Not sure why (the bad economy?), but my law firm’s China lawyers have been getting a rash of China joint venture deals and possible deals over the last six months or so, many of which involve a US or EU company wanting to enter into a Joint Venture with their China manufacturer so as to work jointly on manufacturing and marketing and selling some combined product or products around the world.
One of the mistaken assumptions we are finding foreign companies are making is believing they can contribute existing China-based equipment to this sort of equity joint venture (EJV) and receive capital contribution “credit” for doing so. Virtually every time, the foreign company is getting this wrong based on the bad advice of its putative Chinese joint venture partner.
Chinese law mandates that foreign companies doing equity joint ventures contribute a certain amount of capital to the joint venture. Then, the voting power of each joint venture partner is proportionate to the capital each partner put into the joint venture. Since the foreign partner usually wants to control the joint venture it must contribute more than 50% of the capital to the venture. Since manufacturing operations are usually quite expensive, this means that the foreign JV partner must make a significant capital contribution.
To avoid having to come up with the typically very large capital contribution required, the foreign company side to these joint ventures have been telling our China JV lawyers: “We know the capital amount is large. But don’t worry about it, we have that part covered.” When we ask what they mean and what they will contribute as capital to the joint venture, their reply is “the equipment and molds and tooling we purchased and then placed in the XYZ China factory and have been using for the past year. XYZ acknowledges we own these items and we can just contribute them to the joint venture at full value. So we have the capital contribution problem already solved.”
This does not solve the problem at all because China’s rule on foreign contributions to a joint venture (the same is true for WFOEs also) is that the capital contribution must come into China from outside China for the China Joint Venture. Under Chinese law, it is unlikely the foreign company has ownership in equipment and tooling already located in China and even if it did, that equipment cannot count as a capital contribution because the foreign side of China joint ventures cannot use RMB, cash, equipment, land or intellectual property located in China for that. This is a clear rule with no exceptions.
This same rule applies to China WFOEs. It takes an agonizingly long time to form a WFOE in China and we often get contacted by companies that have “jumped the gun” and started their China business operations before forming the WFOE. In doing that, they enter into leases and purchase equipment required for these operations and they want to contribute the lease payments and equipment (or the equipment costs) to the WFOE as a credit towards their required capital contribution. For the same reasons discussed above, this does not work.
For more on what it takes to succeed with China joint ventures and WFOEs, check out the following:
- China Joint Ventures That Work
- Chinese Joint Ventures — The Information The Chinese Government Does Not Want You To Know
- Joint Venture Jeopardy (article I wrote for the Wall Street Journal)
- Badly Formed China WFOEs are Dangerous