Archives: joint venture agreement

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.

Earlier this week, I was talking with a client regarding a potential China Joint Venture (JV).  In our initial conversation, I told him of how difficult and yet important it is to do joint ventures correctly from a legal perspective and of how negotiating joint venture deals can be so time consuming and then had to run off to a meeting.

A few days later, we resumed our call.

In our second call, the client told me that he had since spoken with a high school friend of his, who is the General Counsel for a large international auto parts manufacturer. The client told me that his friend had told him that for a Joint Venture to work in China, the American company would need to be able to have someone in China pretty much all the time to monitor the day to day goings on at the Joint Venture. Without this, said the General Counsel, the Joint Venture would be doomed to fail. The client asked me if I agreed with that and I immediately said “yes.” I then relayed how co-blogger Steve Dickinson and are of of the view that the successful China Joint Venture nearly always involves close monitoring of the joint venture by someone who both knows China and can be 100% trusted by the American joint venture partner. Without that, the chances of a joint venture working out for the American company are slim.

The Foreign Entrepreneurs in China blog recently did a post, entitled, “A Joint Venture Survival Guide. 22 Facts and 22 Practical Tips.” This post includes the need to monitor and a whole lot more. If you are in a Chinese Joint Venture or contemplating entering into one, you absolutely should check out that post, and to whet your appetite for it, I list my five favorites from it below:

  • “The foundations for your success will be laid before you sign the deal.
  • Put in writing what will happen to the JV and to your participation in it if and when things start going wrong.
  • Your potential Joint Venture partner’s “connections” can be a double-edged sword.
  • “Let me guess: your Chinese partner wants to contribute the land to the joint venture.”  I love this one because it is virtually always true and it is virtually always true that your potential partner will value it at more than double its true market value.
  • Your employees will be used to “suck your money away” from you.

For more on China Joint Ventures, I again urge you to check out the Foreign Entrepreneurs’ Post and also the following:

For more on what it takes to succeed with a China joint venture, check out the following:

What do you think?

Many moons ago, a company contacted us wanting to sue its Chinese joint venture partner for having “clearly” violated their joint venture agreement. We looked at their case and advised them not to bother pursuing it.

It had nearly every hallmark of the China deal gone bad, due almost entirely to the fault of the American company. Here were just some of its shortcomings:

  • The contracts between the Chinese and the American company were drafted by one lawyer. A local lawyer in the small town in which the joint venture is located? Who do you think this lawyer favored.
  • The joint venture was supposed to fulfill all sorts of obligations to the American company. In fact, it was these obligations that made the joint venture so tempting to the American company. But, the contracts were written so that these obligations were attached to the Chinese company that was entering into the joint venture, not to the joint venture itself. The Chinese company that had these obligations was (unlike the joint venture) utterly incapable of fulfilling them and, since it had no real assets, it was also a terrible candidate to sue. 
  • There were three contracts in two languages each, Chinese and English. The relationship between the three contracts was murky at best.
  • The English language contracts were horribly written and in some places incomprehensible. In the end though, we decided that was irrelevant. The English language contracts seemed to say that they would have the same force as the Chinese language contracts. But the Chinese language contracts (no surprise) said that the Chinese language contracts would control. This would mean that they would. Of course the Chinese language contract had all sorts of things in it that were very bad for the American company and that were quite different

Needless to say, this was a disaster in every way. But the two items most deserving of scrutiny are how the American company “just assumed” that the Chinese lawyer would equally represent the two sides and that the Chinese translation either didn’t matter or fairly transcribed the English.

Bottom Line: The lessons to be learned from this badly botched joint venture apply to virtually any China contract or relationship.

I recently read an email from co-blogger Steve to one of our existing clients. Our client was seeking legal advice regarding a potential China joint venture investment. Steve responded with a very long email, some of which I can reveal here and some of which I cannot. I am running an excerpt from that email because it nicely highlights some of the basic issues that typically and initially arise when dealing with a China joint venture investment.

Here’s Steve’s email:

If you plan to invest in China, you will need to do so via a joint venture company. If the existing company in which you are interested in investing is already a joint venture, you will be able to come in as a new joint venture owner. If the existing company is not a joint venture, it will need to be converted into a joint venture. In general, we will need to cover the following:

  • Due diligence to ensure that the Chinese entity is legitimate. Many China companies with Taiwanese investment were NOT properly formed in China.
  • You will need a very careful joint venture agreement that sets out the rights of all the various investors.
  • You will need sales/distribution and related agreements to cover the purchase rights of your side of the deal. Many people forget to do this and this can be a big mistake. We have handled a number of matters for American companies who went into a joint venture just assuming they would get the joint venture product at a discount and that ended up not being the case. In fact, in some cases, the joint venture has refused to sell to them at all.
  • If you are transferring any technology, you will need agreements to protect your technology.
  • Normally, it will be best for your investor group to establish a company in Hong Kong first and then have this Hong Kong company be the investor in China. This almost always provides substantial tax benefits. It also provides flexibility, since you can deal with the investor group issues in Hong Kong as opposed to in China. This can be quite important if you will have changing investors over time. Changing ownership in Hong Kong will nearly always be considerably faster, cheaper and easier than doing so in China. 

