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How to Form a China Joint Venture, Part 4, What’s Hong Kong Got to Do With It?

This is Part Four of our new series laying out the issues companies typically face and the steps our China company lawyers typically go through when forming a China Joint Venture. In Part One, we talked about how despite the increasing difficulties with doing business in China (or perhaps because of those difficulties), our China corporate lawyers are seeing an increase in foreign companies looking to do joint ventures in China. We then discussed how the first thing we do is try to determine whether going into China via a joint venture makes both business and legal sense for the foreign company that has retained us.

In Part Two, we discussed how once both our lawyers and and our client are satisfied that doing a China Joint Venture actually makes sense generally, we see our next task as helping our client determine whether the Chinese company with which they are looking to form the joint venture is the right company for a China joint venture. In that post, we set out the questions to pose to your potential Chinese JV partner to tease out an answer to this.

In Part Three, we talked about what our China corporate lawyers do to try to determine early whether the Chinese side is truly interested in doing a Joint Venture deal with our client, or just feigning interest as a way of gaining access to our client’s intellectual property.

In this Part Four we talk about why it virtually never makes sense to do a Joint Venture with anything other than a Chinese domestic company.

Not sure why, but our China corporate lawyers have been seeing an uptick in Western companies looking to do joint ventures with WFOEs — Chinese companies wholly owned by a foreign company.  This almost never makes sense and is usually a sign of a deal that should be restructured or a flat-out scam. When a scam, the WFOE is usually owned by a Hong Kong company. This makes sense because many people do not realize that Hong Kong companies are not legally PRC companies. See The Legal Relationship Between China and Hong Kong and Why This Matters to You and Your Business, where we describe Hong Kong’s legal business relationship to China as follows:

When I would get asked this, I would usually start by telling American clients to think of Hong Kong’s relationship to China as being similar to New York’s relationship to China. For our European clients I would use London or Madrid or Frankfurt or some other European city as the example and for our Australian clients I would use Sydney. I would then say that for businesses, Hong Kong is essentially a foreign country when it comes to China.

It does not make sense for a foreign company to create a separate Sino Foreign Joint Venture Company in China in a situation where the Chinese-side owner of the joint venture will be a WFOE owned by a Hong Kong company or any other foreign country. Though legally possible under Chinese law, there are two reasons why this sort of deal does not make sense and is virtually never done:

1. The basic reason for doing a China joint venture is to allow a foreign entity to partner with a Chinese owned entity. The goal of the foreign entity is usually to benefit from the Chinese ownership, which will allow the JV to enter into businesses where some form of Chinese ownership is required. For example, Chinese medical institutions oftentimes do not like working with foreign entities and so joint ventures are often used in the medical field to deal with this “Chinese ownership required” issue. But a JV with a foreign entity does not address this issue.

2. The more important reason for why this sort of joint venture deal is virtually never done is because if the Chinese entity is a WFOE, a joint venture structure is simply not necessary. If a joint operation is desired, a foreign entity can simply purchase an ownership in the WFOE directly. Creation of a separate joint venture entity is not required and will invariably take longer to accomplish and cost more than simply taking part ownership in the foreign company that owns the WFOE or in the WFOE directly.

Joint ventures with China 0WFOEs. Very strange. Are you seeing these?

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