China Joint Ventures and the Hotel California Effect.

By way of explanation, here are the key lines from the Eagles’ song, Hotel California:

We are programmed to receive.
You can checkout any time you like,
But you can never leave!

China Economics Blog used the term, Hotel California effect (borrowing from a scholarly article), to describe the problems foreigners so often have in getting their money out of China. I love that term (both because it so well describes things and because it combines law and music) and I have since used that term many times with clients who insist something in China “must be legal” because so and so did it or because the local government is encouraging them to do it. If my using lyrical symbolism fails, I flat out tell them that, “of course, China will take your money, but the problem will be when you try to take it out.” I then tell them of the person who came to us after having sold his condo that he had purchased illegally and having been told by all of the banks that he would not be able to deposit his cash proceeds.

This post focuses on joint ventures and why, somewhat paradoxically, my law firm’s business both in forming joint ventures and in trying to get companies out of joint ventures has grown exponentially in the last 3-4 months. It is meant to serve as a warning to those planning to “joint venture” in China, thinking it is automatically an easier, cheaper, faster way to get into China.

We have written frequently on how to structure joint ventures so as to minimize the likelihood of harm for the foreign joint venture partner, most recently in the post, entitled, Chinese Joint Ventures — The Information The Chinese Government Does Not Want You To Know. We draft these agreements both to prevent problems and to ease the exit should something go wrong.

The down economy has had the interesting affect of accelerating the formation of joint ventures by companies that likely would have gone it alone when funding was easier and also accelerating the breakup of joint ventures due to disputes that were overlooked when plenty of money was coming in. Four to five years ago, many companies would contact my firm with very ill-formed ideas of how to go into China.

These companies were seeking to go into China not so much with well formulated plans for success, but because they were worried that if they did not go in, they would be missing the boat. To a lesser extent, those days have returned as foreign companies feel they “must” go into China because its economy, though weakened, is a last bastion for growth. Believing they lack the funds to go it alone, many mouth the joint venture mantra.

The problem with joint ventures is that their formation is virtually never easy, because the key to a good joint venture is to raise and resolve as many potential problems as possible, before entering into the joint venture agreement. It is virtually always more expensive to form a joint venture than to form a wholly foreign owned entity (WFOE). This is not a reason not to do a joint venture, but it is a reason not to think of them as easy, quick or cheap. The problem with easy, fast and cheap joint ventures comes down the road, when the problems arise.

That down the road time is now for many joint ventures. The end of the boom times means that what could once be passed over or ignored is now important. Foreign businesses that entered joint ventures 4-5 years ago are now trying to get out of them with some semblance of assets, while their Chinese partners insist that they instead put more funds into the venture.

The problem we are seeing is that so many of these hastily formed joint ventures were set up in such a way that the Western company pretty much has two choices: walk away and turn everything over to the Chinese partner or continue in the money draining venture.

China joint ventures. Do them right or you may never leave. . . .

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