Four Keys to a China Joint Venture That Works

Not sure why joint ventures seem to go in waves, but my law firm’s China JV lawyers have been getting more than usual lately. I suspect it has something to do with increased flexibility on the Chinese side as a reaction to recent fears regarding China’s economy.

In any event, our recent joint venture work has gotten me to thinking about what it takes for a China joint venture to succeed. Based on both our own observations and also on what we hear from others, we view the following four things as key to China joint ventures that work.

1. Make ownership and control clear.
Make ownership and control of the joint venture explicit from the very start. Most managers of Chinese companies see the joint venture company as their own property. They are not sensitive to issues of control that arise from percentage ownership interests. It is important to insist the Chinese side recognize and formally agree to any structure that will result in the foreign partner to a joint venture exercising control over the venture, particularly of day-to-day operations. The foreign party should never assume the Chinese side understands the implications of a joint venture arrangement that flows entirely from purely technical legal rules. If the Chinese side feels it has been tricked or duped into signing away its rights, it will likely take action to “correct” the situation.

2. Do not expect a 51% ownership interest to provide effective control.
 51/49 joint ventures are generally a mistake in China. The Chinese see 51/49 joint ventures as fundamentally no different than a 50/50 joint venture and they tend to view legal control afforded by 51% ownership as unfair. As a result, in ventures between Chinese participants where one side clearly intends to exercise control over the venture, a 60/40 or a 70/30 ownership structure is typically used.

Foreign investors that use a 51/49 joint venture structure should not count on their control of the board of directors as giving them control over the joint venture company because the board actually exerts very little control over company operations. The managing director/representative director and the general manager of the company have the actual power to dictate the operations of the company and can act — and usually do — with little or no supervision from the board of directors. Therefore, if the foreign party intends to exercise actual control, it must structure the joint venture so it has the power to control and appoint both the managing director and the general manager of the joint venture company and make these people directly responsible to the foreign partner and not to the Chinese partner. If it is not possible to exercise direct control over these positions, then control over the board of directors is of little or no benefit.

3. Do not proceed with a joint venture formed on a weak or uncertain legal basis. 
It is very common to find business arrangements in China that are of questionable legality under Chinese law. Going forward with a joint venture in the face of potential illegality usually means the foreign party cannot enforce its rights in the joint venture because the Chinese courts will not enforce the terms of an illegal joint venture. Because of this, it is a standard strategy for the Chinese side to convince the foreign side to go forward with such questionable ventures. For the Chinese side, there is little or no risk. If the venture fails, the Chinese side has the advantage of having received funds from the foreign venture. If the venture succeeds, the Chinese side simply takes over. If your China attorney is telling you your joint venture is illegal and your putative joint venture partner is urging you to go ahead anyway, listen to your attorney.

4. You must actively supervise or participate in the joint venture’s day-to-day management.
If you are not actively involved in the operations of your China joint venture, the Chinese side will likely believe it is doing all the work with the reward going to absentee owners. This produces resentment and the desire to take action to restore the “fairness” of the arrangement. Also, when not actively supervised, the Chinese side of the JV will frequently manipulate the JV for its own benefit. Active participation in management of the joint venture and effective supervision of senior management can prevent such issues from arising. Active day-to-day participation in the management of the joint venture company by at least one senior manager appointed and controlled by the foreign partner is usually required.

No guarantees of success if you do the above, but an almost certain guarantee of failure if you don’t.

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