1. Equity Joint Ventures
An equity joint venture (“EJV”) is a limited liability company4 established in China with joint investment from the Chinese and foreign parties. In general, the foreign party to the EJV generally should invest not be less than 25%5 in the registered capital.
While it was true in the past that parties who invested less than 25% into an EJV will not normally be entitled to enjoy the same preferential treatment of tax reduction or exemption offered to EJVs with more than 25% foreign investment, the amendment to the corporate tax law has removed most of such differences.
In EJVs, the underlying principle is joint effort and participation. However, whatever the final percentage of investment is, the risks and losses are shared by the parties in proportion to their respective contributions to the registered capital.6 Transfers of shares are only permitted with the consent of all other parties.7 Legally, the EJV has a separate legal personality and operates as a limited liability company, being governed by its Board of Directors. Either party may appoint the Chairman of the Board and certain important decisions can only be made with the unanimous approval of the Board. Shareholdings cannot be transferred without prior approval from the Government. Once registered, the entity is considered a Chinese legal entity and as such must abide by all Chinese laws. As a Chinese legal entity, it is free to hire Chinese employees but in turn must comply with Chinese labour laws. Joint ventures are able to purchase land-use right on their own account.
(b) Legal Framework
The PRC Equity Joint Venture Law and its implementing rules are the principal law governing EJVs. Other laws, many of which are applicable to both joint ventures and wholly foreign-owned enterprises, have also been promulgated in relation to taxation, business registration, labour, accounting, foreign exchange, equity requirements and registered capital. Through the legislation, the Government protects the investments of foreign parties, the profits due to them, and their other lawful rights and interests pursuant to the government approved agreements, contracts and articles of association. Laws of a more general nature, such as the Unfair Competition Law, Product Liability Law, Advertising Law and various environmental protection laws also apply to EJVs.
(c) Memorandum of Understanding
The procedures for establishing an EJV are set out in the Equity Joint Venture Law, its implementing rules and other relevant regulations. The first step is the finding of a suitable EJV partner and then the signing of a non-binding letter of intent, generally known as a Memorandum of Understanding (“MOU”). The MOU will contain a description of the proposed project, an estimate of the amount of investment required, the equity split between the Chinese and the foreign party, and a general undertaking by both parties to jointly investigate the opportunity. Although technically it is a non-binding agreement, its drafting is important, as it will define preliminarily the scope of the operation of the EJV. Essentially, it must reflect the preliminary understanding among the parties and it would usually state that final agreement is subject to completion of the joint venture feasibility study report and the execution of a joint venture contract and the articles of association.
(d) Feasibility Study Report
An integral step for the parties is the joint preparation of a feasibility study report. The feasibility study report should cover the technical and commercial aspects of the project.
The study shall contain details8of:
- the joint venture partners;
- the objectives, structure and form of the joint venture, including the amount of investment and financing arrangements;
- the joint venture product(s), including a technical description and outline of uses;
- the production technology equipment for the joint venture, including the cost of equipment and technology transfer fees;
- a market analysis for the product both inside and outside China, projected sales, methods of distribution, and an analysis of competition;
- details of the site, including output projections, technical standards of products, transport and warehousing, testing and quality control, by-products and waste;
- supply, utility, and transport requirements;
- foreign exchange projections;
- staff requirements and training programmes; and
- financial projections and economic benefit analysis.
The contents of the feasibility study report are important as it is the basis on which the various Chinese government organisations plan their obligations relating to the operation of the joint venture.
(e) Joint Venture Contract and Articles of Association
The joint venture contract and articles of association for the EJV are the two most fundamental legal documents of the project. These documents are usually prepared at the same time as the feasibility study report.
The joint venture contract sets out the legal rights and obligations of the parties and the articles of association lay out the framework for the internal organisation and operations of the joint venture. They must be written in Chinese, although a second version in an agreed second language will have equal status to the extent that its contents do not conflict with those in the Chinese version.9 In other words, in case of discrepancies, the Chinese version prevails. The documents, together with any supplemental documents, are submitted usually by the Chinese party to the competent government authorities for examination and approval. The review process will normally be completed within 3 months of receipt of application. If approved, the parties shall proceed to register the EJV with the relevant department of the Administration of Industry and Commerce, which will issue a business licence for the FIE, allowing the joint venture to carry on business activities in the PRC as a Chinese legal person. At that time, operations may begin. From that will follow post-business licence registration for the FIE, including, obtaining an institutional code, registration with the local public security bureau, finance and tax registrations, foreign exchange registration, and the opening of RMB and foreign exchange bank accounts.
