This post was written by Damjan DeNoble, a 1L at University of Michigan Law School and a summer associate at Harris & Bricken (Hey, check out the new website). Damjan (pronounced Dame-Yan) is also co-editor of Asia Health Care Blog.

By Damjan DeNoble

Meet Gigamedia, a NASDAQ-listed Taiwanese video game company at the center of a controversy that nicely highlights some of the inherent shortcomings/risks of variable interest entities (VIEs). The SEC case file on the dispute between Gigamedia and T2CN reveals nearly all the ways a VIE structure can go wrong in a country where he/she who posses the chop and license reigns supreme.

The following very briefly summarizes the facts:

  1. Gigamedia (Taiwanese company registered in Singapore) acquired control over a Chinese online game company, T2CN (a BVI holding company).
  2. T2CN owned 100% of T2 Technology. The VIEs contracted to T2 Technology are: Jinyou, T2 Entertainment, and T2 Advertising.
  3. At some point, Gigamedia became dissatisfied with the performance of T2CN Corporate Executive Officer, Wang Ji, and tried to push him out with a dressed up corporate restructuring maneuver that involved Wang Ji stepping down as CEO, and stepping into a board position
  4. Wang Ji retaliated: he walked off with the seals and chops to T2 Technology (the WFOE) as well as the VIEs.
  5. Gigamedia lost out.

The point of conflict arose when Gigamedia fully expected Wang Ji to go along with its restructuring plans, just like countless other executives in corporations across the world had done before him.

As sole owner the VIEs, however, Wang Ji knew he held all of the cards and he intended to use them. He controlled T2CN’s chop and the business registration certificates of T2 Technology and GigaMedia’s VIE.  Just as importantly, he also controlled key PRC licenses and records necessary for T2CN to operate in China. Unless Gigamedia could somehow gain physical control over these things it would not be able to do business in China without having to negotiate with Wang Jin.

Wang Jin must have been fairly confident, therefore, when he chose to execute “Dealing With Foreign Companies 101”: stay quiet and appear to do exactly what the foreign company wants you to do, while actually wholly undermining what the foreign company is seeking to accomplish.

Gigamedia made the first move against Wang Ji:

As a result, T2CN, as the sole shareholder of T2 Technology, removed Wang Ji as a director of T2 Technology on July 27, 2010.  Wang Ji was also duly removed as a director of T2CN on July 29, 2010.  On August 7, 2010, Wang Ji was removed as the legal representative, executive director and manager of T2 Entertainment with immediate effect by way of a shareholders’ resolution passed at a shareholders’ meeting of T2 Entertainment.  On August 10, 2010, the newly appointed legal representatives of T2 Technology and T2 Entertainment, together with their PRC legal advisers, went to the office premises to request that Wang Ji return all properties of T2 Technology and T2 Entertainment in his possession, custody or control.  At that time, the newly appointed legal representatives were forcibly removed from the office premises.  Also, Wang Ji’s employment contract with T2 Technology was terminated on August 12, 2010.

Seven months after Gigamedia announced the restructuring and right about when it was actually time for it to begin, Wang Ji made clear what he really intended to do:

GigaMedia believes that Wang Ji currently has in his possession, among other things, the company seals, financial chops and business registration certificates of T2 Technology and GigaMedia’s VIEs.  Wang Ji also has in his possession all documents, records and data and tangible property, including license agreements, trademark and domain name documentation, held in the offices of T2CN’s wholly-owned subsidiary, T2 Technology.  The company seals, financial chops and business registration certificates of T2 Technology and GigaMedia’s VIEs are necessary for the respective entities to declare dividends and approve service fee payments to GigaMedia, among other things. These documents are necessary for GigaMedia to run its online games business in the PRC.  Under PRC law, the company seals, financial chops and business registration certificates are essential for entering into contracts, conducting banking business, or taking official corporate action of any sort.  Consequently, GigaMedia has not been able to register the resolutions removing Wang Ji from his position as a director of T2 Technology and as the legal representative, executive director and manager of T2 Entertainment.  In short, Wang Ji has effectively usurped control over T2 Technology and T2 Entertainment’s operations and accounts.

If Gigamedia had an actual ownership stake in the VIE’s controlled by T2CN,  the situation would have been salvageable, since it could have argued for the right to gain back control of the chop and relevant documentation. But because Gigamedia enjoyed only a contractual relationship with those companies through T2CN’s VIE set up, its legal options were essentially limited to regaining control of its holding company, which would not be of much help, as Stan Abrams of China Hearsay explains in “GigaMedia: the Answer to the ‘What If?’ VIE Question.”

If so much of the Gigamedia dispute comes down to someone physically controlling the right documents, where does it leave VIEs?

Probably in the same place as before any of this happened. Foreign companies do not go into VIEs so much because they like them, but because they have no other choice if they want to get involved in Chinese markets closed to foreign businesses.

Gigamedia’s T2CN’s problems should be filed away in the multi-volume treatise of China caution stories, as an example of what can go wrong between a foreign company and its Chinese partner. This story should probably be go in the section of the treatise on the importance of holding on to that still important anachronism, the Chinese chop.

For more on the Gigamedia case, I urge you to check out Seeking Alpha’s “GigaMedia Will Survive Current VIE Turmoil,“and China Finance “What’s going on with GigaMedia?

  • Added note:
    The company isn’t American, it was founded in TW and then moved to Singapore.

  • ollumi

    The whole online game industry here is kept firmly locked down by the government against foreign companies. Gigamedia had to resort to what they saw as a VIE in order to circumvent certain Chinese regulations but did not protect themselves with any precautionary measures other than “a set of contractual agreements to give effective control”, then not having enough situational awareness or accurate evaluation of their own position after becoming unsatisfied for one reason or another with the local cut and decided to go in gung-ho. That’s a lot of self-inflicted pain.