Setting up and operating a joint venture

Structure

Are there any particular drivers in your jurisdiction that will determine how a joint venture is structured?

For foreign-invested joint ventures, one of the primary driving factors relating to structuring a specific joint venture in China is whether the intended business scope falls within prohibited or restricted sectors for foreign investment provided for under the Negative List. For certain restricted sectors, the Negative List requires that the Chinese joint venture parties shall hold majority shares in the joint venture to be established. In practice, the joint venture parties also resort to contractual arrangements such as the commonly adopted variable interest entity structure to implement foreign investment in certain sectors prohibited or restricted, though the same is not endorsed by Chinese law.

Other common driving factors include:

  • the objective and purpose of the joint venture and methods of co­operation between the joint venture parties, such as if any specific technologies or assets of a specific joint venture are critical to the joint venture;
  • the corporate governance structure and decision-making mechanisms, taking into consideration mandatory legal requirements and the room that the parties may negotiate;
  • preferential tax treatments or policies available;
  • tax consequences, particularly those relating to the distribution of dividends to foreign joint venture parties; and
  • the level of ease for disposing of the shares of or termination of the joint venture.
Tax considerations

When establishing a joint venture, what tax considerations arise for the joint venture parties and the joint venture entity? How can tax charges be lawfully mitigated?

The main tax considerations for joint venture parties when establishing a joint venture are the overall tax structuring, taxes payable and tax burden in relation to the joint venture to be incorporated.

A domestic joint venture party will also need to consider the tax consequences if it will make its capital contribution by non-monetary assets such as fixed assets, intellectual property rights, etc, and the joint venture party could be subject to enterprise income tax on gains received from such capital contributions, unless the same is regarded as a reorganisation operation and is thus qualified for special tax treatment. In such circumstances, the joint venture party can settle the enterprise income tax payable on a deferred basis over a five-year period.

As for foreign joint venture parties, other tax concerns will be in relation to withholding tax on income from the joint venture such as dividends, interests and royalties, considering the relevant tax treaties entered into with China and the seat of the foreign joint venture parties.

Asset contribution restriction

Are there any restrictions on the contribution of assets to a joint venture entity?

Shareholders to a joint venture may contribute its subscribed capital in cash, in kind or with intellectual property rights, land use rights or other non-monetary assets, provided that the value of non-monetary assets shall be determined through appraisal and the ownership thereof shall be legally transferred to the joint venture.

In relation to EJVs and foreign-invested partnerships, if the capital contribution is made in kind, immovable properties or intellectual property rights, the value of such assets can be determined either through appraisal by a third party or by negotiation between the parties on the principles of fairness and reasonableness.

For EJVs, where a foreign joint venture party contributes in intellectual property rights, the foreign party is also required to provide the company registration authority with documentation relating to the ownership, validity, technical features and the basis for determining the value of such intellectual property rights, as well as the agreement signed with the Chinese party on determining the value of such intellectual property rights.

Interaction between constitution and agreement

What is the interaction between the constitution of the joint venture entity and the agreement between the joint venture parties?

Under the PCL, articles of association are recognised as the constitution of a company in general, and articles of association are binding on the company and its shareholders, directors, supervisors and senior officers. Articles of association must be filed with the company registration authority for registration and record, and can be publicly available. Contractual agreements between joint venture parties are private agreements between the parties and usually regulate the rights and obligations between the joint venture parties. Contractual agreements are not statutory legal documents required for companies regulated by the PCL and are not required to be filed with the company registration authority. The PCL does not designate priority between the articles of association and the contractual agreement between joint venture parties.

The legal requirements for EJVs and CJVs are different. In addition to articles of association, the current effective laws expressly recognise joint venture agreements and joint venture contracts for EJVs and CJVs. A joint venture agreement for an EJV or CJV is defined by law to govern the key points and principles in relation to the formation of the relevant joint venture and is more like a term sheet or framework agreement, while a joint venture contract for an EJV or CJV is an agreement governing the specific obligations and rights of the joint venture parties, thus it actually serves as the ‘real’ shareholders’ agreement between the parties. The joint venture parties may choose not to enter into a joint venture agreement, although the joint venture contract together with the articles of association are statutory legal documents to be filed with the company registration authority when incorporating an EJV or CJV. The law further expressly provides that, in cases of discrepancy between a joint venture contract and articles of association for EJVs and CJVs, the joint venture contract shall prevail.

