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The establishment of operations in Hong Kong and Shenzhen

The establishment of operations in Hong Kong and Shenzhen

16. Sino-Foreign Equity Joint Ventures

16.1 Introduction

A sino-foreign equity joint venture (“EJV”) is a limited liability company, with a governing board of directors, established in the PRC with joint investment from the Chinese and foreign parties.

EJV is considered a Chinese legal entity and as such must abide by all laws, decrees, rules and regulations of the PRC. In particular, EJVs are governed by the PRC Equity Joint Venture Law and its implementing rules. According to these laws, the foreign party to the venture, i.e. the Overseas Corporation, must invest at least 25% of the EJV’s registered capital. The underlying principle is joint effort and participation – the risks and losses of the EJV are shared by the parties in proportions to their contributions to the registered capital. Any profit that the Overseas Corporation receives may be remitted abroad in accordance with PRC foreign exchange regulations and in the currency specified in the joint venture agreement.

Given its Chinese legal entity status, an EJV is allowed to hire Chinese nationals as its staff and are able to purchase land on their own account (unlike representative offices which are not able to purchase land on their own account). Shareholdings in EJVs cannot be transferred without the prior approval from the government and the consent of all the other parties to the EJV.

16.2 Specific Requirements

The steps and procedures described under the section “General Establishment Procedures” applies to the establishment of an EJV. However, the following is various specific requirements particular to the establishment of an EJV.

Memorandum Of Understanding

The first step in forming a EJV is for the Overseas Corporation to find a suitable PRC partner to enter into a non-binding letter of intent, known as a Memorandum of Understanding (“MOU”). Once signed, the Chinese party will seek preliminary approval of the EJV from the SMFIB and relevant government bodies. The MOU usually contains a detailed 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 explore and exploit the business opportunities agreed upon. Albeit the non-binding nature of a MOU, its is important to draft the MOU concisely to define the business scope of the EJV. If it becomes apparent that the submitted MOU is clearly inappropriate or requires modification, the SMFIB may require the Overseas Corporation to resubmit its application. It is paramount that the MOU reflects the preliminary views of the parties and state that the final agreement is subject to completion of the joint venture feasibility study and the execution of a binding joint venture contract between the parties and an articles of association of the proposed EJV.

Feasibility Study Report

The next step is for the parties to jointly prepare a feasibility study, which is again a non-legally binding document. Either the Overseas Corporation or the Chinese party may still opt not to proceed with the establishment of the EJV. The report must contain details of the EJV and its business, including:

  1. the EJV partners;
  2. location of its operation, including details of its factory and office premises;
  3. the objectives, structure and form of the EJV, including the amount of investment and contributions from each of its parties and its financing arrangements;
  4. its business and products, including a description of the technical standards of its products, output projections, testing and quality control;
  5. its production technology and equipment, including estimates for the cost of equipment and any technology transfer fees;
  6. a market analysis for its products both domestically and internationally, projected sales, methods of distribution, and an analysis of its competition;
  7. an analysis of the environment impact, if any, caused the EJV’s operation, including disclosure of the EJV’s by-products and waste;
  8. supply, utility, and transport and warehousing requirements;
  9. foreign exchange requirements and projections;
  10. staff requirements and training programmes; and
  11. financial projections and economic cost and benefit analysis.

Once the feasibility study report is submitted (usually by the Chinese party of the EJV) to the SMFIB, it will be initially reviewed. Then passed, via the local planning commission, to other government organisations, including those involved in labour planning and raw material supplies, finance and utilities, concerned with, or affected by the operation of the EJV.

The contents of the report are important, as the various Chinese governmental organisations rely heavily on the report when making their decisions relating to the operation of the EJV. For example, if the electricity requirement of the EJV factory is underestimated, the Overseas Corporation could find the regular stoppages of the EJV’s operation given the lack of power. Similarly, if export quotas are overestimated, failure to meet quotas may be reason for restricting the EJV’s access to the domestic PRC market.

Joint Venture Agreement and Articles of Association

The joint venture agreement sets out the legal rights and obligations of the parties to the EJV and the articles of association deal with the internal organisation and operation of the EJV. They must be written in Chinese, although a version in an agreed second language will have equal validity. The joint venture agreement is governed by PRC laws. It 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 agreement. However, in the case of conflict or inconsistency between the two, the joint venture agreement usually prevails.

16.3 Time

Once all the necessary documents have been submitted, the review process will normally be completed within 3 months of receipt of the application. If approved, the EJV registers with the Department of Industry and Commerce Administration, which will issue a business licence, allowing the joint venture to carry on business activities in the PRC as a Chinese legal person. After which, operations may begin. From then, the EJV will need to open a foreign exchange account, obtain funding from foreign banks (if required), register for taxation purposes with the local tax authority, register at the Custom House for customs and obtain insurance with Chinese insurance companies.

16.4 Capital Contribution

Under the PRC Equity Joint Venture Law, the Overseas Corporation must contribute at least 25% of the total investment: there is no minimum investment for the Chinese partner. The initial equity investment can take the form of cash, buildings, machinery, equipment, intellectual property rights, land-use rights, and technology, but cannot include labour.

The theory behind the formation of EJVs is that EJVs are usually established to exploit the market knowledge and manufacturing capabilities of the Chinese party, and the technologies, know how and marketing experience of the foreign partner. Accordingly, it is usually the Chinese partner who contributes the buildings, land and other assets from their existing operations, while the foreign party contributes machinery, equipment, industrial technologies and know how. All contributions must be recorded in the joint venture agreement or in the articles of association of the EJV, together with respective values.

In addition, there are strict ratios of debt to equity laid down by the PRC Equity Joint Venture Law according to the size of the EJV:

  1. less than US$3million – equity must constitute 70% of the investment;
  2. more than US$3 million, but less than US$10 million – equity must constitute at least 50% of the investment;
  3. more than US$10 million but less than US$30 million – 40% must be equity; and
  4. more than US$30 million – 33% of the investment must be equity.

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 interest and may eventually result in a cancellation of the EJV’s business licence. If the parties decide to make their contributions to the registered capital of the EJV in one lump sum, the contribution must be paid up within 6 months of the issuance of the EJV’s business licence. If the contribution is to be made in installments, the first installment of not less than 15% of the EJV’s registered capital must be paid within 3 months of the issuance of the EJV’s business licence. Thereafter, the time frame for the payment of outstanding capital contributions is as follows:

Amount: Time following the issue of the EJV’s business licence:
US$500,000 or under one year;
US$500,000 – US$1 million One and a half years;
US$1 million -3 million Two years;
US$3 million -10 million Three years; and
US$10 million and above Subject to specific approval.

16.5 Duration

The operation periods of EJVs vary according to the particular line of business and circumstances in each case. EJVs engaged in some business will specify the operation period of the in the joint venture agreement, while EJVs engaged in other types of business may choose not to do so. Where the operation period is specified, and if the parties decide to extend it, an application must be made to the SMFIB 6 months prior to the expiration of the operation period. The SMFIB shall decide whether to approve the extension within 1 month of the application.

Termination of the EJV may be affected by agreement of the parties, subject to approval by the SMFIB and registration with Industry and Commerce Administration Bureau.

Skills

Posted on

2003-04-21