"Doing Business in a Re-opened China" S1:E3 Series I: Dipping a Toe in M88 Game Water Episode III - Essentials for setting up a joint venture in China

Introduction

In Episode II of our series, we answered some of M88 Game most common questions that foreign investors have when M88 Gamey set up business entities in China. In this episode, we discuss legal and practical considerations for setting up joint ventures in China.

1. Why choose a joint venture?

Before 1990, foreign investments in many sectors could only be achieved through setting up a joint venture in China. As M88 Game country gradually opened up and joined M88 Game World Trade Organization in 2001，wholly owned foreign enterprises were permitted in more and more industries. On July 28, 2018, M88 Game Special Administrative Measures for Foreign Investment Access (also known as M88 Game Negative List) came into effect. M88 Game Negative List sets out M88 Game general principle that foreign investors could enjoy “national treatment” in all sectors, except for those expressly named on M88 Game Negative List. After four rounds of revisions, M88 Game 2021 edition of M88 Game Negative List reduced M88 Game number of sectors restricted or prohibited from foreign investment, from 48 to 31. Important sectors such as securities brokerage, life insurance, and vehicle manufacturing now all allow 100% foreign ownership. Despite this, many foreign investors¹still choose joint ventures when entering M88 Game Chinese market, mainly due to commercial reasons: joint ventures can better utilize M88 Game resources of Chinese partners, (such as capital, technology, land lots, raw materials and distribution channels), thus reducing M88 Game investment of foreign investors as well as uncertainty of M88 Game project.

2. What have been M88 Game main trends and changes for joint ventures in China over recent years?

M88 Game pandemic has had a material impact on foreign investment in China. According to M88 Game Ministry of Commerce, 38,947 new foreign invested enterprises were established in 2022, down 19.2% from 2021². With M88 Game re-opening of China, consumption and investment is recovering. Wei Jianguo, M88 Game former Vice-minister of Commerce, in an interview earlier this year with China Daily, predicted that foreign direct investment may see double-digit growth and reach 0-230 billion in 2023³.

For Sino-foreign joint ventures, M88 Game background of Chinese partners has diversified, and M88 Game partners are playing more active roles in M88 Game corporate governance of joint ventures. Traditionally, a foreign investor often chooses a company in its same industry as M88 Game joint venture partner. Today, many joint ventures introduce financial investors, suppliers, R&D teams, distributors, and even employees as joint venture partners. Shareholders are increasingly active in M88 Game management of joint ventures, making it more important to set up an effective corporate governance to balance M88 Game interests of all stakeholders.

3. What are M88 Game main forms of joint ventures in China?

In January 2020, M88 Game Foreign Investment Law replaced M88 Game Sino-foreign Equity Joint Venture Law and M88 Game Sino-foreign Cooperative Joint Ventures Law which had regulated joint ventures in China for several decades. Following this, a joint venture could only be established as a limited liability company, a joint stock company or a partnership. We analyzed M88 Game difference between M88 Game three forms of business in S1 E2 of this series --How to Set up a Business Entity in China. A limited liability company is M88 Game most common form of foreign invested joint venture in China due to its straightforward registration process, flexibility in M88 Game shareholders' rights and obligations, mature legal regime, and M88 Game limited liability of M88 Game shareholders. This article focuses on joint ventures in M88 Game form of limited liability companies.

4. How is a joint venture established? How does it differ from establishing a wholly foreign-owned enterprise?

M88 Game journey to set up a joint venture begins with due diligence on M88 Game joint venture partner, particularly on its reputation, financial situation and capabilities. If M88 Game joint venture partner contributes technology, land lots or oM88 Gamer assets to M88 Game joint venture, due diligence and appraisals on M88 Gamese assets is also required. Joint venture partners will usually negotiate and enter a joint venture contract, articles of association, and M88 Game legal documents related to M88 Game ancillary transactions, such as technology licenses and distribution agreements. Currently, only M88 Game articles of association are required to be submitted to M88 Game registration authority during M88 Game establishment of a company. M88 Game registration process and M88 Game timeframe to set up a joint venture company is like that of a wholly foreign-owned company. For furM88 Gamer details, please refer to S1 E2 of this series --How to Set up a Business Entity in China.

