Not sure why (the still bad economy?) but my law firm has been getting a rash of China joint venture deals and possible deals over the last six months or so.  Many of these have involved a United States company that wants to enter into a Joint Venture with its China manufacturer so as to work jointly on manufacturing and marketing and selling some combined product or products around the world.

An email from one of our lawyers to a client doing such a China joint venture recently crossed my desk and I am setting it out below because it provides a good introduction to what is involved in “doing” a China joint venture.

There are two steps in forming an equity joint venture in China. The first is to enter into a written joint venture agreement between the Chinese and foreign participants in the joint venture. The second is to formally register the joint venture as a corporation under Chinese law.

With respect to these two steps, please note the following:

a. Since the JV agreement is required, we will move forward with drafting that document first. Issues related to the JV and its structure can be worked out in the process of drafting this document.

b. Please indicate at this time who you will want to use to actually register the joint venture company. There are several options:

  • The Chinese JV partner can be responsible for the registration process.
  • You can engage the services of the local investment development bureau to handle the registration.
  • You can engage our law firm to manage the registration process. If you want to use this option, I can begin working with you to obtain the required    documents and information required for JV company registration.

For the JV Agreement, I have the following questions:

  1. You have provided your desired company name. Please provide that name in Chinese. English versions of company names have no legal effect in China.
  2. Please provide a one or two paragraph statement of exactly what the joint venture company will do in China. In particular, please describe:
  • The proposed facility.
  • If you will manufacture, what will be manufactured and what will be the source of the materials.
  • If you will import, what exactly will be imported.
  • Where will product be sold? In China, for export or both? What entity will handle sales of product.
  • Will any foreign intellectual property be transferred to the JV?

Please note that, in general, Chinese JV companies are free to sell their own manufactured product. A JV company is also permitted to import product manufactured by its shareholder parent. However, in general, it is not possible for a JV company to operate both as a manufacturer and as an importer of product manufactured by companies other than the shareholder. In your emails, you indicate that you desire to obtain approval for what is normally prohibited. If this is the case, we will need to review this issue with the local governmental authorities. If they will provide you with a special approval, you should understand what that is and then make sure that you hold them to their agreement.

Please also note that a primary requirement for company formation in China is that you have a lease on a premises that is approved for the business approved for the company. For a manufacturer, this means a factory, for a trader, this means a warehouse. However, it is also possible to have an initial address that is simply an office in a case where the business plan contemplates later selection of an appropriate factory/warehouse site. Some jurisdictions will permit this, some will not.

Your proposed registered capital is $2,000,000. This means that the Chinese company will need to contribute the RMB equivalent of $400,000 in cash. Are they  aware of this requirement? Do they have the cash? I assume that your group is also planning to contribute cash. As you mention in a related email, it is best from the start to develop a basic plan for contribution of the capital. There should be a basic business plan that provides how much will be contributed, when it will be contributed and for what it will be used.

China’s legal rules for contribution of capital are as follows:

  • 15% of the total amount of the registered capital must be contributed within 90 days after registration approval.
  • The remaining amount must be contributed within two years.

It is common for local governments to impose even stricter requirements and we will need to check with the local government officials on this point. Note that they do not have the power to make the requirement LESS restrictive; they only have the power to make the requirement MORE restrictive.

You asked us how we plan to draft documents that provide for the contingency of your key Chinese counterpart dying.  Since the shareholders in the JV are corporations, the death of any one person is irrelevant to the future life of the joint venture. We will write the JV Agreement to say that your Chinese joint venture partner company has the right to select a single director for the joint venture and that the director will be Mr. ______ at the outset.  However if you believe that the participation of Mr. ______ in management of the JV is critical, you can provide the following:

  1. Mr. _______ agrees to act as a director.
  2. If Mr. ______ is not able to be a director for any reason (refuses to serve, disability, death, etc.), then the foreign shareholder [you] has the right but not the obligation to purchase the stock of the Chinese shareholder. The purchase price will be $400,000, which is the initial amount paid by the Chinese shareholder. It is your choice whether or not you want to add this provision to the agreement. You could also provide the following: in the event that Mr. _______ is not able to be a director for any reason, then 1) all three directors will be chosen by the foreign shareholder but 2) the Chinese shareholder will have a continuing right to 20% of the profits of the joint venture company. I personally prefer the second alternative since it does not require restructuring the stock ownership.

