Equity Joint Ventures in PRC

Professor Shen Wei

Summer 2015

I. Introduction
Two types of JVs in China

Equity JVs and Cooperative JVs

Equity more common than Cooperative

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)

II. Regulatory Framework

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

III. Form/Corporate Structure

EJVs have legal person status

Similar to a corporate person in the West

Limited liability companies

Shareholders in an EJV enjoy limited liability protections
There are no shares in EJVs a partners interest in an EJV is reflected by the portion
of registered capital it contributed to the EJV
Choice of SPV

IV. Location and Partner

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

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

V. Establishment

Preparation of a Preliminary Project Proposal (or Report)

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

VI. Specific Issues/Provisions (Cont)

Preparation of an FSR
At a minimum, the FSR should cover the following topics:
Introduction to the proposed project
Market demand for products to be manufactured, production capacity, and
sales plans for the products (including export commitments)
Financing
Proposed foreign exchange balancing methods
Sources or supply of principal raw materials
Description of plant, property and equipment, as well as technical
engineering information
Utilities and natural resources requirements and environmental protection
programs
Organization and management of the joint venture, and labour
requirements
Plan and timetable for completing the project
Financial and economic benefit analysis for the joint venture

V. Establishment (Cont)
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

V. Establishment (Cont)
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

VI. Specific Issues/Provisions

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

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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VI. Specific Issues/Provisions (Cont)

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

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VI. Specific Issues/Provisions (Cont)

registered capital vs. total investment

registered capital = equity
total investment = equity + debt
difference between registered capital and total investment (if there is a
difference) is the borrowing capacity of the EJV
equity ratios are set by regulations depending upon amount of total
investment, and EJV must abide by the ratio regulations
time limits for registered capital contribution
any change in either amount requires approval of both partners and the
original government examination and approval authority of the EJV
EJV law requires that foreign party must contribute not less than 25% of
the registered capital
Capital Verification Report

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VI. Specific Issues/Provisions (Cont)

Governing Law and Dispute Resolution

EJV Law stipulates that EJV Contract must be governed by PRC law
Disputes may arbitrated outside of China, and it is advisable to include
third country arbitration clauses in the EJV Contract
Common third country arbitrations include ICC Stockholm, Singapore, etc.

Corporate Governance Body

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

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VI. Specific Issues/Provisions (Cont)

Despite division in Board, EJV Law stipulates 4 critical decisions which require
unanimous decision of Board and approval of original approval authority
(1)
(2)
(3)
(4)

Any amendment to Articles of Association

Merger or division
Increase in or transfer of capital; and
Liquidation/dissolution

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
Legal representative
Management usually divided equally, one partner appoints GM and other the Deputy
GM
Supervisory Board or Supervisor

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VI. Specific Issues/Provisions (Cont)

Foreign Exchange
Renminbi not freely convertible
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.
Balancing foreign exchange income and expenditure
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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VI. Specific Issues/Provisions (Cont)

Current/Capital Accounts

Foreign Exchange Control Regulations, Art 52

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 dayto-day business transactions.
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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VI. Specific Issues/Provisions (Cont)

Foreign exchange revenue from current account transactions

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.
Foreign investors will be permitted to convert RMB earnings at the banks before
remitting profits overseas.

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VI. Specific Issues/Provisions (Cont)

Foreign Exchange revenue from capital account transactions

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

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VI. Specific Issues/Provisions (Cont)

Current / Capital Accounts

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.
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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VI. Specific Issues/Provisions (Cont)

Current / Capital Accounts

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.
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 companys capital
accounts. The conversion of RMB into foreign exchange also requires SAFE
approval.

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VI. Specific Issues/Provisions (Cont)

Foreign Exchange Control

The remittance of profit is a current account item.

When the foreign investor in an FIE remits abroad the current years 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;

Auditors report on the profit, dividend or bonus;

Board resolution regarding distribution of profits, dividends or bonuses;

The FIEs foreign exchange registration certificate;

Capital verification report; and

Any other materials the SAFE may require.

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

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VI. Specific Issues/Provisions (Cont)

Land / Land Use Rights

All land is owned by the State.

Transferable land use rights may be granted to individuals and entities.
Granted vs Allocated Land Use Rights
Only granted land use rights can be transferred
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
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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VI. Specific Issues/Provisions (Cont)

Land / Land Use Rights

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.)
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.
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.
In some cases, the building ownership certificate and land use right
certificate have been combined. Please check carefully.

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VI. Specific Issues/Provisions (Cont)

Exit
Liquidation
Trade sale of interest/registered capital

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