Our China lawyers have written countless articles on China joint ventures (for this blog, for the Wall Street Journal, for Above the Law, and for many others), so it is good when someone we know and respect says the same basic thing about them, which is that you should watch out.
The writer is my friend Randall Lewis, who has headed up Asia legal out of China for both Danone and ConAgra and who truly knows China. Randall recently wrote about setting up joint ventures in emerging market countries in an article “intended to be your general ‘watch-out’ guide to avoid basic and simple joint venture mistakes.”
Randall begins his article by commenting on how people are wrong to believe that if they “set up a good platform for a business, agree on ownership percentages and the business plan/finances work. . . . the lawyers will work out the rest.” He then proceeds to list “common mistakes your commercial folks WILL make when taking your company into a foreign market.” He makes clear his list is “not hypothetical”, as he has encountered every situation personally. Guess, what, our joint venture lawyers have encountered every situation personally as well, and multiple times.
But without further ado, here are the China-relevant mistakes Randall has seen and about which he wants to warn you, with my comments about China joint ventures in italics:
- Commercial people frequently engage in detailed discussions with potential partners before discussing options, strategic structures and legal issues with their own legal counsel. This leads to promises being made and structures being agreed to that are against your own best interest and which benefit only your JV partner. Once these “agreements” have been made, it is difficult to change once you bring in legal counsel. A wise approach is to consult legal counsel before you have discussions on structure, methods of investment, holding companies, corporate governance structures or just about anything outside of pure commercial matters and general alignment. Definitely true for China as well.
- Never take legal advice from your potential JV partner. Your commercial people will start a discussion and the “local” will advise your team on what they can and can’t do in their country. This advice is more likely than not 100% incorrect or misleading for very good reasons; it is being given to take advantage of your company and to secure a structure not in your best interest and it is being given by someone whose only “legal” qualification is that they are local. 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. And guess what, disaster is the usual outcome.
- If someone says; “we don’t need to involve the lawyers yet” or “we don’t need to have your legal counsel in the room for this discussion” or “we prefer to let the lawyers work out the contracts after we agree on XYZ,” stop immediately and ask yourself if that makes sense. Usually, excluding lawyers is not for cost savings or to do you a favor in terms of simplifying your discussions; it is to pull the wool over your eyes. True for China.
- If someone says “ we have someone that will act as our CEO/GM and CFO/finance people” be wary that you have enough control over key functions so you don’t end up a financial investor in a JV vs a real partner. Keep in mind that if someone is appointed to an executive function by your partner, that person is likely viewing your partner as their “employer” vs the joint venture entity or your company. Their interest will be completely aligned with your partner and not to your company. 100% true for China as well. The key is control, and one of the biggest mistakes we see is Western companies wrongly assuming that because they own 51% or more of the joint venture, they control it.
- When your partner says they will build your factory and secure all the licenses and permits for your new business, use caution! If you are in a JV and your partner is engaging in illegal behavior that violates the UK Bribery Act, FCPA or other local equivalent you may find yourself on the hook for all your partner’s activities! In short, you need to be able to manage and control your partner’s activities beyond just signing a contract that obligates them to comply with your FCPA and UK Bribery Act obligations. Many times a JV partner will sign anything and proceed to do whatever they desire because they don’t understand the obligations, nor do they care or “that is not how they do things in their country”. Way too many companies enter into contracts thinking they can trust their partner to follow the rules and then they get burned. This happens in China all the time.
- Don’t be impressed by your partner’s government connections and think this is of great benefit to your new potential JV. It is 99% possible, those connections will be used to benefit your partner in the future and to your detriment. I have seen more than my fair share of commercial people get overly excited about a “connected” potential partner only to find out a few years down the road that those connections are being used privately to do things and take actions the partner is not contractually or legally able to do. Definitely true of China.
- Don’t be led to believe that if you have a controlling position at a Board level you are in control of your JV. For example, in China (and other locations), the right to control the Board does not give you effective control of the company. For actual control you need to control the appointment of the General Manager and ultimately the company “chop” or seal (which allows the possessor the power to make binding contracts on behalf of the joint venture company and to deal with the company’s banks and other key service providers). In addition, your access to financial information and the ability to audit will not necessarily be assured unless you control the CFO position. Securing this finance position will also assure early warning of problems with the business and potential fraud. Agree on all counts.
- Don’t let your partner convince you that setting up a JV on a 50/50 basis with no mechanism to resolve a deadlock is a good idea. I have seen more than my fair share of JVs that have 50/50 shareholding and no deadlock mechanism leading to a complete breakdown of the JV business. This usually only benefits your local partner that had this as their goal from the beginning. Once the JV is successful (or they have what they need from the partnership) they manufacture a way to push you out so they can either buy your interest (in a manner outlined by a local court) or exit to run a new business that looks identical to your own. We see one of these pretty much every year involving China joint ventures and they are never a good situation.
Randall ends his article by calling for companies looking at doing a joint venture to “slow down, use caution, exercise common sense and surround yourself with advisors that challenge your assumptions and criticize your deal.” I agree with that also.