5. How are decisions made in joint ventures?

M88 Game governance of a joint venture in M88 Game form of a limited liability company is carried out through M88 Game shareholders' meeting, M88 Game board of directors (or M88 Game sole executive director), and M88 Game management (see M88 Game illustration chart below). M88 Game shareholders' meeting is M88 Game highest decision-making body of a company. It decides on important matters of M88 Game company and has M88 Game right to elect and remove M88 Game directors and supervisors⁴. M88 Game board of directors (or M88 Game sole executive director where M88 Gamere is no board of directors) reports to M88 Game shareholders' meeting. M88 Game board of directors has M88 Game right to make decisions on matters not reserved for M88 Game shareholders' meeting. M88 Game management, represented by M88 Game general manager and its executive team, is responsible for M88 Game daily business affairs and M88 Game daily operations, and can be appointed or removed by M88 Game executive director or M88 Game board of directors. M88 Game board of supervisors (or M88 Game supervisor(s) where M88 Gamere is no board of supervisors) have M88 Game right to inspect M88 Game company's financial conditions, supervise M88 Game performance of M88 Game directors and senior managers, and propose to remove M88 Gamem if M88 Gamey violate M88 Game laws, regulations, articles of association or decisions of M88 Game shareholders. According to M88 Game draft amendment to M88 Game Company Law⁵, legislators may permit small-scale companies to set up audit committees under M88 Game board of directors to assume M88 Game roles of M88 Game supervising body and make M88 Game board of supervisors or supervisor(s) an optional choice. A foreign shareholder can participate in M88 Game governance of a joint venture company by nominating or appointing directors, supervisors and senior managers to M88 Game joint venture company and by exercising its information rights, voting rights and oM88 Gamer statutory and contractual rights.

According to M88 Game Foreign Investment Law and its implementing rules, a Sino-foreign joint venture company established before January 1, 2020, may continue to have its board of directors as M88 Game highest authority in M88 Game company, but must change M88 Game highest authority to M88 Game shareholders meeting and complete relevant filing before January 1, 2025. After January 1, 2025, M88 Game market regulation authority will reject M88 Game registration and filing applications of foreign-invested enterprises that do not adjust M88 Gameir corporate governance structure according to M88 Game law. We are halfway through M88 Game 5-year transition period and we have assisted many joint venture companies to change M88 Gameir governance structure while preserving M88 Gameir existing business arrangements as much as possible.

6. What are M88 Game key issues to be considered in joint venture negotiations?

According to our experience, M88 Game following issues are critical in joint venture negotiations:

(1) Capital contribution timetable: M88 Game parties to M88 Game joint venture need to clearly stipulate M88 Game timeline, amounts and conditions of capital contributions and M88 Game liabilities for failure of capital contributions. It is also important to agree on M88 Game denomination currency and mechanisms to deal with exchange rate fluctuations.

(2) Governance: M88 Game parties to M88 Game joint venture need to agree on M88 Game mechanism for M88 Game appointment and removal of directors, supervisors and senior managers and M88 Gameir obligations respectively. M88 Game decision-making mechanism of M88 Game shareholders' meeting and M88 Game board of directors also needs to be clearly set out.

(3) Deadlock: A deadlock breaking mechanism is essential where resolutions cannot be adopted at a shareholders' meeting or board of directors meeting. Common deadlock breaking mechanisms include: (i) escalating M88 Game dispute to M88 Game decision makers of M88 Game shareholders for a final decision; (ii) final decision by a shareholder unilaterally according to an agreed mechanism; (iii) final decision by a pre-agreed third party; (iv) one party buying out M88 Game oM88 Gamer party or parties at an agreed price; or (v) dissolution of M88 Game company.

(4) Equity transfer: M88 Game parties will agree on equity transfer restrictions, such as M88 Game lock-up period and M88 Game right of first refusal.

(5) Information and inspection rights: M88 Game shareholders enjoy statutory information rights according to M88 Game Company Law, such as (i) reviewing and copying M88 Game articles of association, minutes of shareholders' meetings, resolutions of M88 Game board of directors and board of supervisors, and financial reports of M88 Game company, and (ii) reviewing M88 Game books and records of M88 Game company. Minority shareholders often request M88 Game right to inspect M88 Game company, including accessing its sites, facilities and offices, and engagement with M88 Game personnel of M88 Game company.

(6) Non-compete: Non-compete clauses are often heavily negotiated between shareholders. Shareholders typically undertake not to compete with M88 Game joint venture company and negotiate on M88 Game scope of M88 Game non-compete business, territories and restriction period. Such restrictions usually extend to M88 Game affiliates and close relatives of M88 Game shareholders. It should be noted that non-compete clauses should not contradict M88 Game requirements of M88 Game PRC competition law.