There are a number of alternative ways to deal with this issue. Please consider the options that I have proposed and let me know whether you need additional information in to make your decision on how to proceed.

You are right to ask about dispute resolution.  Dispute resolution should be in China. You can use the Zhanjiang Courts or arbitration at CIETAC in Shenzhen. Arbitration in Hong Kong will be of little to no benefit to you in resolving any disputes because Chinese courts do not recognize their decisions regarding the corporate governance of Chinese companies.  We will need to discuss the pros and cons of Chinese courts and Chinese arbitral bodies.

We also will need to discuss who you will want to be the Representative Director. The day to day business of a Chinese companies is conducted by the general manager, not the representative director. The representative director role is limited to executing important contracts. This can be done by that person without any need to be physically located in China. In any Chinese company with a foreign representative director, there is always a challenge in allocating responsibility between the two individuals. The key issue is usually control of the company seal (“chop”). However, it is always best to appoint officers who are willing and able to travel to China freely. This is not a requirement, but it does make it easier to operate the company.

In answer to your question about scheduling contribution of capital, yes you are correct that it is an important issue for China joint ventures and one that should be resolved before executing the joint venture agreement.

I trust that the above answers your initial questions and lays out a bit of what we will need to be working on over the next few weeks.  If you have any additional questions based on the above, please don’t hesitate.

A member of our China Law Blog Group on Linkedin left the following comment (modified slightly) regarding Chinese company names, prompting this post:

Recently I happened to meet with a Chinese lawyer in Qingdao who told me about how the Province [Shangdong] registers the Chinese name of a company. The companies are registered only with Chinese names. Let’s say for a contract with an Indian or a US company they do use just the English name. He says it is compulsory to have the contract in English and in Chinese also. Otherwise the Chinese company simply can deny its English name to avoid participating in the arbitration. Is this true? How we can make a contract foolproof without making a Chinese contract?

Great questions.

Let me start out by saying that we are of the view that in most cases it makes sense to have your contract with a Chinese company be in Chinese.  We explain why we take this position in China OEM Agreements. Why Ours Are In Chinese. Flat Out:

Because international contracts are so often between parties from different countries, they commonly are written in two or more languages. Nearly all of the contracts we draft for our Western clients doing business in China are in English and Chinese (though about ten percent of the time, we also translate them into German, Spanish, Korean, or French as well). This duality of language can, if not handled properly, pose big problems.

When we do a contract in both English and Chinese, we always call for the contract to specify ONE official language to control if there is a dispute. We do not advise drafting a contract that is silent on the official language, nor do we advise drafting contracts that call for both English and Chinese to apply. Having two official languages pretty much doubles the chances for ambiguity and pretty much doubles the attorney time (and fees) that will be incurred in fighting over the meaning of the two contracts. It is expensive enough litigating on one contract; there is no benefit litigating on two.

So the question for us comes down to whether English or Chinese should be the official language of the contract and the answer to that question requires we first decide where we would most like to see disputes resolved. If we go for arbitration in English (and if the Chinese manufacturer actually agrees to this, which is quite rare), then we almost certainly will want English as the official language. But if we decide the Chinese courts will be the best place to resolve conflicts, then we want Chinese to be the official language.

But, having said this, it is not true (as many seem to believe) that English language contracts will be deemed invalid by Chinese courts or arbitral bodies.

But what about company names?  The only official company name is the Chinese language version and this is true as well for WFOEs in China and Joint Ventures as well.  If you are going to form a China WFOE, you must come up with a Chinese name for your WFOE and that Chinese name will become your one and only official name.

But must one put the Chinese name on any contract with a Chinese company?  No, this is not required, but it is certainly smart to do so. I have actually never heard of a Chinese company claiming it is not them who signed a particular contract using the English language version of their name, but it absolutely does not surprise me to hear that happens.  Our firm has always used the Chinese language version of a Chinese company’s name, even on the English language version of our contracts and we do so for clarity. We also typically put in the address of the company as well and sometimes its license number as well.

