yahoo?  I think what Alibaba/Alipay is saying about the need to make the transfer makes sense, legally. I do not know why it appears not to have kept Yahoo more in the loop.

At which point, many of the advisers told me that they had heard that when Yahoo’s new CEO, Carol Bratz, came on board, she tried to rein Jack Ma in and did so in a way that caused him to lose face. The word on the street is that this is payback for that.

What will the Chinese government do? This whole thing is pretty public and if in the end it makes it seem as though Chinese companies can just go off and seize assets that belong to foreign companies (whether this is what happened or not), it will not be good for China business. Therefore, I am guessing that the Chinese government wants this matter resolved and resolved “somewhat fairly” and is probably operating behind (or in front of) the scenes to try to accomplish that.

Is this sort of thing unprecedented? Not at all. My tiny law firm has been involved in probably a dozen similar matters. The only difference here is that we are dealing with extremely well-known companies. This sort of thing goes on all the time with small and mid-sized companies and nearly every time it is due to a fault in the initial structure of the business. The Chinese company took advantage of the legal ignorance of the foreign company and set things up so that it would eventually be able to shut the foreign company out, purely legally. Is this what happened to Yahoo? I do not know.

Will this lead to a decline in foreign investment into China? To a large extent it will depend on how it is finally resolved. But probably not.

Are we going to hear more stories like this in the future? Yes. 

What do you think?

 

  • http://zhongguojinrongblog.wordpress.com/ Fredrik

    I wrote about this a while back, and just on the off chance you didn’t catch it I’ll shamelessly plug my own blog here:
    http://zhongguojinrongblog.wordpress.com/2011/05/26/what-happened-with-alipay-some-guesswork-and-musings/
    Basically I think they’re talking about two different things, Alibaba say that Yahoo agreed to transfer the company to a VIE (which it did), Yahoo complains about the VIE being deconsolidated (which they naturally didn’t agree to)

  • http://www.chinaaccountingblog.com Paul

    I think Fredrik has this right. Alibaba Group is a foreign company (Cayman Islands I think). Alipay was a WFOE and the found out that a WFOE could not get the soon to be required third party payment license. Therefore they transferred it to the VIE. I suspect they then learned that they could not get the license with the VIE agreements so they terminated the agreements. That deconsolidated Alipay and that is when Yahoo figured out they had lost something. Now, most of the value might be in the contracts between Alipay and Taobao, and that seems to be what Alibaba Group has been telling Yahoo.
    It is not a situation that deals with Chinese law and the protection of minority interests. The decision to sell Alipay to Jack Ma was made by the Cayman Islands company board.

  • Twofish

    Dan: China does not protect minority shareholders nearly to the same extent as the United States
    Pretty strongly disagree with this statement. If you own 40% of the shares of the company, but you don’t have control of the board or anyone other agreements, then as long as there is some business justification for the move, there is really nothing much that you can do about it.
    Chinese corporate law tends to be more favorable to shareholders than US law in part because the shareholders are often state entities.
    Dan: Therefore, I am guessing that the Chinese government wants this matter resolved and resolved “somewhat fairly” and is probably operating behind (or in front of) the scenes to try to accomplish that.
    I don’t see why the Chinese government would get involved at all. This is your standard “messy corporate family argument” and I see zero interest on the part of the Chinese government to step in.
    In fact, from a public relations point of view, it’s better for the Chinese government to do nothing. If you are worried about your assets getting taken over, then having the Chinese government twist arms is probably the last thing that will give you more confidence.

  • http://blog.theepochtimes.com/1/china Matthew Robertson

    Isn’t there any sense among foreign investors that the Chinese are just bad for business, then? If the prevailing sentiment is that “They’ll find a way to screw you over, and do it legally as far as possible,” then isn’t it playing with fire? The committed thief will always be able to find a loophole, or implant a subtle one in a contract, won’t he? If the assumption behind the business relationship is that the Chinese side is bringing in a foreigner in order to rip them off, and the foreigner must work very hard to make sure that doesn’t happen, then what kind of business environment is that? Also, is it possible that even if you think you’ve got a rock-solid contract with every possibility covered, that the locals could do something to screw you over that you never even considered? It all seems troubling.

