Equity Joint Venture

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Equity Joint Ventures in PRC

Professor Shen Wei

Summer 2015

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I. Introduction

z Two types of JVs in China – Equity JVs and Cooperative JVs – Equity more common than Cooperative

z Background on EJVs – At one time very popular with foreign investors – Entry into market – gave foreign investors some comfort having a

local partner – Tide has now swing – in the last 5 years more than 70% of foreign

direct investment in PRC has taken the form of wholly foreign-owned enterprises (“WFOEs”)

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II. Regulatory Framework

z PRC, Sino-foreign Equity Joint Venture Law z PRC, Sino-foreign Equity Joint Venture Law Implementing Regulations z The Foreign Investment Guidance Catalogue (2007) z PRC, Company Law z Other relevant regulations regarding labor issues, capital contributions,

tax, certain industry specific regulations, etc.

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III. Form/Corporate Structure

z EJVs have legal person status – Similar to a “corporate person” in the West

z Limited liability companies Shareholders in an EJV enjoy limited liability protections z There are no shares in EJVs – a partner’s interest in an EJV is reflected by the portion

of registered capital it contributed to the EJV z Choice of SPV

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IV. Location and Partner

z Typically, location and partner go hand in hand – In other words, if you find a partner in Shanghai, your EJV

will be established in Shanghai

z While it was once comforting to have a local partner, experience has shown that wherever possible, a WFOE tends to be a better vehicle for investment.

z Due Diligence on a partner is crucial, and unfortunately is overlooked by many foreign investors.

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V. Establishment

z Preparation of a Preliminary Project Proposal (or Report) z Preparation of a Joint Feasibility Study Report (“FSR”)

– “Joint” means jointly produced by both Chinese partner and foreign investor.

– FSR is similar to a business plan in the West; it should provide the technical and economic assumptions upon which the EJV will operate

– FSR is the first real document submitted for approval of a project – FSR is not a legally binding document, but it should accurately

reflect the business and objectives of the EJV, and authorities may point to it down the road in the event of a dispute

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VI. Specific Issues/Provisions (Con’t)

– Preparation of an FSR At a minimum, the FSR should cover the following topics:

z Introduction to the proposed project z Market demand for products to be manufactured, production capacity, and

sales plans for the products (including export commitments) z Financing z Proposed foreign exchange balancing methods z Sources or supply of principal raw materials z Description of plant, property and equipment, as well as technical

engineering information z Utilities and natural resources requirements and environmental protection

programs z Organization and management of the joint venture, and labour

requirements z Plan and timetable for completing the project z Financial and economic benefit analysis for the joint venture

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V. Establishment (Con’t)

z Negotiation and Execution of Joint Venture Contract and Articles of Association – EJV contracts originally followed a model standard form produced by MOFCOM,

now MOFCOM – EJV Contracts contain standard provisions regarding capital, the Board of

Directors, Management etc (discussed in more detail below) – EJV Contracts are negotiated by both parties before being submitted for

government approval – Approval body depends on size of investment – (usually MOFCOM at the

city/local/provincial level, or Beijing central government level if large project) – EJV Contracts are generally for a fixed term; an amendment in the EJV Law

allows for an indefinite duration, but most PRC parties claim law stipulates 50 years maximum

– Reason for this lies with land use laws which limit industrial use to 50 years

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V. Establishment (Con’t)

z Articles of Association – Constitutional documents of an EJV – Provisions mirror those in EJV Contract, but can be more detailed than an EJV

Contract – Can cover such matters as: the purpose and business scope of operations the total investment and registered capital the organizational framework, and the powers and duties of its officers principles governing finance, accounting, foreign exchange, labour

management, duration, termination, liquidation, and amendments to the articles of association

– Submitted for approval at same time as EJV Contract

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VI. Specific Issues/Provisions

z “Equality and Mutual Benefit” – Chinese partner will introduce this principle early on in negotiations – Chinese partners in negotiations use it to negotiate positions which

are equal but are really not

z Capital Contributions and Financings – Each party required to make capital contributions – Contribution may be in cash or in-kind; there are limits on amount of

contributions in form of technology/intellectual property – Portion of capital contribution determines may significant aspects of

EJV, (e.g., number of board seats, control, allocation of profits risks and loss, etc.)

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– Business Scope

z Under English or Hong Kong law, companies almost have no restrictions on what act they can carry out, e.g. s5A of the Companies Ordinance, “(1) a company has the capacity and the rights, powers and privileges of a natural person; (2) without limiting subsection (1), a company may do anything which it is permitted or required to do by its memorandum or by any enactment or rule of law.”

z A corporate entity (including an EJV) in China, does not have the capacity, power nor rights to carry out any business activities unless they are specifically included in the business scope in the business licence.

z The business scope stated in the business licence, the JV contract and Articles of Association should be consistent.

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– registered capital vs. total investment

z registered capital = equity z total investment = equity + debt z difference between registered capital and total investment (if there is a

difference) is the borrowing capacity of the EJV z equity ratios are set by regulations depending upon amount of total

investment, and EJV must abide by the ratio regulations z time limits for registered capital contribution z any change in either amount requires approval of both partners and the

original government examination and approval authority of the EJV z EJV law requires that foreign party must contribute not less than 25% of

the registered capital z Capital Verification Report

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– Governing Law and Dispute Resolution

z EJV Law stipulates that EJV Contract must be governed by PRC law z Disputes may arbitrated outside of China, and it is advisable to include

third country arbitration clauses in the EJV Contract z Common third country arbitrations include ICC Stockholm, Singapore, etc.

