China lawyers for joint ventures‘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, [link no longer exists] 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:

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Photo of Dan Harris Dan Harris

Dan is a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

He primarily represents companies doing business in emerging market countries, having spent years building and maintaining a global, professional network. 

Dan is a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

He primarily represents companies doing business in emerging market countries, having spent years building and maintaining a global, professional network.  His work has been as varied as securing the release of two improperly held helicopters in Papua New Guinea, setting up a legal framework to move slag from Canada to Poland’s interior, overseeing hundreds of litigation and arbitration matters in Korea, helping someone avoid terrorism charges in Japan, and seizing fish product in China to collect on a debt.

He was named as one of only three Washington State Amazing Lawyers in International Law, is AV rated by Martindale-Hubbell Law Directory (its highest rating), is rated 10.0 by AVVO.com (also its highest rating), and is a recognized SuperLawyer.

Dan is a frequent writer and public speaker on doing business in Asia and constantly travels between the United States and Asia. He most commonly speaks on China law issues and is the lead writer of the award winning China Law Blog. Forbes Magazine, Fortune Magazine, the Wall Street Journal, Investors Business Daily, Business Week, The National Law Journal, The Washington Post, The ABA Journal, The Economist, Newsweek, NPR, The New York Times and Inside Counsel have all interviewed Dan regarding various aspects of his international law practice.

Dan is licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at his firm, Dan focuses on setting up/registering companies overseas (via WFOEs, Rep Offices or Joint Ventures), drafting international contracts (NDAs, OEM Agreements, licensing, distribution, etc.), protecting IP (trademarks, trade secrets, copyrights and patents), and overseeing M&A transactions.