China Joint Ventures: The Tide is Out

“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 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. 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 and European (mostly) companies are contacting my law firm’s China lawyers for help with their faltering China joint ventures. Again though, the problem for many of these companies 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 China’s laws/legal system to resolve the problems with their 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 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 China, we are effectively precluded from taking such direct action. A Stockholm arbitrator does not have 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 the formation legal work. This is a guaranteed disaster. We have seen 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, we often see joint ventures where the foreign participant has made every single one of these mistakes and more that I have not even 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 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. I strongly suggest that you next time 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….

For more on China Joint Ventures, check out the following: