2. CO-OPERATIVE JOINT VENTURES
In contrast with an EJV, a co-operative joint venture (“CJV”) is more flexible in its structure and allows for the parties to negotiate the profit-to-contribution or loss-to-contribution split among themselves.
(a) Legal Framework
CJVs are governed by the PRC Sino-foreign Co-operative Joint Venture Law and its implementing rules. The CJV must comply with Chinese law and regulation and shall not operate contrary to public interest.
A CJV may be either a limited liability joint venture with a Chinese legal person14 status obtained according to law, or an unlimited liability joint venture in a non-legal person form, similar to a partnership.
A limited liability CJV in many ways resembles the structure of an EJV. The joint venture contract and articles of association set out the relationship between the parties and the internal organisation of the joint venture. The key difference between this type of CJV and EJV is that in an EJV, profit distribution must be in proportion to the registered capital contributions of the parties. In a CJV, however, profit distribution may be determined by contractual arrangements irrespective of the proportion of capital contributed by the parties.15 The foreign investor may use this as a means of recouping investment and reducing its capital risk by getting its capital out or by repaying any loans used to make the original investment. The rights and obligations of the parties participating in the joint venture, including the provision of investment and conditions for cooperation, the distribution of profits or products, the sharing of risks and losses, the form of operation and management, may all be negotiated and agreed upon by the parties in the joint venture contract.
The other form of CJV is similar to a partnership where the parties jointly incur unlimited liability for the debts of the enterprise. Each party deducts its own operating expenses from the distributed profit and tax is paid on the remainder. No separate legal personality is created. The precise division of liability and profit share is set out in the joint venture contract. Management, technical and marketing functions are also allocated contractually. A joint management committee is formed by representatives (appointed by the parties) to manage the joint venture.
The investment made or co-operation conditions provided by all parties to the CJV may be in cash, in any other kind, or in other property rights such as industrial property rights, know-how and land-use rights. Where the investment or co-operation provided by the Chinese party falls into the category of state-owned assets, an asset evaluation must be conducted. For a joint venture with a Chinese legal person status, unlike the equity joint venture, there is no minimum investment made by the foreign party.16 The parties shall stipulate in the joint venture contract (based on the production and operation requirements of the venture) the duration of the investment to be made and the co-operation conditions to be contributed. Any transfer of rights must be agreed by the other party to the JV and approved by the examination and approval authority.
The establishment of a CJV needs approval from MOFCOM or the department or local people’s government authorised by the State Council, which may approve CJVs in the following circumstances:
- the total amount of investment is within the authorisation for approval as set out by the State Council;
- the capital has been raised by the applicants themselves;
- exportation of the joint ventures products do not require export quotas and licences, or if they do, consents of the relevant departments have been obtained prior to the application for the establishing of the CJV; and
- other circumstances specified by the MOFCOM or the department or local people’s government authorised by the State Council.
For establishment purposes, the Chinese party needs to submit the following documents in Chinese, to the department in charge of foreign economic relations and trade under the State Council, or to the department or local government authorised by the State Council:17
- application document for establishing a CJV, and where accompanied by the examination and approval documents of the relevant authorities;
- feasibility study report jointly prepared by the parties, and where applicable, accompanied by the examination and approval documents of the relevant authorities;
- joint venture agreement and articles of association signed by the legal representatives (or representatives authorised by the parties);
- Business licences or registration certificates, credit status letter, financial credit documents and valid certification documents of the legal representatives of the parties to the joint venture;
- a list of members of the board of directors; and
- any other documents as required by the examination and approval authority.
The documents must be in Chinese, but may be accompanied by a version of a foreign language agreed upon by all parties. The examination and approval authority will decide whether to approve or disapprove the application for the establishment of the CJV within 45 days of the submission.18 Upon approval, MOFCOM or its relevant local authority will issue a certificate of approval. The CJV may then apply to the relevant department of the Administration of Industry and Commerce for registration and obtain a business licence. Approval, however, may not be granted if the joint venture:19
- is detrimental to China’s sovereignty or public interest;
- jeopardizes State security;
- pollutes or damages the environment; or
- violates other laws, administrative rules or State industrial policies.
Upon issue of the certificate of approval, the joint venture agreement and articles of association enter into force. There are detailed requirements as to what information needs to be included in these documents: the most important document is the joint venture agreement itself, which sets out the rights and obligations of the parties. This should contain details of the investment or conditions for co-operation, distribution of earnings or products, sharing of risks and losses, management structure, ownership of property, and events for termination of the joint venture. Any future amendment will require further approval. Once established with the legal person status, the CJV takes the form of a limited liability company, with each party being liable to the extent of its original investment. The registered capital, if any, may be in RMB or any other freely convertible currency.
