Introduction to Sino-Foreign Joint Venture Contract Drafting in China

Despite the recent economic crisis facing the world’s major markets, China remains a relatively safe destination for Foreign Direct Investment (“FDI”). Statistics show that since its popularity in the late 1980s, the use of the joint venture (“JV”) structure has declined in favor of wholly foreign-owned enterprises (“WFOE”). This is the result of both freer markets and the general preference of companies to fully own and control their management operations in China. However, the use of JVs should not be ruled out, as there are other factors to consider when establishing a company in China.

JVs not only have the benefit of fewer and fewer legal requirements, but also provide foreign investors with the following: local knowledge, locally established distribution/marketing channels, local organization, industry experience, cash, and facilities/land. However, such benefits must be weighed against the unfortunate fact that many previous JVs established with the best of intentions have failed. Although this failure may be due, in part, to cultural differences, poor early discussions or negotiations and pre-screening of potential partners are largely to blame. Although there are many subtle factors to consider during preliminary discussions or negotiations, the author hopes that outlining some necessary points to consider and conveniently include when entering into Joint Venture Agreements (“JVCs”) will increase the likelihood of success in future JVs.

Standard Form Agreements

Local trade ministries often have bilingual English and Chinese standard form agreements. Although such contracts act as the basis/format from which signed contracts can be derived, it is not advisable to use such contracts without making substantial modifications.

Main terms of the agreement

Here are some important (although not exhaustive) terms that should be included in a joint venture agreement:

1. Parties: The parties to the contract and the Joint Venture must be clearly identified and defined.

2. Business scope: All companies in China must define their business scopes before approval and establishment. While Chinese companies can broadly define their business scope, foreign investors must define it narrowly. That said, the Joint Venture should define its scope as broadly as is reasonably permissible to allow for future expansion of operations (and avoid further filings in the future).

3. Total Investment/Registered Capital: Regarding the business scope and size of operations, the registered capital must be a minimum of 30,000 RMB for the most basic (domestic) companies. Please note that the registered capital can be in cash, land, buildings, intangibles, equipment and other assets, however, it must be no less than 30% in cash. In addition, the total investment must be capped as a maximum proportion of the registered capital, depending on the size of the investment.

4. Responsibilities of the parties (before the incorporation of the company): Generally, the national party will assume most of the responsibilities at this stage. For example, the common-law partner will generally be in charge of making the necessary filings with tax authorities, examination and approval authorities, registration authorities, labor authorities, and others.

5. Transfer Restrictions: Based on the current status of failed and bankrupt Joint Ventures, it is very important to word this section carefully, allowing the parties to transfer/purchase shares in the Joint Venture with minimal disruption to operations . Based on the Companies Law, it is required that the partner or partners of the Joint Venture have the preferential right of rejection when one of its partners wishes to transfer its shares. While this provides a general framework for share transfers, it is prudent to outline the detailed mechanics of such a requirement.

6. Board of Directors: Generally, representation on the board of directors is proportional to the shareholding of the shareholders. The number of directors generally varies from 3 to 5, although any number is possible, up to 13. Unless otherwise specified, the board of directors may make all important decisions of the company, with the unanimity required by law only for the most important ones. fundamental. issues such as the modification of the bylaws or the dissolution. While this is predetermined by law, the parties are free to otherwise define the board’s decision-making authority. Typically, a prudent partner will insist on a minimum of several other key decisions that will require unanimous board approval, particularly when the investor is in a minority position.

7. Deadlock: It is quite possible for Joint Ventures to reach an impasse on certain fundamental issues during operations. When this occurs, it is imperative that mechanisms are in place to optimize the likelihood of a quick and effective resolution. In addition, in the event that a resolution cannot be obtained, there must be purchase/sale options to allow the disposal of the company and/or its dissolution.

8. Operations and Management: Typically, a PRC company will have a General Manager, who is the highest-ranking corporate officer. A number of other corporate officers will often support the General Manager. Generally, the majority shareholder will appoint the General Manager, while the minority shareholder will appoint the Deputy General Manager or the Chief Financial Officer of the company. From the outset, it is important to carefully define the scope of the General Manager’s authority, at least for material financial transactions, which may require the consent of another officer or the board of directors.

9. Financial matters and accounting: Since the company will operate in China, it is necessary to comply with the laws and accounting principles of China. As a result, the accounting currency must be in the renminbi, while an additional set of books may be held in the foreign investor’s currency. It is also important to specify that the foreign investor must receive a monthly profit and loss statement, as well as a quarterly/biannual/annual audited report.

10. Intellectual Property: It is common for one or both investors to license their trademarks and trade names to the Joint Venture. Although the main terms of such a license will be dealt with in separate agreements, it is important to include this as a fundamental issue for cooperation.

11. Non-competition: It should be noted that the parties may not compete in any way with the Joint Venture. The language used for restrictions is generally broad, so it is important to be clear and explicitly state exemptions, to be clear on expectations and avoid potential disputes in the future.

12. Effective date and validity of the company: Although the joint venture contract and the articles of association can be signed on a certain date, the contracts do not become effective until they are approved by the relevant authorities (the Ministry of Commerce or your local branch). As a result, if the parties believe that the other party may not perform its obligations under the agreement, it may be advisable to include a liquidated damages provision prior to approval.

13. Insurance: Chinese businesses are severely underinsured due in part to the culture and developing nature of China’s insurance markets and the availability of profitable products. However, it is important that the shareholders require that the Joint Venture maintain an adequate level of insurance, at least what is common in the relevant industry.

14. Termination: Given the number of failures of the Joint Ventures, it is important that the shareholders define what failures allow the termination of the contract and the rights corresponding to the termination.

15. Arbitration: Since Chinese courts are often uneven, especially in less developed areas, we often advise clients to select arbitration as their dispute resolution method. Arbitration can take place in China or internationally (in any state signatory to the New York Convention), although domestic arbitration allows access to Chinese courts for injunctive relief.

16. Applicable Law: Joint Venture contracts must be governed by the law of China.

17. Language: The predominant language of the contract may be English or Chinese.

18. Conflicts: In such lengthy documents, it is quite possible that there are conflicts between the Joint Venture Agreement and the Articles of Association. Typically, the parties to a Joint Venture spend most of their time negotiating the Joint Venture Agreement, with the Articles being an afterthought to the Agreement. As a result, it is typical to state that the Joint Venture Agreement will govern in the event of a conflict with the Articles of Association.

While the importance of negotiating and concluding a foolproof contract is well known, it is equally critical, if not more so, to ensure that agreed terms are monitored and adhered to. More importantly, it is necessary to keep in mind that since this is a real business in China, its operations cannot be successful without real managers on the ground representing the interests of both parties. This requires regular time, especially for attendance at meetings, which must be invested by the management of the Joint Venture. Too often we see foreign joint venture partners, especially foreign investors, who rely entirely on reports and directors’ meetings for information and management, rather than observing day-to-day operations firsthand.