China's faltering economy is exposing bad joint ventures
China’s faltering economy is exposing bad joint ventures

“Only when the tide goes out do you discover who’s been swimming naked.”

Warren Buffet

We have been getting a lot of heat from one reader who keeps accusing us of pointing out mistakes being made by foreign businesses. Our excuse is the above. There is an old expression about how lawyers (old because it is true) do well when an economy is growing and when it is contracting, but not when it is stagnate. We do well when economies contract because that is when disputes arise, often because one company can no longer tolerate the status quo. I talked about this last month In Litigating or Arbitrating Against Chinese Companies 

There is an old saying about how lawyers do well when an economy is either rising or falling, just not when it is stagnating. Put simply, litigation occurs when a company has decided that the highest and best use of a particular chunk of its time and money is to sue someone. When profits are difficult to find outside litigating, litigating becomes more likely. Companies in financial pain tend to lash out by suing or by threatening to sue and we are seeing a wealth of that these days from Chinese companies.

This is my long-winded explanation for why I am about to chastise foreign companies that enter into China joint ventures without using their own lawyer to do so. I am writing about this today because as the tide of China’s faltering economy goes out, a large number of American (mostly) companies are contacting our China lawyers for our help with their faltering China joint ventures. Again though, the problem for these American companies (and thus for us as well) is that their Joint Venture agreements have been so unfavorably written that the only advise we can give them is to move on or (in one case) to sue their American lawyer who allowed them to sign it.

In many cases we are not able to assist the foreign party in a troubled JV because their original joint venture agreement has been so poorly drafted as to preclude any real assistance. Far too often, the foreign joint venture participant failed to secure good legal representation when it went into the joint venture deal, leaving us with little or nothing to work with in terms of fixing the joint venture problems. The foreign joint venture participant has made basic mistakes that make it impossible to use Chinese laws and legal system to resolve the problems that have arisen in the JV. The issues between joint venture partners more often hinge on issues relating to control and operations, which typically require a Chinese court ruling.

Our China attorneys consistently see the following mistakes with China joint ventures:

  1. Resolving a joint venture dispute usually most be done in China, either through litigation in the Chinese courts or through arbitration with CIETAC, BAC (Beijing Arbitration Commission), or some other legitimate Chinese arbitration body. Foreign partners often provide in the JV agreement, however, that litigation or arbitration must take place outside of China, either in the home country of the foreign partner or in some expensive and well known arbitration forum like Stockholm or London. This type of provision does little to nothing to protect the foreign partner and makes it difficult to impossible to resolve any joint venture disputes in China, where the problem exists. By way of an example, many companies come to us complaining that the JV’s representative director has hijacked the operations of the China joint venture company and is operating without supervision and against the wishes of the board of directors. To effectively address this issue, we must proceed in court in China directly against the rogue director. However, if the JV Agreement provides for jurisdiction outside of China, we are effectively precluded from taking such direct action. A Stockholm arbitrator does not have any authority to command changes in a China joint venture.
  2. Our China lawyers are often asked to help foreign companies in deep trouble with their China JV for reasons stemming from the foreign company’s having failed to hire their own independent legal and accounting advisors during the joint venture formation process. Instead of using their own independent counsel, these companies relied on the Chinese JV partner for all of the formation legal work. This is a guaranteed disaster. We have seen US companies that have put tens of millions of dollars into a Chinese joint venture, using no legal counsel at all, using the legal counsel of their joint venture partner, or using a local Chinese lawyer who has no experience with foreign joint ventures and no real incentive to protect the foreign company.
  3. Relying on a majority share interest to control the joint venture, rather than actually having effective control via the right to appoint the representative director and the general manager.
  4. Failing to provide protections for the foreign joint venture partner, wrongly assuming that majority share ownership would be sufficient to provide adequate protection.
  5. Failing to carefully monitor capital contributions and the use of contributions to capital, assuming that accounting reports would accurately show the money contributed.

Though the above looks like a long list, I often see joint ventures where the foreign participant has made every single one of these mistakes and more that I have not mentioned. When this happens, we as attorneys are severely constrained in what we can do to help. It is frustrating for us when we have to tell a foreign company that comes to us for legal help that their own failure to properly form and manage their China JV has made it impossible for us as lawyers to fix any of their problems. Their unhappiness often leads me to say something like, “Believe me, if we thought it were otherwise, we’d tell you; telling you that we cannot help is not good for us either because it is the equivalent of telling you NOT to hire us. Next time, please bring us on a lot earlier in the process.”

Joint venture agreements are really no different from any other contract with a Chinese company. The better the agreement, the less likely there will be problems and the more likely there will be a quick and inexpensive resolution to whatever problems arise.

Better you know this before you too find yourself exposed by the tide….

 

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Dan Harris

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

I mostly represent companies doing business in emerging market countries. It has taken me many years to build my network and it takes constant communication and travel to maintain it. My 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.

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

I am a frequent writer and public speaker on doing business in Asia and I constantly travel between the United States and Asia. I most commonly speak on China law issues and I am the lead writer of the award winning China Law Blog (www.chinalawblog.com). 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 me regarding various aspects of my international law practice.

I am licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at my firm, I focus 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.