I can certainly imagine a Chinese company seeking to get out of a contract by claiming that it never signed one because the contract at issue does not contain its Chinese language name. But at the same time, I also think that someone facing such a claim ought to — in most instances — be able to prevail against it by marshaling evidence to show that it was indeed the Chinese company that signed the contract. This will be particularly easy if the Chinese company has a well-known and often used English language name or if the English language name is a direct translation of a unique Chinese language name.

I actually think the bigger issue regarding contracts with Chinese companies is whether the contract is sealed or not.  In How To Write A Chinese Contract That Works, we wrote on how Chinese companies were notorious for trying to get out of contracts they had not sealed/chopped:

For written contracts in China to be effective, one of the following must be true:

  1. The company’s legal representative signed it. Chinese law provides that a company’s legal representative has apparent authority to bind the company. This means that even if that representative lacks the actual authority to bind the company (maybe because the board of directors or the shareholders never gave the representative the authority to contract with you), the legal representative’s signature will bind the company. There is, however an exception to this and that is when you know that the legal representative lacks the authority to bind the company.
  2. The contract is appropriately sealed.  An appropriate seal (oftentimes called a chop) is applied to the contract. It does not matter who applies the seal, so long as it is the right seal. This means it must be sealed either with a contract seal that sets forth the name of the company or, as is more commonly done, with the Company Seal. Each Chinese company has only one company seal (no copies).

Chinese companies are notorious for trying to get out of contracts by claiming they never actually signed them or that they were signed without the proper authority and so if your contract is big enough and important enough, you should consider doing all of the following to minimize even further the likelihood of the Chinese company seeking to get out of your contract:

  1. A signature from the company’s legal representative. Of course, you must first confirm from the company’s business license who exactly is the company’s legal representative.
  2. A resolution from the company’s board explicitly approving the contract and authorizing the legal representative to sign it.
  3. The affixation to the contract of the company seal or the company’s contract seal.

In that same post, we set out the basics of what it takes to write a good Chinese contract:

If you want to greatly increase your chances of being able to enforce your contract with your Chinese counter-party, you should do the following (you should do a lot more than this, both within and outside your contract, but I am limiting this post to just those things directly related to being able to enforce the contract and its terms)

  1. Have a written contract (see this, this and this);
  2. Have that written contract be in Chinese;
  3. Have that written contract set out clearly how disputes are to be resolved and, even more importantly, pick the right forum for those disputes;
  4. Have that written contract set out in excruciating detail what the Chinese company must do to be in compliance with the contract;
  5. Set out the liquidated damages the Chinese company must pay if it fails to comply with the contract;
  6. Make sure the Chinese company signs AND seals your contract.

It is impossible to make any contract foolproof in that there will always be risks in any deal, but doing the above will increase your odds.

What do you think?

 

 

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Nearly a year ago, we wrote about the importance of including “seal confirmation” in your China due diligence:

One of our recurring themes is the need for due diligence when working on any business matters in China. Most foreign companies think of due diligence only when they are planning to make an investment. Most companies are not aware that due diligence is required whenever you do any kind of business with a Chinese company. If you do not already know the Chinese company with which you will be conducting business, you must confirm that the company really does exist and that you are dealing with the actual company and not an impostor.

I want to share a conversation I had yesterday with some young Chinese lawyers who work for the one of the largest and best law firms in Shandong province. I was discussing with them the question of whether or not the company seal on a particular document was valid or not. It seemed like a simple matter. The resulting conversation was not so simple.

When asked how they go about confirming the validity of a seal, the lawyers told me that “you have to go the town where the company is located.” Once there, you then have to determine if the seal is registered. Often the seal is not registered as registration of seals is not mandatory in China. Then you inspect various documents filed with the local authorities to determine if the same seal was used on those documents. If the seal is registered, or if the same seal was used on all company documents filed with the local authorities, you know that the seal is valid.

Even this is not enough. Even though the seal is valid, you still have to determine if the seal is being used in an authorized manner. Just on the surface, there are two possible issues. First, an impostor may have created a fake company seal. Second, someone within the company may be using the seal in an unauthorized manner. The only way to resolve these issues is to actually visit the company at its headquarters and to ask: is the person who stamped this document employed at your company? If the answer to this is yes, you then must ask whether the person is authorized to do this particular business.