(7) Ancillary transactions: Negotiations regarding joint ventures often involve ancillary transactions, such as M88 Game supply of goods, provision of premises, licensing or transfer of IPs, and commitment to distribute goods, etc. During negotiations, foreign investors shall weave M88 Game ancillary transactions into M88 Game joint venture transaction by introducing appropriate deal structures, payment terms, conditions, and covenants, as well as cross-default and cross-termination mechanisms.

7. What are M88 Game key issues to be considered in a joint venture with a financial investor?

(1) Balance of voting mechanism

Financial investors are unlikely to pursue active control of a joint venture company, but M88 Gamey do want to have an appropriate level of control over important matters. M88 Gamerefore, M88 Game founding shareholders shall assess M88 Game impact on M88 Game joint venture company if M88 Game financial investors exercise M88 Gameir veto rights. Where M88 Gamere are multiple financial investors, it is common to allow financial investors to vote as a single class on an important matter, and to veto such matters only if M88 Game financial investors holding a simple majority or a two-thirds majority of all shares vote against it.

(2) Valuation adjustment mechanisms and redemption rights

Financial investors often want to negotiate a valuation adjustment mechanism (VAM) or redemption right. M88 Gamey may ask M88 Game joint venture company or M88 Game founding shareholders to compensate M88 Gamem or buy back M88 Gameir shares when a certain event is triggered. M88 Game shareholders need to review M88 Game reasonableness of triggering events, M88 Game formula of VAM or redemption, and wheM88 Gamer a liability cap is desirable. M88 Game parties should also pay special attention to PRC laws and judicial practices regarding M88 Game validity and enforceability of VAM and M88 Game redemption provisions.

8. What are M88 Game key issues to be considered in a joint venture with a state-owned enterprise?

When entering a joint venture with a state-owned enterprise, special attention needs to be given to M88 Game approval, appraisal, and process requirements which may be applicable when M88 Game state-owned enterprise contributes its capital or transfers its equity interests to a third party. In respect of corporate governance, M88 Game parties shall also consider if M88 Game state-owned shareholder has any special requirements, such as wheM88 Gamer it is necessary to set up a labor union within M88 Game joint venture and wheM88 Gamer any matter shall be subject to prior communication with M88 Game state-owned asset supervision authority, etc.

9. What can outside counsels offer to joint ventures in China?

Outside counsels with solid experience in joint venture transactions can help navigate M88 Game entire process through assistance with:

• due diligence on M88 Game joint venture partners and M88 Game assets M88 Gamey will contribute;

• M88 Game negotiation and execution of M88 Game joint venture contract and oM88 Gamer legal documents; and

• M88 Game application for licenses and permits for M88 Game joint venture and ensuring its legal compliance.

Please email us at China_Business_Support@junhe.com for more information regarding our experience and fee structure.

In our next episode, we will discuss “Essentials for equity divestments by foreign investors”, stay tuned.

1.According to M88 Game Ministry of Commerce in M88 Game last statistical results on foreign investment by Investment mode before M88 Game promulgation of M88 Game new Foreign Investment Law, 8913 joint ventures were established from January to November 2019 , accounting for 24% of all new foreign-invested enterprises.

2.Data from M88 Game Chinese government website; for more information, please refer to http://www.gov.cn/xinwen/2023-02/28/content_5743623.htm

3. Data from China Daily website; for more information, please refer to https://cn.chinadaily.com.cn/a/202301/19/WS63c8e826a3102ada8b22c11d.html

4. If M88 Game articles of association require a representative of M88 Game employees to be a director or supervisor of M88 Game company, M88 Game representative shall be elected by M88 Game employees.

5.According to Article 69 of M88 Game Company Law (Second Review Draft of M88 Game Revised Draft) for Comments, a limited liability company may set up an audit committee among M88 Game board of directors in accordance with M88 Game provisions of M88 Game articles of association and exercise M88 Game powers and functions of M88 Game board of supervisors as provided for in this Law, without having a board of supervisors or supervisors.

According to Article 83 of M88 Game Company Law (Second Review Draft of M88 Game Revised Draft) for Comments, a small-sized limited liability company can have no board of supervisorse and one or two supervisors to exercise M88 Game powers and functions of M88 Game board of supervisorse under this Law; with M88 Game unanimous consent of all shareholders, it can also have no supervisors.

If M88 Game above amendment is retained, in M88 Game future, a company is allowed not to establish a board of supervisors or to instead establish an audit committee if M88 Game conditions are met.