In any event, the first step is to do due diligence on the Chinese side and to design the basic structure of the deal. Also note that the business you are looking at is in a very hot indsutry and so you should take extra care to make sure you are dealing with people who can perform. There are many, many fraudulent companies operating in this industry in China.

What do you think?

‘You sit by yourself grasshopper. What do you think of?’ -Master Po
‘My mother, my father. Both gone. I am alone.’
‘You hear the flock of birds flying overhead? You hear the fish? The beetle?’ To all of this the young Caine nods. ‘In this crowded place you feel alone. Which of us is the most blind?”

Kung Fu, Episode 1.

Lawyers (myself included) are loath to weigh in on someone else’s pending legal matter for fear of being proven wrong by not having all of the facts. So despite having received a couple of emails from readers suggesting I discuss the brouhaha between Groupe Danone and Wahaha (yes, that was an attempt to rhyme), I had read nothing more than a few headlines.

I started reading some articles today on it though and my eyes just about popped out of my head.

By way of very brief background, Danone is a food conglomerate based in France, the maker of Danone dairy products and Lu biscuits, and the bottler of Evian and Volvic water.  Wahaha is China’s leading and best known domestic beverage company.  It was also the focus of a full chapter in James McGregor’s book, One Billion Customers (a true must-read for anyone doing business in China).

In a Xinhua story, entitled, Fight between beverage giants spills out in public, Wahaha’s president, Zong Qinghou, is quoted as saying that “the original agreement between the two beverage giants was never approved by China’s trademark office and so is not in force or effect.” Wahaha’s president says Wahaha signed the contract, but admits it is not valid because it was never properly recorded.

In a letter posted on one of China’s major web portals, Sina.com, Zong said a trademark-license contract must be approved by the Trademark Office of the State Administration For Industry and Commerce but he never submitted the original which restricts China’s largest drink producer from independently expanding.

“We did sign the contract,” admitted the president of the Hangzhou-based conglomerate. “At the time, Wahaha was only focused on management concerns and the interests of employees and knew nothing about capital operations.”

“My ignorance and breach of duty brought trouble to the development of the Wahaha brand,” said Zong.

“Wahaha has fallen into a trap deliberately set by Danone,” he said.

Near as I can piece together from this article and from another article in the Wall Street Journal, it appears the joint venture agreement between Wahaha and Danone had Wahaha licensing all rights to its name and other trademarks to the Danone-Wahaha joint venture.  It also appears Danone either thought Wahaha was going to record this licensing agreement with the government or never even realized such a recordation would be required.

Now if what it appears (from the above) to me to have happened here did in fact happen here, Danone has fallen victim to one of the oldest tricks in the book. I describe it as such because back in the “pre-China days” when licensing IP in Japan was so popular, Japanese companies commonly did this to foreign companies in Japan, and Chinese companies now commonly do this to foreign companies in China. The “this” that was commonly done was intentionally failing to record an IP licensing agreement so as to prevent any licensing transfer from actually taking place.

In China today, some IP licenses must not only be recorded for the licensing transfer to take effect, they must first be approved by the government. I understand there was a time in China when all IP licensing needed not only to be recorded with the government, but also pre-approved by the government and I think this may have been the case back when the Danone-Wahaha licensing agreement came into effect, but I do not know if the newer laws on this operate retroactively or not.

Wahaha seems now to be justifying its actions to the Chinese media by going on the offensive, claiming Danone “trapped it” into licensing out its important, Chinese, IP. The thing is that if the licensing agreement was never recorded, Wahaha may well be entitled to prevail under the prevailing interpretation of Chinese law.

I find it very interesting that the Western media and blogosphere have so far completely ignored this licensing recordation requirement and are instead focusing on how Wahaha “breached” its agreements with Danone. But if the licensing transfer never in fact took place, we must start at least raising questions as to whether Wahaha actually breached its agreement with Danone at all. I say “raise” questions because I am woefully short of sufficient facts to give any answers to this question. There is also no way I am going to engage in the hundreds of hours of legal research that will likely prove necessary to answer this question once armed with the facts.

Not only is this Danone-Wahaha fight interesting for what it appears to teach regarding Chinese IP licensing laws, it is also a fascinating story of what can (and nearly always does) go wrong with Chinese joint venture deals.  In a Wall Street Journal article written by James T. Areddy, entitled, Danone’s China Deal Goes Sour: French Food Firm Accuses A Leading Businessman Of Undermining Venture, Areddy talks about how Danone is accusing Wahaha of undermining their joint venture with “a mirror organization” of manufacturers and distributors.  The article calls this dispute an opportunity to take “a rare peek at tension inside a joint venture between a Chinese company and its foreign partner,” and that is exactly what this is.

