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Everything You Always Wanted To Know About China VIEs. The Transcript.

By Dan Harris on Posted in China Business, Legal News

On November 4, CLB’s own Steve Dickinson participated in an Internet discussion regarding Variable Interest Entities (VIEs) in China. The discussion was entitled, “Foreign Ownership in China: Still VIEable?” and the other participants were China Hearsay’s Stan Abrams (an attorney), China Accounting Blog’s Paul Gillis (an accountant), and China Finance Blog’s Fredrik Öqvist (a financial analyst).  A full transcript of the proceedings can be found here. If you have any interest in VIEs or investing in the companies that have VIEs, I strongly urge you to read the transcript. I also urge you to check out this post on VIEs, which has a long list of good readings on VIEs.

What I found most interesting about the discussion is that everyone seemed to agree that Chinese courts will not enforce the contracts on which VIE structures are based. In light of this, what exactly do U.S. listed companies with VIE structures really have in China?

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    I am not sure why U.S. companies still have VIE structures in China. I guess it’s easier to stick with what you have vs. changing it up even in difficult times.

  • Twofish

    Dan: What I found most interesting about the discussion is that everyone seemed to agree that Chinese courts will not enforce the contracts on which VIE structures are based. In light of this, what exactly do U.S. listed companies with VIE structures really have in China?
    Someone that stands to loose access to money outside of China if they don’t behave.
    The main enforcement of VIE contracts appears to be the fact that the Chinese company will lose their US listing (and access to US financial markets) if they violate the contracts. Also in many situations, the overseas company is in fact controlled by the Chinese company. Also the contracts are usually designed so that they are enforceable in a US court. If the Chinese company breaks the contract, you don’t go to China, you go to Delaware and kill the Chinese’s companies overseas funding.
    One reason that VIE’s seem to be popular among media companies is that media companies don’t have much in the way of assets to begin with, so getting court judgments in your favor aren’t going to help anyway.
    Also, the situation in which you have no legal recourse to assets in China is not a new one. Practically all overseas Chinese listed companies are structured so that it would be difficult to get access to the Chinese assets anyway. Typically, you have a holding company in China, and what is being listed in a subsidiary. If the parent company transfers the Chinese assets from the subsidiary into the parent company, then you are out of luck.
    For that matter, you usually don’t have much in the way of legal recourse for *any* stock investment. If you put money into GM stock, and the company goes bankrupt, you aren’t going to get anything through the courts anyway (business judgment rule etc. etc. etc.)
    One analogy for this is that legally speaking, under US law, the President of the United States can order a nuclear strike against Shanghai and under Chinese law, the President of China can order a nuclear strike against Los Angeles and there is nothing that a US or Chinese court can do to stop this. However, I don’t think that this is going to happen tomorrow, because there are other constraints involved here (i.e. if the US nukes Shanghai, China is going to nuke Los Angeles and vice versa).

  • Russell Bateson

    I thought you should be telling us the answer to the question you pose “what exactly do U.S. listed companies with VIE structures really have in China?”

  • Twofish

    Dickinson: The new rules say unequivocally that a structure that uses contractual
    devices to evade the requirements of Chinese law is invalid and unenforceable, and that
    the government has the right at any time to instruct the Chinese entity that it’s so
    controlled to either terminate the control or be — have their license to operate revoked.
    As a matter of law, I strongly disagree with this statement. That’s simply not what the regulations say. Also, as far as telecommunications goes, the Telecommuncations Law gives the Chinese government discretionary authority to shut down an internet company regardless of whether it’s been obeying regulations or not.

  • Twofish

    One point is that if as an investor you have to go to court, you’ve already lost your money.
    Dickinson: It might happen tomorrow. It might happen in 30 years but the day the
    money reverses you’re going to see a different point of view, and when you invest I
    assume you want your money to come back to you. Maybe I’m wrong.
    Private equity firms typically look at things with a five to ten year horizon at which point they cash out. If things blow up after they cash out, then it’s not their problem, and most companies that they invest in are going to blow up. PE firms go in *knowing* that they are probably going to lose their investment on a deal, but it’s the somewhat rare situation in which you hit a home run that makes up for it.
    As far as public companies, it makes a big difference whether it blows up tomorrow or thirty years from now. If it blows up in thirty years, then the odds are that you’ve made enough money to far, far exceed what you’ve invested.
    Either you think that you are going to make enough money to make it worth your effort to be in China or you don’t. If you do, then the corporate structure isn’t going to matter much. If you don’t, then the corporate structure isn’t going to matter much, because there isn’t any sort of legal structure that will save you if the government decides to crack down.
    The other thing is that VIE is only one of a dozen corporate problems that PE firms face, and it’s not even the largest. The biggest problem is that there is no easy way under Chinese law to create preferred shares of a company.
    Gillis: So they’ve got to allow a company like Baidu to take their Chinese
    corporation and list it directly in New York the same way that it allows Petro China to list directly in New York.
    Except that PetroChina is 85% owned by the China National Petroleum Company which has got the same board of directors.
    What the Chinese government gets out of the VIE structure is someone physically in China that they can toss in jail if something goes wrong.
    What the Chinese government has ultimately got to do is to set things up so that Chinese companies can get capital in China, but that’s going to take a while to set up.