– Corporate Governance Body

z Board of Directors - highest authority of EJV z Board seats - determined by equity split z Chairman can be the legal representative of the EJV; no casting vote z No nationality or residential requirements for board members of EJVs z Legal representative z Board of Supervisors

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z Despite division in Board, EJV Law stipulates 4 critical decisions which require

unanimous decision of Board and approval of original approval authority

(1) Any amendment to Articles of Association (2) Merger or division (3) Increase in or transfer of capital; and (4) Liquidation/dissolution

z These 4 decisions effectively are control “fall back” provisions, which make it difficult for foreign investors to extricate themselves from EJVs when they run into disputes/trouble

z Legal representative z Management usually divided equally, one partner appoints GM and other the Deputy

GM z Supervisory Board or Supervisor

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– Foreign Exchange

z Renminbi – not freely convertible z Foreign exchange controls affect most accounting activities, and should be

factored into all financial planning. Foreign exchange risks can be managed well with adequate planning.

z Balancing foreign exchange income and expenditure z Level of control over inbound or outbound foreign exchange depends on

whether the nature of the transaction involves the transfer of capital or ordinary expenditures.

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– Current/Capital Accounts Foreign Exchange Control Regulations, Art 52

z “current account items” - ordinary transaction items within the context of international receipts and payments, including balance of payments from trade, labour services, payments of interest (but not repayment of principal), repatriation of dividends from a joint venture. In practice, this refers to payments and receipts in the normal course of buying and selling goods and services and other normal day-to-day business transactions.

z “capital account items” – items which serve to either increase or decrease the debt

or equity of an enterprise through the inflow or outflow of capital, including direct investment, loans, securities investments, fixed assets, and working capital.

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– Foreign exchange revenue from current account transactions

z Under Article 10 of the Foreign Exchange Control Regulations, all foreign exchange revenue from current account transactions must be repatriated to China and either sold to designated forex bank or placed into foreign currency account at such banks.

z Foreign investors will be permitted to convert RMB earnings at the banks before

remitting profits overseas.

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– Foreign Exchange revenue from capital account transactions

z All foreign exchange receipts relating to capital account transactions must be deposited into a foreign exchange account opened with a designated foreign exchange bank (Article 20).

z Conversion of such foreign exchange to RMB is subject to approval from SAFE. z Remittance of capital account revenue requires SAFE approval.

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– Current / Capital Accounts

z Current account: the procedures required for buying foreign exchange to pay for a current account expense, or withdrawing foreign currency from a forex account to pay for a current account item, are designed to ensure that the payment qualifies as a current account payment.

z The official review of current account foreign currency transactions is intended to be

an administrative check, not a discretionary review of the underlying business purpose of the related payment.

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– Current / Capital Accounts

z “Capital account” transactions are tightly restricted. Both receipts and payments of foreign exchange for capital contributions, loans, purchases of fixed assets, and other capital account items, whether inside or outside China, are subject to discretionary view.

z FIEs and domestic Chinese companies must deposit foreign exchange receipts

relating to capital account items with designated foreign exchange bank. SAFE approval is required for payments made out of an FIE or domestic company’s capital accounts. The conversion of RMB into foreign exchange also requires SAFE approval.

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– Foreign Exchange Control

z The remittance of profit is a current account item. z When the foreign investor in an FIE remits abroad the current year’s profits,

dividends etc., it must submit the following materials to a designated foreign exchange bank (The Questions concerning the Remittance of Profits, Dividends and Bonuses out of China through Designated Foreign Exchange Banks Circular): – Proof of tax payment and tax returns; – Auditor’s report on the profit, dividend or bonus; – Board resolution regarding distribution of profits, dividends or bonuses; – The FIE’s foreign exchange registration certificate; – Capital verification report; and – Any other materials the SAFE may require.

z Foreign investors can only remit profits, dividends, bonuses when they have completely paid in their registered capital contribution.

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– Land / Land Use Rights

z All land is owned by the State. z Transferable land use rights may be granted to individuals and entities. z Granted vs Allocated Land Use Rights z Only granted land use rights can be transferred z The Granted Land Use Rights can be acquired through means of

agreement, tendering and auction. The grantees are required to enter into a land use rights grant contract with the local land administration authority. The land use rights are usually granted for 50 years for industrial purposes and 40 years for commercial purposes

z By contrast, certain land use rights in China are allocated by administrative orders to state owned enterprises or entities free of charge (the “Allocated Land Use Rights”)

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– Land / Land Use Rights

z The Allocated Land Use Rights cannot be transferred, leased, charged or otherwise disposed of without first being converted into Granted Land Use Rights (i.e. by paying the relevant government department the land grant fees, which could be substantial in certain cases.)

z Allocated Land Use Rights can be taken back by the government without

any compensation. Land use certificates may or may not be issued for Allocated Land Use Rights.

z In the transfer of property e.g. a building, the local government will also

issue a building ownership certificate showing the owner of the building. z In some cases, the building ownership certificate and land use right

certificate have been combined. Please check carefully.

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– Exit z Liquidation z Trade sale of interest/registered capital

Equity Joint Venture

Documents

Transcript of Equity Joint Venture