An affirmative answer to both these questions is the only way you can be assured that the signature and the seal on your document are valid and will effectively bind the company. There is no other way to do it: a visit to the relevant  government office and to the company office is required. There is no service available to do the work. You have to hire a Chinese licensed attorney to do it. A Chinese attorney is normally required because local governments rarely open their files to a private person and they certainly will not open their files to a foreigner.

My first response to all of this was to say that this is far too expensive a procedure for normal commercial transactions. The Chinese lawyers looked at me with a mixture of amusement and contempt. They said that they understand my response since it is typical of their North American and European clients. They further stated that they are amazed at the naivete of their foreign clients on the need for basic due diligence in commercial transactions. One lawyer looked at me and said: “What do you think we do all day at this law firm. Most of our young lawyers and legal assistants are primarily engaged in basic due diligence about potential business partners of our Chinese clients. We travel to the local offices and we charge for the expense. Our Chinese clients willingly pay the fee because they know the risk is too great to act in any other way. We constantly see foreign companies enter into contracts without doing any such investigation and it continues to surprise us. You say that our form of due diligence is too expensive. We say that being cheated is far more expensive. Given that the chance of being cheated in China is extremely high, it makes no sense to us to take the risk. Our Chinese clients would never enter into an important contract without a personal investigation of the other side and we find it very strange that these foreign clients who know even less about China will willingly take a risk that virtually no Chinese company would take.”

It makes sense to take seriously what these young Chinese lawyers are saying. Let me give you just one example of what can go wrong in China. Say you are dealing with a large and well established Chinese company. There is no question that this company exists and that it makes the product that you wish to purchase. Now ask yourself this: are you really dealing with that big company? Or are you dealing with an impostor? How do you know?

It is easy in China to fake company seals, business cards, bank accounts and even a website. The unsuspecting foreigner makes a deal with the impostor and sends funds to the bank account. Product never arrives. The foreigner contacts the well established Chinese company and that company truthfully responds by saying “we have never heard of you.” It turns out the foreigner had been dealing with a fake, virtual company the entire time. This happens all the the time in China. Trust me when I tell you we see instances of this at least once a month.

One of the services we are constantly providing for our clients is what I call the “first pass review” of a company seal. In this review, one of our China lawyers who is fluent in Chinese and very experienced with Chinese contracts will review a seal for our client. This review consists of pretty much nothing more than looking at it to determine whether it may be fake or not. If this review cannot determine that the seal is fake, we then suggest our client conduct a more thorough review to confirm that it is real. This is because our first pass review is good at spotting obvious fakes, but it certainly is not good at making sure that a seal is real or that the seal really did come from the company it represents or that it really was authorized by the right company. But as a gratis first pass, it does have its benefits. Shockingly often in fact.

Let me explain.

As stated in the post above, at least once a month we come across an instance where there is something very wrong with the seal/Chinese company with whom our client is thinking of entering into a  deal. My favorites are when we detect that the seal is a fake, which has been happening more often in the last six months than in the past — it is amazing how direct and quick a correlation we see between a declining economy and a rising incidence of fraud. Just last week, I was cc’ed on some emails between two of our lawyers doing a first pass review of an alleged company seal. The email exchange was as follows:

First email:  Attached please find one of our OEM agreements, signed and stamped by the Chinese side. Please note the following that seem out of whack to me:

1. The seal is in blue and not red ink
2. The seal is rectangular and not circular
3. The seal is almost illegible — does that matter?
4. The signature is the Chinese manufacturer representative’s English name

Also, the client tells me that he signed it and scanned it to them for their signature, but they sent back a copy with their signature but without his, and asked him to sign the copy they had signed. Is that normal?

Second email:  None of this is normal or legally binding. The seal should be circular, the ink should be red, and the company name should be entirely in Chinese. The seal should also always be completely legible.  And why is the manufacturer signing with his English name?  A lot is not right here and you should so instruct the client.

Aww snap. You didn’t know?

If you want to greatly increase your chances of being able to enforce your contract with your Chinese counter-party, you should do the following (you should do a lot more than this, both within and outside your contract, but I am limiting this post to just those things directly related to being able to enforce the contract and its terms)

  1. Have a written contract (see this, this and this);
  2. Have that written contract be in Chinese;
  3. Have that written contract set out clearly how disputes are to be resolved and, even more importantly, pick the right forum for those disputes;
  4. Have that written contract set out in excruciating detail what the Chinese company must do to be in compliance with the contract;
  5. Set out the liquidated damages the Chinese company must pay if it fails to comply with the contract;
  6. Make sure the Chinese company signs AND seals your contract. 