  • Twofish

    Robertson: Isn’t there any sense among foreign investors that the Chinese are just bad for business, then? I
    No. The prevailing sentiment among foreign investors is that China is great for business.
    There are some factors at work here:
    1) if you talk to a divorce lawyer you may get a mistaken impression that no marriages ever work. Same with lawyers. If you have a business situation in which everyone is happy, then the lawyers are never going to see it.
    2) Everything is relative. People for whom China is their first overseas experience often run into problems because they are hitting general problems with international business.
    On the other hand, people for whom China is “just another emerging market” are usually *glowing* about the legal and business environment. It’s relative. When I’ve talk to people that have done business in Thailand, Indonesia, Vietnam, Egypt, Russia, India, and Mexico, they are absolutely glowing about how easy and wonderful the business environment in China is. The bureaucrats are clean. The government is helpful. The courts are efficient. Contracts are enforceable. That might sound bizarre if you are comparing it to Vermont, but the people that do this for a living are comparing China to Indonesia.
    3) In a lot of situations the problem really isn’t China, but it’s because the company is generally incompetent. For example, sometimes you take a company that is doing badly in China, but if you look at it, it’s doing pretty badly everywhere else in the world.
    4) Ultimately if the person that you are doing business with wants to screw you over, they can and will, and that’s true in China, the United States, or anywhere else. Business partnerships are ultimately human relationships, and a lot of running a successful business is to figure out who you can trust and who you can’t. If you can’t trust your partner, then it’s not going to work.
    Also, it’s possible to have bad relationships without either side being a thief. It’s also possible to have business relationships with people that you know are trying to screw you over.

  • Ollumi

    @Twofish
    Going to have to call bull on almost every single one of your statements, which is just a mutation of the standard propaganda of “look how bad it is elsewhere” certain institutions spread daily over media in China.
    1) I’ll leave that statement to Dan.
    2) The helpfulness of the government here is very dependent on your business, your scale, your location, and the temperature of the political climate at the time. The word I’d use for bureaucrats is “guided”. The courts vary vastly from province to province, city to city, and sometimes even district to district. Contracts are enforceable, and you probably have a good chance of winning if you can avoid the legal traps ahead of time, but usually it’s not a good way of doing business to depend on legal enforcement to complete your contract. That’s universal, what’s not is what role does the contract play when it isn’t your bludgeoning collection club, so saying a contract is enforceable is sidestepping the issue. As for your comment on people doing it for a living, I find it condescending and insulting, not to mention inaccurate. Ask Siemens, Unilever, Henkel, Google, Microsoft, all of whom I suppose are mom-and-pop shops venturing outside of their shells for the first time.
    3) This is the only statement I would agree with, but only because you tempered it with “generally” and “a lot”. People who make mistakes elsewhere are likely to make them in China as well, but that doesn’t mean China doesn’t have its own levy.
    4) This statement breaks down completely when you start talking about trust, since trust as a concept develops after a long relationship in China, not before. This is why you have people who are used to a credit system shocked all the time about “cheaters” and “frauds”.
    I remember talking strategy about Chinese SOE’s, their tendencies, and their motivations with one particular foreign executive, who scoffed the whole thing off by saying “We only buy IBM” wasn’t a phrase invented in China. No, not exactly, but neither was it a near-gospel like preternaturally widespread phenomena. If you really want to, you could probably find some example for every “offense” to business in China in another country, and that does absolutely nothing towards describing the depth, tempo, or climate of the Chinese business environment.
    If you had said some investors find China to be the ideal blend of risk and reward compared to the other countries named, I would’ve wholeheartedly agreed. It is an opportunity filled market because it is a market filled with holes and inefficiencies, not because it is a market that’s perfectly clean and fully-regulated and a utopia for investment. Going via Chinese reasoning, however, one would START by guessing at what interests motivates universal white-washing statements.

  • LH

    Analyzing this thing is impossible without all the documents laid out in front of you, especially the corporate by-laws, stock purchase agreements, etc. All the power over such transactions are encoded in those docs. The rest is guesswork.
    The timing can’t be seen as good for Chinese companies seeking to raise money on foreign equity markets, regardless. Most of the business community won’t be interested to obtain and scour those documents; their takeaway will simply be that questionable transfers of ownership are common practice in China, for better or worse. Add it to the rash of accounting fiascos plaguing recent stock offerings from China, and you have, roughly speaking, a black eye.

  • Twofish

    Olumni: Going to have to call bull on almost every single one of your statements, which is just a mutation of the standard propaganda of “look how bad it is elsewhere” certain institutions spread daily over media in China.
    It’s also what I happen to see in my daily experience.
    Olumni: Ask Siemens, Unilever, Henkel, Google, Microsoft, all of whom I suppose are mom-and-pop shops venturing outside of their shells for the first time.
    I have pretty direct experience with the China operations of one of the companies on that list.

