Corporate governance of a CJV
Today, as anticipated, with the present entry I am going to complete the exposition about the functioning of this investment vehicle, i.e. the CJV, adding some information about the
corporate governance.
Regardless of whether or not the CJV has the ‘status’ of a legal person, it must be administrated jointly by the parties and in accordance with the approved contract and its Articles of Association (in this sense see Art. 11,
Law of the People’s Republic of China on Chinese-Foreign Contractual Joint-Ventures, available at:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/foreign-investment/law-of-the-peoples-republic-of-china-on-chinese-foreign-cooperative-joint-ventures-2000.htmln
) The law on CJV states that a contractual joint venture must establish a
Board of Directors
or a
Joint management Committee
which is its organ of power, to decide on important issues in accordance with the contract and the articles of association (Art. 12). It is noteworthy that management issues are also regulated in arts. 52 and 53 of the CJV Implementation Rules (available at:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/foreign-investment/detailed-rules-for-the-implementation-of-the-law-of-the-peoples-republic-of-china-on-sino-foreign-cooperative-enterprises-1995.html
).
The Board, or the Joint management Committee must have at least three members, and the allocation of the number of members is to be determined by the parties through consultation and with reference to their investments or cooperative means. The board of directors or the joint management committee shall appoint a general manager in charge of the daily operations of the CJV. The general manager is accountable to the board or to the joint management committee (directors or committee members may concurrently serve as the general manager). The directors or committee members shall be appointed or replaced by the parties. If the chairperson of the board of directors or the head of the joint management committee is from one side, the vice-chairperson or deputy head must be from the other side. The chairperson of the board of directors or the head of the joint management committee is the legal representative of the CJV. The term of office of a director or committee member shall be stipulated in the articles of association, but each term cannot exceed three years. Upon expiration of the term, the director or committee member may serve another term if reappointed by the appointing party.
Resolutions of the board of directors or the joint management committee shall be adopted with affirmative votes of more than half of the directors or committee members, with respect to the following matters, a unanimous vote of all the attending directors or committee members is required: i) the amendment of the articles of association; ii) the increase or reduction of the registered capital; iii) the dissolution of the CJV; iv) the mortgage of the joint venture’s assets; v) the merger, division, or change of organizational form of the joint venture; and vi) any other matters agreed upon by the parties to be adopted only by a unanimous vote. Moreover after the formation of a CJV, the board of directors or the joint management committee may unanimously agree to engage a third party to manage the business, in which case the CJV must obtain approval from the MofCOM and the change must be registered with the SAIC (see Art. 12 of the CJV Law).
Advantages and disadvantages in choosing to operate a CJV
Since the late 70s when the Chinese government decided to adopt the so-called “open-door policy”, many Chinese expatriates began to look for investment opportunities back in their homeland using contractual joint ventures with the dual objective of taking advantage of government incentives, and learning to adapt to new forms of investment in China.
Compared with the equity joint venture, the contractual joint venture provides the investors with more flexibility because the distribution of profits and assumption of risks need not to be in strict proportion to party’s capital contribution. For foreigners the benefits of this flexibility is evident: for example in the contract it can be established that a foreign party can recover its investment prior to the expiration of the
venture.
This is not provided for EJVs, however all the
fixed assets
in
a CJV remain the property of the Chinese party (as agreed upon parties in the contract establishing the cooperative joint venture) – Reference must be done both to articles 12 and 22 of the
Law of the People’s Republic of China on Sino-foreign Contractual Joint Ventures,
and to article 44 of the “CJV Implementation Rules.
If it has been agreed upon in the contract that the foreign party is to recover his investment prior to the payment of income tax, he must applies to tax authorities which shall examine and approve the application in accordance with State regulations concerning taxes (Art. 21 CJV Law).
On the other hand, a
contractual joint venture
can better be modeled on the needs of investors compared to an
equity joint venture
. The CJV is more project-oriented and short-term. Moreover if it is true that foreign investors in a CJV may recover their investment more easily and before the expiration of the venture, and focus on other projects of entirely different nature without consuming a lot of time in fixing issues because of the termination of the business relation with their Chinese counterpart, they must, however, in exit the venture, providing a guarantee (issued by a bank or other financial institution based in China) as a guarantee for the debts of the CJV (See also
Provision 3
of MOFTEC’s
Interpretation of the Implementation of Certain Articles of the Detailed Rules for the Implementation of the Law of the PRC on Sino-foreign Cooperative Enterprises).
Dissolution of a CJV
A
contractual joint venture
will be dissolved under one of the following circumstances:
1) expiration of the term of the contractual joint venture;
2) inability to continue operations due to its heavy losses or huge losses caused by
force majeure
;
3) inability to continue operations due to the failure of one party or several parties to fulfill its or their obligations stipulated in the contract or articles of association;
4) occurrence of other causes for dissolution stipulated in the contract and articles of association; or
5) closing down of the venture due to violation of laws or administrative regulations.
(Art. 48 of the
CJV Implementation Rules).
In the case of points 2 and 4 the
Board of Directors
or the
Joint management committee
shall apply to the examination and approval organ (MofCOM) for approval. In the case of point 3, the non-breaching party or parties have the right to apply to the MofCOM for approval, and the breaching party or parties will be liable for compensation for losses.
Immediately after the dissolution, the venture must be liquidated. If in the contract parties have agreed that the foreign party may recover his investment before the expiration of the venture, it is expected that the application is submitted to the tax authorities (Art. 21 CJV Law) and examined in accordance to the new regulations also (i.e. Enterprise Income Tax Law, available at:
http://www.lehmanlaw.com/fileadmin/lehmanlaw_com/laws___regulations/Enterprise_Income_Tax_Law_of_the_PRC__LLX__03162007_.pdf
). In particular, art. 23 of the CJV Law states that
“upon the expiration or termination in advance of the term of a CJV, its assets, claims and debts shall be liquidated according to the legal procedures. The Chinese and foreign parties shall, in accordance with the agreement specified in the contract, determine the ownership of the venture’s property”
. In addition, the CJV shall apply for cancellation of registration with the SAIC and the tax authority.
The commentary exposed above complete the explanation about the functioning of this investment instrument. However, It is necessary to stress that common risks associated with entering into partnerships with other companies in China is often exacerbated by disparities in culture and business practices between the foreign and local partners. Foreign Companies should enter into JVs only when both parties have reached a clear understanding of the business objectives and appropriate exit strategies have been developed, otherwise, it is better to consider a WFOE.
Cristiano Rizzi