This post is going to focus on the signing/sealing requirement, because it matters and because American (that includes Canadian) and British companies seem to get this wrong way too often.

In many countries, including the United States, apparent authority is a pretty broad concept. Grossly simplified, it means that if an employee reasonably looks as though he or she has authority to enter into a specific contract on behalf of the company, the company will be bound to that contract. Here is an example. At my law firm, our legal assistants/paralegals are always ordering office supplies from Office Depot in fairly small increments — maybe USD$50 to $150 at a time. And our law firm always pays these Office Depot bills. If my law firm were to refuse to pay a $75 bill tomorrow by claiming that we had never authorized the Office Depot order, Office Depot could sue us and they would surely win. They would win because we have clearly let the outside world believe that our legal assistants and paralegals have authority to make such orders on our law firm’s behalf. But what if one of our legal assistants ordered $50,000 in computer equipment sent to his or her house? Would we have to pay? Almost certainly not. 

But that is the United States. China has a much more limited apparent authority concept and it can be so prone to dispute that you may better off pretending that it does not exist.  

For written contracts in China to be effective, one of the following must be true: 

  1. The company’s legal representative signed it. Chinese law provides that a company’s legal representative has apparent authority to bind the company. This means that even if that representative lacks the actual authority to bind the company (maybe because the board of directors or the shareholders never gave the representative the authority to contract with you), the legal representative’s signature will bind the company. There is, however an exception to this and that is when you know that the legal representative lacks the authority to bind the company.
  2. The contract is appropriately sealed.  An appropriate seal (oftentimes called a chop) is applied to the contract. It does not matter who applies the seal, so long as it is the right seal. This means it must be sealed either with a contract seal that sets forth the name of the company or, as is more commonly done, with the Company Seal. Each Chinese company has only one company seal (no copies).

Chinese companies are notorious for trying to get out of contracts by claiming they never actually signed them or that they were signed without the proper authority and so if your contract is big enough and important enough, you should consider doing all of the following to minimize even further the likelihood of the Chinese company seeking to get out of your contract: 

  1. A signature from the company’s legal representative. Of course, you must first confirm from the company’s business license who exactly is the company’s legal representative.
  2. A resolution from the company’s board explicitly approving the contract and authorizing the legal representative to sign it. 
  3. The affixation to the contract of the company seal or the company’s contract seal.

What do you think?

We are constantly getting calls/emails from companies that have contracted with a Chinese company and then get cold feet regarding the validity of their contracts. After we explain to them how it is better to contact us before they sign the contract, we answer their questions. Here are three that epitomize the sorts of questions we get, along with our answers:

Q.  “We recently entered into an agreement to buy product from a Chinese company. I just noticed that the Sales Manager of the Chinese company signed the agreement. Do you see any immediate issues with a Sales Manager lacking authority to bind the Manufacturer?”

A.  The issue is not so much who signed on behalf of the Chinese company, but rather, whether the document was stamped with the Chinese company’s seal. If the document was signed by a Sales Manager and stamped with the correct seal, it is binding on the company. If the Chinese company’s seal is not on the contract, then you may well face issues down the road.  

Q.  We entered into an English languagea agreement with a Chinese company and I just read that the Chinese courts do not enforce agreements in any language other than Chinese. What should we do?

A.  The courts in China will enforce agreements that are in languages other than Chinese. if you are going to need to resolve your contractual disputes in a Chinese courts, you are better off having your contract in Chinese, but that is not absolutely necessary. For more on this issue, check out “China OEM Agreements. Why Ours Are In Chinese. Flat Out.” Short of requesting a new contract, however, there really is not much you can do about this one.  

Q.  The Chinese company had their attorneys review our agreement. Their attorneys used footnotes in Chinese to provide feedback. I asked that the footnotes be removed, which they were, but the footnote numbers remained and one of the footnotes does as well. Does this pose any issues that you can think of (specifically having footnote numbers without corresponding text)?

A.  I doubt the footnotes without corresponding text will have any impact, but the footnote with the Chinese text may now be part of your contract. We would have to review the contract to better assess this.