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.

On June 6 and June 7, the Institutional Investors Shareholders Services (ISS) will be putting on a webcast discussing their findings from a couple reports they published a month or so ago entitled “Institutional Shareholder Services 2006 Global Investor Study,” which included their special report, “China — The Next Corporate Governance Hotspot.”

According to the ISS, this study “reflects the collective voice of the institutional investor worldwide and is unprecedented in scale and scope, with over 300 institutions across 18 countries participating.” The International Corporate Governance Blog (which tipped me off to this study) notes that the report indicates “huge corporate governance risks” in China, stemming in large part from the “close relationships among issuers and governmental agencies through state-owned enterprises and closely linked ownership structures.”

According to the ISS, the study’s key findings are as follows:

9 out of every 10 Chinese investors sees corporate governance as extremely or very important today

Chinese investors believe an increased focus on returns and risk management will drive future corporate governance importance

73% of Chinese investors listed executive pay for performance among their most desired corporate governance improvements

And 93% of Chinese investors listed better disclosure, transparency and reporting among most desired improvements

In a previous post, entitled, “Corporate Governance in China Slowly Improving,” I discussed similar findings from the Institute of International Finance and I concluded as follows:

China’s corporate culture is not yet generally imbued with a recognition of the importance of corporate transparency and China’s laws [and enforcement] are not yet strong enough to force it.

With the floodgates of Chinese IPOs open again, I would expect this webcast will be of interest to many of you.

The Institutional Shareholder Services 2006 Global Investor Study was just published and it includes a special report on China, entitled, “China — The Next Corporate Governance Hotspot.”  According to the ISS, this study “reflects the collective voice of the institutional investor worldwide and is unprecedented in scale and scope, with over 300 institutions across 18 countries participating.” The International Corporate Governance Blog (which tipped me off to this study) notes that the report indicates “huge corporate governance risks” in China, stemming in large part from the “close relationships among issuers and governmental agencies through state-owned enterprises and closely linked ownership structures.”

According to the ISS, the study’s key findings are as follows:

9 out of every 10 Chinese investors sees corporate governance as extremely or very important today

Chinese investors believe an increased focus on returns and risk management will drive future corporate governance importance

73% of Chinese investors listed executive pay for performance among their most desired corporate governance improvements

And 93% of Chinese investors listed better disclosure, transparency and reporting among most desired improvements

In a previous post, entitled, “China Corporate Governance Improving Slowly,” I discussed similar findings from the Institute of International Finance and I concluded as follows:

China’s corporate culture is not yet generally imbued with a recognition of the importance of corporate transparency and China’s laws are not yet strong enough to force it.

Apparently, the ISS agrees.

What do you think?

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International Corporate Governance Blog just ran a post entitled, “Corporate Governance in China Improving Slowly.”  The post cites a just released report from the Institute of International Finance, concluding that China has made substantial strides in corporate governance of its publicly traded companies since the Institute’s last report in 2003. This institute is made up of representatives from nearly all the big financial players (including, Franklin-Templeton, Citicorp, and UBS) and its report is comprehensive and very incisive.

The report states that it expects China’s recently enacted New Company Law to accelerate improvements in corporate governance in China.  However, the report also notes that China still has quite a ways to go before it achieves the level of corporate governance the Institute expects from developing countries and it also pointedly notes that China’s stock markets were among the ten worst performing equity markets in the world in 2005.

Bottom Line:  China’s corporate culture is not yet generally imbued with a recognition of the importance of corporate transparency and China’s laws are not yet strong enough to force it.