As already stressed the foreign investor has at his disposal several instruments to establish a presence in China. We already treated the WFOE (
http://blawg.lehmanlaw.com/wordpress/?p=1686
) the FICE (
http://blawg.lehmanlaw.com/wordpress/?p=1695
) and introduced the theme of M&A. Today it is the turn of the Joint Venture.
First of all it is necessary to remind that the investor has two options when planning to set up a Joint Venture in China for conducting his business, namely the Equity Joint Venture (EJV) and the Contractual or “co-operative Joint Venture. These two instruments are extremely diffused, and maybe our followers and readers are already aware about their functioning and characteristics. However, this entry and the next ones will treat about these instrument because it is worth from time to time to recall their existence and to highlight some aspects of the corporate governance. In fact it is difficult to find something so specific out there, even if you search on the Internet some information seem to be difficult to find, and in any case if you do not pay it is rare that law firm give out so detailed pieces of information if you do not pay for them. Here at Lehman, Lee & Xu we have adopted a different philosophy: information are essential not only to understand how to structure and operate a particular business entity, but they are something really precious not only for lawyers but for clients also. You cannot do a good job if you are jealous of the information you have and you are not willing to share them with your clients and potential clients. There is nothing good in be reticent, and what is most important you cannot capitalize on these information if you just preserve them in order to sell them to your clients if you only have a bunch of clients interesting in using your service. Instead we at Lehman think that more information we can provide to help our clients and potential clients in better assessing a move into China, the better is for both the client and the firm. Only acting proactively may be useful and attracting new investors. Because if you show them that you really care about them and their investment it is more likely that these potential investors and client will return to you more willing to use our knowledge and services in order to better develop their business here in China.
So today I will offer not only some general information about the functioning of an EJV but I also will explain the corporate governance of this particular instrument of investment.
Basic characteristics of the Sino-Foreign Equity Joint Venture
The most important characteristic of the
equity joint venture
is that it has to be registered as a Chinese legal person assuming the form of a limited liability company (see Art. 4,
Law of the People’s Republic of China on Chinese-foreign Equity 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-equity-joint-ventures-2000.html
) The foreign investor must contribute at minimum 25% of the registered capital of the venture, and at maximum is it possible to reach 99% of the participation. The registered capital must be expressed in RMB or in a foreign currency agreed upon the parties and it refers to the total amount of capital contributions of the parties that is to be registered with the SAIC for the effective establishment of the
venture
.
Contributions can also made in kind, in this case they cannot exceed 50% of the entire capital, and when “technology” is contributed it must not exceed 20%.
The legislation on EJV does not provide a minimum amount for the capital, it depends on the nature of the business, however EJVs are not established with less than one million RMB. During the term of its operation, once it has registered with the Chinese authorities the EJV cannot reduce its registered capital. If it is necessary to reduce the registered capital due to changes in the total amount of the investment, the joint venture must obtain the approval of the examination authority (i.e. MofCOM) and go through the formalities of change of registration with the SAIC. The same procedure will apply in case of increase in registered capital. Share holdings in a joint venture are usually non-negotiable and cannot be transferred without the approval from the Chinese authorities.
The partners of an EJV must share the profits of the venture, considering also the risk of loss, in proportion to their contribution of the registered capital (Art. 4 EJV Law).
The period of operation of the EJV depends on the nature of the investment. Although in China theoretically this investment instrument can be established for an indefinite period of time, in practice EJVs are approved to operate for only a limited term, commonly 50 years, corresponding to the term for which land use rights are usually granted for industrial project, though shorter, 20 to 30 years, terms are not uncommon. At the end of the term, the parties may agree to extend the period of operation of the venture otherwise the JV is liquidated and the proceeds are distributed between the parties in proportion to their equity stake.
The establishment of an EJV
To establish an equity joint venture, the parties must obtain approval from the MofCOM and register the new entity with the
State Administration for Industry and Commerce
(SAIC). However, the State Council also delegates to provinces, autonomous regions, and municipalities as well as relevant department under it the power to examine and approve the establishment of equity joint ventures that meet two requirements: i) the total amount of investment should be within the approval limit as set by the State Council, and the source of capital of the Chinese party must have been ascertained; ii) additional allocation of raw material by the state must not be needed, and for example the national balance of fuel, power, communications and transportation, and foreign trade export quotas would not be affected.
If the prospective JV meets these two requirements, then the venture can be approved by the local authorities and register with the SAIC to obtain the
business license
.
The permissible debt to equity ratio of a joint venture is regulated depending on the size of the joint venture as stipulated in the joint venture contract and the article of association and it should be as follows:
a) If the total amount of investment is US$ 3 million or less, the registered capital should be at least 70% of the amount of total investment;
b) If the total amount of investment is more than US$ 3 million but US$ 10 million or less, the registered capital should be at least 50% of the total amount of investment;
c) If the total amount of investment is more than US$ 10 million but US$ 30 million or less, the registered capital should be at least 40% of the total amount of investment;
d) If the total amount of investment is more than US$ 30 million, the registered capital should be at least 33% of the total amount of investment.
The documents to be submitted for the approval of the investment project are specified by the MofCOM and it is necessary to translate them into Chinese. It is noteworthy that the
JV Agreement
refers to the document agreed upon the parties with respect to certain major points and principles governing the establishment of the joint venture. The
JV Contract
refers to the document concluded by the parties with respect to their mutual rights and obligations. The
Articles of Association
refer to the document agreed upon by the parties delineating the objectives, management methods of the joint venture. If the
JV Agreement
and the
JV Contract
have conflicts, the JV Contract will prevail.
Having received all the required documents, the MofCOM must approve or not the investment project within three months. Within one month of the receipt of the certificate of approval, the parties must register with the SAIC to obtain the business license.
This is just to delineate the basic characteristics of the EJV. In the next entry it will be exposed the “corporate governance” of an EJV. In fact the foreign investor has to master all these elements in order to better manage his investment, and sometimes this theme is not so clear.
Cristiano Rizzi