China Joint Ventures: This Time We Blame The Victims

We are writing about joint ventures because as doing business in and with China becomes more complicated and risky we are seeing a resurgence in companies wanting to go into Chinese joint ventures and in companies coming to us needing legal assistance with their failed and failing China joint ventures.

In many cases we are not able to effectively 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. We usually attribute this to the foreign company’s originally misinformed view that “China has no laws” or that the “JV contract is not worth the paper it is written on.”

Based on these misguided views of Chinese law, the foreign joint venture participant failed to secure good legal representation when it went into the joint venture deal, leaving our law firm 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 and legal system to resolve their JV problems. Though China’s courts will often enforce foreign arbitral awards, the issues between joint venture partners more often hinge on issues relating to control and operations, which typically require a Chinese court ruling.

The following are examples of some of the basic JV mistakes we see:

1. Joint venture disputes often must be resolved 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 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 Hong Kong, Stockholm, London, Geneva, or Singapore. This type of provision does little to protect the foreign partner and makes it impossible to resolve any disputes in China, where the problem usually exists.

By way of an example, many companies come to us complaining that the JV’s representative director has highjacked 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, it is usually imperative that we proceed in a Chinese court directly against the rogue director. However, if the JV Agreement provides for jurisdiction before an arbitral body outside China, we are effectively precluded from taking such direct action.

2.  Our China lawyers are often called on to try to help foreign companies in deep trouble with their China JV for reasons stemming from their failure to hire their own independent legal and accounting advisor during the joint venture formation process. Instead of using their own independent counsel, these companies relied on their Chinese JV partner for all of the JV 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 the legal counsel of their joint venture partner or a local Chinese lawyer with little or no  experience with foreign joint ventures and no real incentive to protect their foreign client. We had one client who when he first came to us boasted of the great job his Chinese lawyer had done for only $600. His pride quickly faded when we pointed out how his joint venture had a loophole that would allow his joint venture partner to never pay his company a penny.

3.  Relying on a majority share interest to control the venture, rather than exercising effective control through the right to appoint the representative director and the general manager. See China Joint Ventures: The Information the Chinese Government does not Want you to Know.

4.  Relying on a personal guarantee from the Chinese JV partner as a substitute for failing to properly document the project.

5.  Failing to provide clearly for protections for the foreign partner, assuming share ownership is sufficient to provide adequate protection.

6.  Failing to carefully monitor capital contributions and the use of contributions to capital, assuming that accounting reports will be adequate to reveal the fate of money contributed.

Though the above may look like a long list, we often see joint ventures where the foreign participant has made every single one of these mistakes and more not mentioned here. When this happens, our attorneys are severely constrained in terms of what we can do to help. But this is not because China has no law or because Chinese contracts are worth nothing. It is because the failure to properly form and manage the JV has made fighting back against the JV sleights untenable. The blame for this falls more on the shoulders of the non-Chinese JV partner than on the Chinese side or on China’s legal system.

Joint venture agreements are really no different from any other contract. 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.