  • Twofish

    To Ollumi:
    I’d be interested if you can list any non-developed countries that you think have a better business and legal environment than China.
    China is a wild place to do business but for a non-developed economy, it’s really, really good.
    Ollumi: Going via Chinese reasoning, however, one would START by guessing at what interests motivates universal white-washing statements.
    Because business people are used to living in an imperfect world with imperfect people and trying to figure out how to make money in those situations. Putting your money in Utopia is not an option. You put your money in China, or Vietnam or Indonesia or you stay home. The fact that China doesn’t have a perfect system doesn’t matter. You aren’t a priest, you aren’t a philosopher. You are trying to make cold hard cash.

  • http://www.pasadenacriminalattorneys.com Joseph

    An online payment business in China can only be owned by a Chinese company? Do other big nations have laws like this? It seems like this would severely limit foreign investment into Chinese economic affairs.

  • Twofish

    LH: Most of the business community won’t be interested to obtain and scour those documents; their takeaway will simply be that questionable transfers of ownership are common practice in China, for better or worse
    Not true. There are armies of people who get paid reasonably large amounts of money to scour over contracts and documents. Business is hard and time consuming because of the details, and the details are what makes or breaks a deal.

  • Twofish

    I think people are missing something basic here…..
    This very complex structures are in place only because a foreign company wants to make an investment into a field in which the Chinese government has prohibited or restricted foreign investment.
    So foreign company comes up with some complex scheme to get around a Chinese regulation. Said scheme then blows up in their face, and they lose a ton of money.
    We are then to expect that the Chinese government to do something to help the foreign company, because if they don’t then foreign companies will figure out that they shouldn’t invest in the area that the Chinese government doesn’t want them to invest. Instead we are to expect that the Chinese government will help a foreign company that tries to work around Chinese law, so that in the future the foreign company knows that when the Chinese government tells them that they are prohibited from investing in an area, that really the Chinese government wants them to invest. Because…. Well just because….
    Also, if a foreign company comes up with some convoluted scheme to work around the explicit prohibition of the Chinese government, they lose their shirts, we are then to blame the Chinese side for being sneaky and underhanded. It’s irrelevant that the Chinese side is following the contracts and the laws as written, they are being sneaky and underhanded because they….. Well did something sneaky and underhanded…. I mean if we hand over the control of the company to the Chinese partners, they must be devious and evil if they then think that they are actually in control of the company. I mean Chinese law says they run the company. The contracts as written say they run the company. But really we should run the company because well…. Just because…..

  • Jac

    Complex structures to limit foreign ownership: Trade restriction should also be held against Chinese companies across the board. What’s good for the goose…
    @twofish:
    “1) if you talk to a divorce lawyer you may get a mistaken impression that no marriages ever work. Same with lawyers. If you have a business situation in which everyone is happy, then the lawyers are never going to see it. ”
    If you talk to a divorce attorney you may get the correct impression that it’s a 49/51 chance of failure. I do not know of many investors that put money in on those odds if you are trying to equivocate!
    I invest in China and have direct experience but I limit where and what I do because of the restrictions which create this externally gray area for foreign businesses. Its not good but as international business investors (money seeking whores) we try where we can feel the safest anyway…greed. I certainly limit where, what, and how much I invest and know others who feel the same.
    When you create an that ownership restriction you create that “gray” area you choose not to see. Its very institutionalization means that some Chinese will be encouraged to take advantage of such a situation through nuances that any Jim Crow/Apartheid system (although applied to foreign ownership) sets up.
    Cannot own land in Thailand…well marry a Thai woman and have ownership in her name. How many Thai women now look for foreign men who have money for a possible investment/home purchase in Thailand? Not all I am sure but I personally know of 5 guys who have been rested free of large sums because of these types of restrictions. Some Chinese businesses will become these Thai “brides”. It creates a GRAY area of business predation that exist only by way of these laws…thus, GRAY laws. (At least how I have always understood them to be). After the coming economic disconnects the flow of industry will drain from the mountain tops of Chinese commerce to the valleys and rivers of other underdeveloped nations who have less of these restrictions. Gray again is not necessarily found directly in the black and white of contracts so much as it is in the system in which these types of contracts are necessitated in the first place.