Opportunities for foreign investors to integrate into the Chinese market have increased since the launch of the China Pilot Free Trade Zone, in September 2013. While there are five avenues to acquire a business in China, foreign investors most commonly use joint ventures and wholly foreign-owned enterprises.
A joint venture is a business arrangement between a foreign partner and a Chinese partner with profits and losses being shared between the partners. The two most common types of joint ventures are the equity joint venture and the cooperative joint venture. Both types require the drafting of a detailed contract specifying the responsibilities, rights and interests of each partner. This usually involves a lengthy and complex negotiation between the partners.
Chinese partners typically bring their market knowledge, preferential market treatment and manufacturing capability to the venture, with the foreign partner contributing the technology, manufacturing know-how and marketing experience.
Equity joint venture: Despite its lack of flexibility, the equity joint venture is popular among investors. The foreign partner must contribute at least 25% of the registered capital but there is no ceiling on the foreign partner’s contribution except where Chinese law requires the Chinese partner to have minimum ownership of the company. Chinese partners commonly contribute capital in the form of cash, land development or lands rights use, and clearance fees. Foreign partners often contribute cash, construction materials, technology and machinery.
By law, the equity joint venture must have limited liability, with the partners’ liability limited to the contributions made to the registered capital of the equity joint venture. This is advantageous for the partners should the joint venture fail, as they have no personal liability to repay debts. Because of this corporate structure, stringent rules apply to the company design, such as the requirement for a board of directors that has the authority to make all major decisions concerning the venture.
Cooperative joint venture: The cooperative joint venture allows for more flexible agreements between the partners. They can organize themselves either as a limited liability company or as a non-legal person in which the partners may incur individual liability for the losses of the enterprise. In practice, the majority of cooperative joint ventures are set up as limited liability companies.
The other major difference between a cooperative joint venture and an equity joint venture is that, in the former, profit allocation may be discretionary and need not be proportional to the investments made by the partners in the enterprise. The recovery of investments can also be flexible, as the parties may agree a variety of structures and plans which can be unique to each partner, such as through an accelerated repayment structure in which the remaining investor would become the owner of the enterprise upon full repayment.
The joint venture must be able to respond to possible difficulties linked to relations between partners, and provide for all accounting, tax and social repercussions, so reliable legal and commercial advice is essential.
100% foreign ownership
In a wholly foreign-owned enterprise, foreign investors have complete control over all aspects of the company. Originally conceived to encourage manufacturing activities, particularly those which were export-oriented or introduced advanced technology, taking advantage of China’s development of special economic zones, the wholly foreign-owned enterprise structure is now available for almost all investment types, and is increasingly being used by service providers, for software development and for trading and logistical businesses. A wholly foreign-owned enterprise is a limited liability company, and thus a separate legal entity. As in an equity joint venture, this means investor liability is limited to the contributions made to the registered capital of the enterprise.
It is simpler to establish a wholly foreign-owned enterprise than a joint venture. Other notable advantages include the autonomy and independence to carry out global strategies of a parent company without having to consult Chinese partners, the maximization of profits through 100% ownership, and the protection of intellectual property. However, such an enterprise could lack valuable assistance from a knowledgeable local partner, potentially hindering the growth of its business in the region. The foreign investor will need to navigate all aspects of running the enterprise, though Chinese advisers may be consulted.
Any joint venture has advantages and disadvantages and can continue to flourish in modern China. The wealth of opportunities for foreign investment ensures that China will retain its position as Asia’s, and the world’s, most rapidly developing, and most exciting, economic hub.
Gautam Khurana is the managing partner at India Law Offices in New Delhi. Lenon Woo is the managing partner at Shanghai Promise Law Firm in Shanghai. The firms collaborate on legal matters arising out of investments and transactions involving Indian and Chinese companies.
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