(d) Management and Operation
Once established, a CJV may, by presenting its business licence, open a foreign exchange account, obtain loans from financial institutions, and take out insurance. Within its approved scope of operation, it may import required materials and export the products it produces. Raw materials may be purchased from both domestic and international markets and the State encourages joint ventures to sell their products in international markets. Profits are shared by the parties and taxed in the usual way. Early recovery of investment by a foreign investor is allowed provided that the parties agree to have all fixed assets of the joint venture reverting to the Chinese party upon expiration of the term of the joint venture, and the joint venture has made up for its losses. A foreign investor may proceed to early recovery of its investment in the following ways:20
- by increasing its proportion of profit sharing;
- with approval from the relevant authorities, recover its investment before income tax payment is made by the CJV;
- other investment recovery measures approved by the examination and approval departments and finance and taxation departments.
The CJV, the Board of Directors (comprising at least 3 persons), being the governing body of the CJV shall meet at least once a year. Some decisions require unanimous consent of the board and these include21, but not limited to,
- amendment to the articles of association;
- increase or reduction of the registered capital;
- dissolution of the CJV;
- mortgage of the assets;
- merger or change in the form of the organisation; and
- any other matters previously agreed upon by the parties.
If the CJV does not have a legal person status, a joint management committee will be established. The joint management committee shall have, essentially, the same functions as a Board of Directors regarding matters such as number of members, meetings and voting. With unanimous consent from either type of management body, together with approval from the examination and approval authority, a CJV may entrust a third party with the management and operation of the joint venture. This arrangement is common, for example, in the hotel business, where an outside hotel management team is often appointed.
The procedure for making contributions to CJVs is similar to that of EJVs. Furthermore, similar to the investment may be in cash or in kind. Again, it is usually the foreign investor who will provide the majority of the funding, whilst the Chinese party provides land, equipment, industrial property rights, non-patent technology, and other facilities. Profits are divided according to the terms of the governing contract rather than by initial investment share, allowing a more flexible schedule for return on investment where one investor provides cash while the other party’s investment is primarily in kind. After the foreign party has fulfilled its obligations, the profits it receives for its share, other legitimate income, and any other equity received for its share upon the termination of the venture, may be sent abroad.
Termination of EJVs and CJVs
The duration of the joint venture must be stated in the joint venture contract. For most projects, the approved term is usually 10 to 30 years. If an extension is required, a formal application must be made to the examination and approval authority 180 days before expiry of the term.22 However, the duration shall not be extended if the joint venture contract has allowed the foreign party to first recover its investment and such investment has already been fully recovered. A joint venture, for example a CJV, may be dissolved in the following circumstances:
- end of its term;
- inability to continue operations due to financial losses or heavy losses caused by force majeure;
- inability to continue operations due to the failure of one party to fulfill its contractual obligations;
- occurrence of other reasons as stipulated in the contract and articles of association; or
- revocation made by authorities according to law due to violation of laws and administrative regulations
In many instances, establishing a non-legal person CJV can be a better option for an investor than an incorporation of an EJV joint venture. As a starting point, the foreign investor does not need to set up a new corporation in China – the foreign investor and the Chinese partner participates in the CJV by using the Chinese party’s business licence, under a contractual arrangement. Often such an arrangement is used in land and hotel projects due to the tax advantages: if the business vehicle is an EJV, upon the Chinese party transferring the land to the joint venture company, tax liability upon transfer will arise. However, under a CJV, the land stays in the possession of the Chinese partner and therefore no transfer taxes are payable.
Also, where the Chinese partner is in possession of the land but does not have a clear legal title, (a common occurrence in China) under an EJV, the land would have to be bought from the Chinese Bureau of Land Control if the title was to be transferred; under a CJV, provided that the status of the Chinese partner is high enough to maintain possession of the land, no such transfer will be necessary.
Flexibility is another key factor – the percentage of the CJV owned by each partner can change throughout the joint venture’s life, with the idea being that the foreign investor can receive a faster return on his or her investment.
14 Please see article 2 of the Law of the People’s Republic of China on Chinese-Foreign Contractual Joint Ventures.
15 Article 21 of the Law of the People’s Republic of China on Chinese-Foreign Contractual Joint Ventures.
16 Please see article 18 of Detailed Rules on the Implementation of the Law of People’s Republic of China on Sino-Foreign Joint Cooperative Ventures.
17 Please see article 7 of the Detailed Rules on the Implementation of the Law of People’s Republic of China on Sino-Foreign Joint Cooperative Ventures.
19 Please see article 9 of the Detailed Rules on the Implementation of the Law of People’s Republic of China on Sino-Foreign Joint Cooperative Ventures.
20 Please see article 44 of the Detailed Rules on the Implementation of the Law of People’s Republic of China on Sino-Foreign Joint Cooperative Ventures.
21 Please see article 29 of the Detailed Rules on the Implementation of the Law of People’s Republic of China on Sino-Foreign Joint Cooperative Ventures.
22 Please see article 24 of the Law of the People’s Republic of China on Chinese-Foreign Contractual Joint Ventures