As a general rule, both articles of association and joint venture agreements (whether for joint ventures with foreign investment or not) may not violate or override the mandatory law provisions, and on this basis the joint venture parties may agree on specific arrangements or agreements between them and have the same incorporated into the articles of association or the joint venture agreements, although it is common for the articles of association of a company to include mandatory provisions only.

Party interaction

How may the joint venture parties interact with the joint venture entity? Are there any restrictions?

The interaction of the joint venture parties with the relevant joint venture will be subject to mandatory law provisions, the articles of association and the contractual agreements between the joint venture parties.

As a statutory law principle, a shareholder may not damage the interests of the company or other shareholders in abusing or taking advantage of its shareholders’ rights or its affiliated relationship with the relevant company, or the said shareholder may be held liable to assume compensation liabilities according to the law. Moreover, when a company intends to provide a guarantee for a shareholder or the actual controller of the company, the matter shall be approved by the shareholders’ meeting and the related shareholder shall refrain from voting on the matter.

Shareholders in a company are entitled to right of information access provided for under the PCL, whereby a shareholder is entitled to review (for both LLCs and JSCs) and take copies of (for LLCs only) the company’s articles of association, minutes of shareholders’ meetings, board resolutions, resolutions of the supervisory board and financial accounting reports, and a shareholder of LLCs is also entitled to check the company’s account books for legitimate purposes.

Exercising control

How may the joint venture parties exercise control over the joint venture entity’s decision-making?

The control over a joint venture by joint venture parties is commonly implemented through means such as:

  • the allocation and balancing of power to appoint or remove directors and senior management personnel; and
  • reserved matters that either require a special majority of shareholders or a vote from specific shareholder(s), which generally is more favourable to and pursued by minority shareholders.

For joint ventures regulated by the PCL, the decision-making mechanism of the joint venture could be substantially agreed by the shareholders freely, except for mandatory rules that must be complied with, such as:

  • amendments to the articles of association, an increase or reduction of registered capital, change of corporate form, the merger, split or termination of the company, which shall be approved by shareholders holding two-thirds or more voting rights;
  • the transfer of shares by one shareholder to a third party shall be subject to the consent of a majority of other shareholders; and
  • the voting rights of shareholders at shareholders’ meetings shall be exercised in proportion to their respective capital contributions, unless the shareholders have agreed on a different method of exercising their voting rights.

The mandatory rules in relation to decision-making mechanisms are different for EJVs and CJVs, for which amendments to the articles of association, an increase or reduction of registered capital, and the merger, split, suspension or termination of the joint venture shall require unanimous approval of all directors, and a transfer of shares by a joint venture party to a third party shall be approved by all other joint venture parties.

Governance issues

What are the most common governance issues that arise in connection with joint ventures? How are these dealt with?

The most common governance issues for joint ventures in China are:

  • the allocation and balancing of decision-making and management power among the joint venture parties;
  • deadlock issues; and
  • route of exit from the joint venture.

The governance issues are to be deliberated at the very beginning when the joint venture parties negotiate terms for a proposed joint venture, taking into consideration the proposed shareholding structure, and the roles and expectations of joint venture parties in relation to the proposed joint venture. In the case of a foreign-invested joint venture, the joint venture parties shall also consider the mandatory rules relating to decision-making of the joint venture (see question 10) in combination with the proposed allocation of management control between the joint venture parties and the potential deadlock issue.

For example, for an EJV, the law requires that the number of directors shall be at least three, the appointment of directors can be discussed between the joint venture parties by reference to (rather than in proportion to) their shareholding percentage, and the statutory quorum for a board meeting is two-thirds of all directors. Accordingly, in many circumstances, the minority joint venture party is encouraged to negotiate and request the power to appoint directors to the board, plus as many reserved matters as possible to be approved by the board that require a favourable vote from the minority party, and as a result the governance structure agreed between the joint venture parties may easily lead to deadlock.

Nominee directors

With an incorporated joint venture, what controls exist in your jurisdiction in relation to nominee directors? How should a nominee director balance the potentially conflicting interests of the joint venture company and the appointing shareholder?

The directors of a joint venture company owe duties of loyalty and diligence to the joint venture company by law, and as a general principle a director may not act in damaging the interests of the company by taking advantage of his or her affiliated relationship with the company. A director could be also held liable to compensate the company for losses caused to the company when performing its duties in violation of the constitutional documents of the company or law.

