New insight into disputes over Sino-foreign JVs

By Jenny Wang and Ma Lisha,Merits & Tree Law Offices
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A Sino-foreign equity joint venture (EJV) is a form of organization used by the pioneer foreign investors to enter China. However, its governing law, the Law on Sino-foreign Equity Joint Ventures, and the rules for its implementation, showed many disparities with the Company Law, the Partnership Law and other laws and regulations currently in force, resulting in a lack of uniform criteria for the application of law when disputes occurred with enterprises. With the Foreign Investment Law (FIL) and the regulations on its implementation coming into force on 1 January 2020, the above-mentioned problem are likely be solved. Along with the effectiveness of the FIL, the three laws that originally regulated foreign investment activities – i.e., the Law on Sino-foreign Equity Joint Ventures, Law on Foreign Invested Enterprises, and Law on Sino-foreign Co-operative Joint Ventures –have been abolished.

Sino-foreign
Jenny Wang
Partner
Merits & Tree Law Offices

For example, article 4 of the Law on Sino-foreign Equity Joint Ventures stipulates that the transfer of one party’s share of its registered capital shall be effected only with the consent of the other parties to the EJV, and the parties to the venture shall share the profits, risks and losses in proportion to their respective contributions to the registered capital.

Share transfer to third parties. As for share transfer to third parties, the Implementation Rules for the Law on Sino-foreign Equity Joint Ventures stipulates more detailed requirements: “Where any party to an [EJV] transfers all or part of its equity in the [EJV], the other parties shall have the pre-emptive right… The conditions under which any party to an equity joint venture transfers its equity in the [EJV] to a third party shall not be more favourable than those for the other parties to the [EJV]. Any transfer in violation of the above provisions shall be void.”

sino-foreign
Ma Lisha
Lawyer
Merits & Tree Law Offices

By contrast, the Company Law stipulates that, “Transfer of the equity interest of a company by a shareholder to anyone other than another shareholder of the company is subject to consent by a majority of all the shareholders… Failure by the other shareholders to give a reply within 30 days following the receipt of written notice is deemed consent to such transfer… The dissenting shareholders shall purchase such shares to be transferred; refusal to purchase is deemed consent to such transfer. Where the articles of association provide otherwise relating to share transfer, the articles of association shall prevail.”

Although the Law on Sino-foreign Equity Joint Ventures and the Company Law impose different percentage requirements on the consent of other shareholders (consent of all other shareholders versus consent of more than half of other shareholders), the foregoing percentage cap has no material impact on share transfer to third parties.

However, since the Law on Sino-foreign Equity Joint Ventures does not stipulate that the non-reply, or the dissent but refusal to purchase, by other shareholders shall be deemed consent to such transfer, the situation has frequently occurred in reality that when a party to an EJV requests share transfer, the other parties to the joint venture treat the transfer request passively, making it difficult to prove the “consent of the other parties to the EJV”, which seriously impedes share transfer. This situation has frequently given rise to disputes. To address the issue, the Supreme People’s Court (SPC) issued the Provisions on Trial of Cases involving Disputes Relating to Foreign-funded Enterprises (I) in 2010, stipulating that, “Where a shareholder of a foreign-funded enterprise transfers all or part of its equity to a third party rather than the shareholders thereof, the transfer shall be subject to the consent of all the other shareholders.

“If any other shareholder requests cancellation of the said equity transfer contract on the ground that the contract is signed without its consent, the people’s court shall uphold such request, except for any of the following circumstances: (1) where there is evidence proving that the other shareholders have granted their consent; (2) where the transferor has made written notice regarding the equity transfer but the other shareholders fail to give a reply within 30 days upon receipt of the written notice; or (3) where the other shareholders disagree to the transfer but refuse to purchase the involved equity.”

However, this judicial interpretation only provides stipulations for the request for cancellation without clarifying what circumstances constitute “deemed consent to transfer”. The Law on Sino-foreign Equity Joint Ventures, revised in 2016, also provided no clarification.

After the FIL entered into force, the share transfer by shareholders is subject to relevant provisions of the Company Law, which will likely solve this issue.

Profit distribution. As for profit distribution, the Law on Sino-foreign Equity Joint Ventures stipulates that the parties to an equity joint venture are only entitled to profit sharing in proportion to their respective contributions to the registered capital of the EJV. Therefore, if the parties hope not to share the profit in proportion to their respective contributions to the registered capital, generally they need to establish a co-operative joint venture (The Law on Sino-foreign Contractual Joint Ventures allows Chinese and foreign partners to distribute income in accordance with the contract in a co-operative enterprise. This form of organization, however, ceased to exist upon the FIL becoming effective).

If an EJV fails to distribute profits or share risks in proportion to its registered capital contributions, such distribution or sharing may be deemed invalid due to violation of law. In a series of contract disputes between DLP Investment Holdings and Meng Fanyong, the Chinese party to an EJV requested the court to invalidate the foreign party’s special arrangements for profit distribution and risk sharing, and its request was upheld by the court. As a result, it is difficult for a Sino-foreign EJV to make more flexible arrangements for profit distribution.

However, the Company Law stipulates that, “the shareholders are entitled to dividend distribution in proportion to their actual capital contribution percentages… except that all shareholders agree that the dividends will not be distributed in proportion to their capital contributions or they will not subscribe for capital by exercising the pre-emptive right in proportion to their capital contributions.”

After the FIL entered into force, a company’s profit distribution will also be subject to relevant provisions of the Company Law. The parties to an EJV may include special provisions on profit distribution in its articles of association without worrying about invalidation of its profit distribution.

Conclusion. The promulgation of the FIL provides further clarification on the activity rules for Sino-foreign joint ventures. After a joint venture adjusts its articles of association and joint venture contract in accordance with the FIL, there will be a clearer legal basis of resolving any future dispute. In the adjustments to existing Sino-foreign joint ventures, a series of new issues such as non-co-operation of parties and application of law to legacy issues may emerge, pending for the implementation of relevant rules by relevant authorities.

Jenny Wang is a partner and Ma Lisha is a lawyer at Merits & Tree Law Offices.

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