Chinese law governs exclusively the joint venture contract, which is often supplemented by ancillary contracts, such as technology transfer contracts, technical assistance contracts, trademark licence contracts, and various supply and distribution agreements. The articles of association mirror many of the provisions of the joint venture contract. However, in the case of conflict or inconsistency between the two, the joint venture contract is usually expressed to prevail.
(f) Capital Contribution
Under PRC law, the registered capital can either be paid in lump sum or by installments. If it is by installments, it is usually required that parties investing in the joint venture contribute at least 15% of the total registered capital, which can take the form of cash, buildings, machinery, equipment, intellectual property rights, land-use rights, and technology, although it cannot include labour, with the remainder to be paid up within two years. If it is paid by lump sum, it shall be paid within six months. EJVs are usually established to exploit the market knowledge and manufacturing capability of the Chinese party, and the technology, know-how and marketing experience of the foreign partner. Accordingly, it is usually the Chinese party who contributes the buildings, land and other assets from their existing operations, while the foreign party contributes machinery, equipments, and industrial technology and know-how. Contributions by both parties must be recorded in the joint venture agreement or in the articles of association, together with their respective values.
In addition, there are debt-to-equity ratios10 laid down by law according to the amount of investment in the joint venture as below:
- If the total amount of investment of a Chinese-foreign equity joint venture is less than US$3 million (including US$3 million), its registered capital shall be at least 7/10 of the total investment.
- If the total amount of investment of a Chinese-foreign equity joint venture is from US$3 million to US$10 million (including US$10 million), the registered capital shall be at least one-half of the total amount of investment; within this, if the total amount of investment is less than US$4.2 million, the registered capital shall not be less than US$2.1 million.
- If the total amount of investment of a Chinese-foreign equity joint venture is from US$10 million to US$30 million (including US$30 million), the registered capital shall be at least 2/5 of the total amount of investment; within this, if the total amount of investment is less than US$12.5 million, the registered capital shall not be less than US$5 million.
- If the total amount of investment of a Chinese-foreign equity joint venture is more then US$30 million, the registered capital shall be at least 1/3 of the total amount of investment; within this, if the total amount of investment is less than US$36 million, the registered capital shall be not less than US$12 million.
The timing of the capital contributions, whether in cash or in kind, is also important. Failure to make timely contributions will result in financial penalties in the nature of default interests and may eventually result in the cancellation of the joint venture’s business licence.
The timing provisions are as follows. As a general rule, if the total registered capital is to be paid in a lump sum, it shall be paid in full within 6 months as of the date of establishment of the joint venture. If the capital contributions are to be made by installments, the amount of the initial capital contribution shall not be less than 15% of the registered capital11 and shall be paid in full within 3 months of the issuance of the business licence. Thereafter, the remaining capital contribution shall be contributed within two years of the establishment of the enterprise or for an investment company, within 5 years of its establishment. The same rules also apply to cooperative joint venture and wholly foreign owned enterprises. What should be noted is that foreign-invested enterprises in specific sectors, such as in banking or insurance industry, there may be sector-specific timelines for capital contribution.
The operation period of EJVs may vary according to the particular line of business and circumstances. EJVs engaged in some lines of business may specify the operation period in their contract, while EJVs engaged in other lines of business may choose not to do so. Where the operation period is specified, if the parties decide to extend it, an application must be made to the examination and approval authority 6 months before the expiration of the operation period. The examination and approval authority shall, within 1 month of receipt of the application, decide whether to approve or disapprove the application for extension.12
Any profit that a foreign party receives may be remitted abroad in accordance with the foreign exchange regulations and in the currency specified in the joint venture contract.
Termination of the EJV may be affected by agreement of the parties, under all circumstances subject to approval by the examination and approval authority and should deregister with the relevant department of the Administration of Industry and Commerce.13
4 Please see article 4 of the Law of the People’s Republic of China on Chinese-Foreign Equity Joint Ventures
8 Please see Appendix 1 for a step-by-step description of the approval and registration process for the setting up a FIE.
9 Documents with a second version in an agreed second language also apply to feasibility study report and list of candidates for chairman, vice-chairman and directors appointed by the participants. Please see article 7 of the Regulations for the Implementation of the Law of the People’s Republic of China on Joint Ventures Using Chinese and Foreign Investment.
10 Please see article 3 of the Provisional Regulations for the Proportion of Registered Capital to Total Amount of Investment of Joint Ventures Using Chinese and Foreign Investment.
11 Please see article 9 of the Implementation Opinions on Some Issues concerning Law Application for the Administration of Examination and Approval and Registration of Foreign-funded Companies for business licence issue.
12 Please see article 13 of the Law of the People’s Republic of China on Chinese-Foreign Equity Joint Ventures.
13 Please see article 2 of Circular on Several Issues Regarding Dissolution and Deregistration of Foreign Invested Enterprises.