Emmanuel Faber, president of Danone Asia Pacific accuses Wahaha of producing “the whole range of our [the JV’s] products.” Wahaha responds to this by stressing its Chinese roots:

Danone’s accusations follow a report Mr. Zong released last week on a Chinese Web site that accused Danone of trying to take control of businesses he owns and saying terms of their existing agreements are unfair.

Mr. Zong founded the Wahaha group in the late 1980s. In 1996, he and Danone started to set up a series of joint ventures to sell products under the Wahaha name. Danone says that in China, it now owns 51% of 38 joint ventures in partnership with Mr. Zong, who remains chairman of the joint venture’s umbrella company.

When Danone and Mr. Zong struck their initial deal in 1996, joint ventures were often required to do business in China or were seen as a quick way for entry into the market. But increasingly, foreigners have tried to go into China on their own, concerned by stories of partnerships gone awry.

The stakes for both sides are high. Danone’s main toehold in China is Wahaha, and the accusations challenge the integrity of one of China’s most famous consumer brands, which remains closely identified with its founder, Mr. Zong. China represented 10% of Danone’s global business last year, and the company says 75% of the ‘1.4 billion ($1.9 billion) in Chinese revenue it reported last year came from legitimate sales of Wahaha products.

Yet, Danone now estimates Mr. Zong’s own operations sold nearly as much as the joint ventures. The calculation is based partly on Mr. Zong’s own assertion that his private businesses rival the joint venture in size.

Wahaha does not appear to deny any of these accusations, but instead invokes Chinese nationalism in its defense, saying that if Wahaha signed a contract requiring Wahaha to do X, then Danone must now sign a contract requiring Danone to do X:

In his online comments, the 61-year-old Mr. Zong pitted himself as a defender of China against Danone. He didn’t specifically address some of the company’s assertions. Instead, Mr. Zong said it is unfair that Danone has separate joint ventures in China making juice and milk under other brand names that compete with the Wahaha-branded products. “So these terms are unfair and need to be revised. Either you call off the restrictions on us, or I add restrictions on you,” Mr. Zong said.

The extent of Wahaha’s “mirror operations” appears to be so huge and so intertwined with the operations of the Danone-Wahaha joint venture, that virtually nobody is capable of figuring out who is who and who owns what anymore:

Mr. Faber said yesterday that Wahaha products are being made at factories owned and managed by Mr. Zong’s family interests that haven’t been approved under the joint venture. Some of these products are secretly fed into the joint venture’s existing sales network, the Danone executive said; others are sold separately. “It’s normal that employees, distributors and others would get confused,” Mr. Faber said.

My favorite quote from the article, because I am constantly telling our clients to be on guard for this, is that the Danone-Wahaha joint venture is using factories secretly owned by Mr. Zong’s family to do outside manufacturing for the joint venture:

In addition, he [Mr. Faber] said, some factories designated as third-party manufacturers for the joint venture are secretly owned by Mr. Zong’s family.

Using a joint venture to enrich relatives is probably the oldest, the simplest, and the most common joint venture trick known to man. It is nearly always the first example my law firm’s China lawyers give to clients for why they must be so careful when considering a China joint venture.

Here goes.  Typically, the reason for a joint venture is to make profits by taking advantage of a local company’s on the ground knowledge and expertise.  Typically, this means the local, in this case Chinese, company will be in charge of hiring and/or subcontracting out.

The goal of both the foreign and the Chinese company is to make as much money as possible from the joint venture. This “common goal” leads the foreign company to believe its interests are aligned with its Chinese joint venture partner, when in reality, nothing could be further from the truth. The foreign company is expecting to profit from the joint venture’s sales. The Chinese company, however, may very well be planning to profit from its right to operate the joint venture.

The joint venture company may need only 25 employees, but the Chinese company goes out and hires 50 relatives. The joint venture may be able to hire good employees at $150 per month, but the Chinese company goes out and hires 500 employees at $250 per month to get $100 monthly kickbacks from each of them. Company A may be the best outside company to make a component part for the joint venture and it can do so at $1 a part. The joint venture company, however, goes out and contracts with company C to make the component part at $2 a part because company C is secretly owned by the owner of the Chinese company in the joint venture.

It goes on and on, but it is tricks like these that make profitable joint ventures about as rare as a coconut in Antarctica.

Beware the joint venture.

For previous posts on the China joint ventures pitfalls, check out the following:

For more on the Danone-Wahaha war, check out the following:

I am now hooked on this story and I will report back when I learn more.