To JV or Not to JV That is The Question

Richard KimberManaging Partner

RHK Legal25th January 2011

1. Legal Structures Available in China2. A Joint Venture - The Pros and Cons3. Danone JV- What went wrong4. Lessons Learned

Outline

Equity Joint Ventures Cooperative Joint Ventures Wholly Foreign Owned Entities Partnerships - New

There are four legal structures under which foreign companies can conduct business in China

Profit and Risk Sharing are proportionate to the equity of each partner

A minimum of 25% of the capital must be contributed by the foreign partner

No minimum investment for the Chinese Partner Equity in a joint venture cannot be transferred

without approval of from the Chinese government Either party can appoint the Chairman (Legal

Representative)

Key Elements of Equity Joint Venture

German Chamber of Commerce Survey - 2007 The ratio of WFOEs to JVCs was 2:1 75% of JV companies would enter the market as

WFOES if they could choose again Reasons:◦Direct Management Control of Operations◦Control of Technology and Know How◦ Independent Market Exit Decision◦No need to share Profits◦Quicker Set Up

So why JV?

Same 2007 Survey: JV Partners support in dealing with authorities Access to JV Partners Customer or Sales Network Access to large local labour force Better Chance of Getting Government Contracts Sharing Risk and Capital Expense of R&D

So what are the Pros of a JVC

JVs only permitted for :◦ -development and application of new technologies for

recovery of crude oil◦ -production and R&D of automobile electronic devices

and control systems◦ -power transmission and transformers, geothermal power

generation, wind power generation, nuclear power generation

Also - Market Access

Local Partner's Objectives may be different from Foreign Partner

Cultural Differences may lead to misunderstanding / operational conflicts

Potential loss of control over daily operations Foreign Partner may lose control of its intellectual

property

So what are the Cons

Due Diligence: Thoroughly vet joint venture partner Make LOI or MOU as detailed as possible - less to

argue about in JV Agreement Develop a jointly agreed business plan for the joint

venture Exert daily management control over the Joint Venture

- if you are minority shareholder seek power to appoint CFO and General Manager

Recognize that the Chinese side will always seek to vary the rights under a Joint Venture to suit changes in business conditions - try to be flexible in response

How to Maximize the Prospects for a Successful Joint Venture

Plan carefully for dispute settlement - mediation is better option

Plan for an orderly dissolution - if disagreements cannot be resolved

How to Maximise the Prospects for Success (cont'd)

What Went Wrong and Why?

Background:◦ 1996 - Joint Venture Formed◦Chinese Party - 49% (SOE)◦ French Party 25.5% and Hong Kong Party 25.5%

through a Singapore SPV (total 51%)

Sino-Foreign - Beverage Joint Venture

Chinese Party - majority shareholder - 49% - board control

It saw other 2 shareholders as minority shareholders

Its sole contribution to the JVC had been the Chinese Party trademark -

valued at RMB 100 million

Foreign Investors had contributed cash - RMB 500 million

However - TM was never assigned to JV because Trademark Office refused -

saw TM as "most famous trademark" belonging to the State.

This issue was never resolved however parties agreed in 1998 to enter into a

license agreement giving JVC defacto ownership of mark and exclusivity of

use.

1996 to 1998 - JV ran smoothly

French Party bought out HK Party and became 51% shareholder with board control.

Chinese Party and Chairman of JV saw this as a loss of control of the trademark and of the company.

Problems then arose:◦ (i) While French Party was majority shareholder it delegated

effective management control to Chinese side – French Party took its eye of the ball.

◦ (ii) Chinese side then established other competing companies and installed his relatives to operate these companies.

◦ (iii) These non JV companies effectively competed with the JVC and used the trademark exclusive licensed to the JVC.

1998 - a watershed

Result: French Party and Chinese Party have now been

in arbitration for the past 4 years and French Party is now trying to recover its investment in a company which has grown to be the No.1 beverage supplier in China with a 15% market share.

Most importantly – file for IPR protection within China whether it be trademark, patent, technology, trade secrets or just know how and before you commence negotiations.

- if assigning technology to a JVC ensure that the foreign party has rights to receive a license back of improvements to the technology, preferably an exclusive license back or if not exclusive then a perpetual royalty free license.

-in the case of a license of technology insert a change of control clause to provide that if Chinese side disposes of its shares in the JVC this will trigger a cancellation of the license.

Lessons Learned

Clearly define who may use the technology transferred to the JVC (are subcontractors and subsidiaries excluded)

Include clauses binding both the JVC and its personnel, e.g. non-compete clauses, confidentiality clauses, non-solicitation clauses.

Lessons Learned (cont’d)

Be active in the management of the JVC - attend all board and shareholder meetings

Don’t let the Chinese side consider the foreign party is an absent shareholder - resentment will form.

If minority shareholder - try to get CFO position and daily management control

Try to avoid 50/50 JVCs or 51/49 JVCs - in Chinese business culture local joint ventures are alway either 70/30 or 60/40 so it is crystal clear who controls the business.

-the Chinese side does not differentiate between 51/49 and 50/50. “A meeting of equals”

Lessons Learned (cont'd)

Provide a solid base on which to establish the JVC

- show as much as possible what the foreign side is bringing to the JVC - technology/management expertise/new markets/new products

-avoid the scenario where all that was being

given was IP (trademark) and the focus turned to that, instead of to the business itself.

Lessons Learned (cont'd)

At the employee level: Make employees aware that unauthorized

communication hurts their company and their jobs

Ensure employment contracts contain non-compete clauses and confidentiality agreements

Lesson Learned (cont’d)

A successful JV in China can be one...

"where the parties lie in the same bed but have

different dreams”

But always remember in the words of Longfellow, a

JVC is like a child...

"when they are good, they are very very good

but when they are bad they are horrid"

In Summary

Our Clients

Thank you for your attention and time!

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