In addition, the board of supervisors or supervisors (if there is no board of supervisors) of a company are empowered by law to supervise the performance of duties by directors, and are entitled to request the relevant director to rectify his or her actions and to propose the removal of directors who have acted in violation of constitutional documents, shareholders’ resolutions or the law.

A shareholder may also in his or her own name initiate a lawsuit against a director who violates the constitutional documents of the company or the law in damaging the interests of the shareholders.

In addition to statutory provisions, it is also common to stipulate specific matters that are to be approved by shareholders or alternatively restrict the specific powers of directors or the board of directors in the articles of association to the extent permitted by law.

Competition law

What competition law considerations are engaged by the formation and operation of the joint venture? Is approval needed?

The formation of a joint venture in China falls within the scope of ‘concentration of undertakings’ prescribed under the PRC Anti-Monopoly Law, and the relevant transaction will be subject to merger control clearance by the competent anti-monopoly authority if prescribed statutory thresholds are met; namely, if in the preceding financial year:

  • the combined worldwide turnover of all the undertakings concerned exceeds 10 billion yuan, and the nationwide turnover within China of each of at least two of the undertakings concerned exceeds 400 million yuan; or
  • the combined nationwide turnover within China of all the undertakings concerned exceeds 2 billion yuan, and the nationwide turnover within China of each of at least two of the undertakings concerned exceeds 400 million yuan.
Provision of services

What are the key considerations in your jurisdiction in structuring the provision of services to the joint venture entity by joint venture parties?

One of the key considerations in relation to the provision of services to the joint venture by a joint venture party is that the relevant transaction is to be carried out on an arm’s-length basis and shall not damage the interests of the joint venture or other joint venture parties, or the said joint venture party could be held liable for compensating the damages caused to the joint venture or other joint venture parties.

Relevant tax consequences are also key factors in structuring the services from joint venture parties to the joint venture, depending on the nature of the services involved and the identity and seat of the joint venture parties providing the services, as well as if the services involve transfer-pricing issues. For example, if the tax authority believes that transactions between the joint venture parties and the joint venture are not on an arm’s-length basis and as a result the taxable income of the joint venture or the joint venture parties is unreasonably reduced, the tax authority is authorised to step in and adjust the taxable income.

Employment rights

What impact do statutory employment rights have in joint ventures?

Under Chinese law, secondment of employees shall be carried out in line with statutory legal requirements, for example:

  • secondment of employees shall only be for temporary, auxiliary or substitute job positions;
  • the entity dispatching employees to be seconded will be regarded as the employer and shall enter into a formal fixed-term labour contract for at least two years with the employees to be seconded and undertakes all relevant labour law obligations to such employees; and
  • the dispatching entity shall also need to enter into a secondment agreement with the entity receiving the employees.

In addition, the entity receiving the seconded employees shall also provide statutory employee protection and conditions for the seconded employee in line with law.

Where an employee is to be transferred to the joint venture, the joint venture will be the employer and it shall enter into a formal labour relationship with the employee.

Intellectual property rights

How are intellectual property rights generally dealt with on the creation, operation and termination of a joint venture in your jurisdiction?

When incorporating a joint venture, the joint venture parties can contribute subscribed capital with intellectual property rights. It is becoming increasingly popular for joint venture parties to license their technologies instead of transferring them to the joint venture through a capital contribution at the outset of the incorporation of a joint venture.

In the context of an EJV, if a foreign joint venture party contributes its subscribed capital in intellectual property rights, the foreign party is required to provide documentation relating to the ownership, validity, technical features and the basis for determining the value of such intellectual property rights to the company registration authority. In addition, the intellectual property rights shall be either technologically advanced or energy-saving. Furthermore, for technologies to be transferred to an EJV by a joint venture party or a third party, the relevant technology transfer agreement shall meet mandatory legal requirements, such as that the technology transfer fee shall be reasonable, and the party providing technologies may not restrict the areas, quantity or price of the products that are to be exported by the joint venture unless otherwise agreed.

In the case of termination of the joint venture, the intellectual property rights, depending on whether they are transferred or licensed to the joint venture, will be dealt with in accordance with the arrangement as agreed in the relevant joint venture agreement or licensing agreement.