Renegotiating the Terms of Your Joint Venture in China
Renegotiating terms of the joint venture is not common practice in China, but we discuss which considerations can require parties to revisit the contract. We also suggest due diligence measures that foreign investors should keep in mind.
Establishing a joint venture (JV) is a common way to open a company in China, a strategy pursued by all types of entities, from multinational firms to startups. This is because the JV structure offers some attractive advantages to foreign investors entering or expanding operations in the Chinese market.
First, by investing in a JV, foreign firms can enter industry areas classified as restricted on China’s Negative List – a document outlining businesses that are barred or limited to private investment. Second, it allows a foreign firm to employ a Chinese partner’s local know-how, talents, sales channels, and distribution networks, thus facilitating early business operations and expansion. Moreover, travel restrictions caused by the COVID-19 pandemic have also made JVs more popular as foreign investors prefer to rely on their local partners to access the market from overseas.
Although not common, there might be several special occasions when parties need to renegotiate the terms of their JV. Renegotiation of terms enables management from all sides to amend JV contracts ex-post. In this article, we briefly present some typical instances of when this happens and the key points all parties involved in a JV contract should pay attention to during the renegotiation process.
Why renegotiating the JV terms becomes necessary
While not common, there are several reasons why renegotiation might happen. The terms of the joint venture can be renegotiated when parties to the contract find their interests, rights, and liabilities have changed.
One or more parties wish to increase or decrease their share in the JV
In some cases, one or more parties may wish to renegotiate the initial shares partition and subscribe more capital in the JV to increase their participation – and subsequent influence in the partnership.
This usually happens when foreign partners are allowed to have more equity ownership in the JV with China further opening up its economy. For example, following China removing the cap on the share ratio of foreign investment in passenger car manufacturing starting from January 1, 2022, on February 11, 2022, BMW announced that its share in the Chinese JV, BMW Brilliance Automotive, has been raised to 75 percent after JV term renegotiation.
It could also happen when one or more parties think the share ratios in the original JV contract are not reasonable. For example, investments that happen at a 50-50 share are usually not recommended, as they may lead to difficulties in decision-making. Under such extreme cases, parties may want to renegotiate the JV terms at certain points. On the other hand, one or more parties involved in the JV may want to decrease their shares in the JV due to certain concerns, such as when a foreign party has changed its investment strategy.
Notably, if both parties have cooperated for many years and know each other well in the JV, conditions for the increase or decrease in the capital may have already been settled in the original JV agreement. If so, renegotiation might not be needed.
A new shareholder has joined the JV
Another common reason for terms renegotiation happens when a new shareholder joins the JV and possibly brings in considerable new resources – more funds, cheaper suppliers, a larger distribution channel, new technical expertise, and new human resources. As this is a very important addition to the business, which will have an enhanced capacity to expand and navigate further towards success, it is likely that the incoming new partner may want to renegotiate the JV terms.
Need to comply with China’s new Foreign Investment Law
Businesses must become acquainted with China’s new Foreign Investment Law (the FIL), which became effective on January 1, 2020, to assure compliance with China’s most recent corporate-related laws. The FIL affects several of the structural requirements of JVs, including the ownership ratio, organizational composition, and certain transaction rules. For example, for existing JVs that were established according to the old JV Laws, need to change their governing structure within the five-year transitional period to the new structure in accordance with the Company Law.
The highest authority of the JV is the Board of Shareholders instead of the Board of directors. If JV intends to transfer the equity, in the past, all the shareholders shall reach a unanimous agreement on it. But under Company Law, it can be passed by a simple majority of votes cast by shareholders, unless otherwise agreed by shareholders.
To be compliant with the Company Law, existing JVs shall need to renegotiate the term to achieve such transitional adjustments.
How to renegotiate the terms of your JV in China
The renegotiation of initial conditions should be fair to all the parties of the JV in line with the Company Law.
Usually, partners in a JV would maintain good relations between them so that, at the time of negotiation, a friendly process can be initiated. Following due diligence, when proposing changes to the initial terms, shareholders can send the proposal to the other parties involved, or they can call a shareholder meeting with the objective of drafting the new agreement terms. Once the shareholders agree to the new terms, the JV agreement shall be revised, or a supplementary agreement shall be prepared.
At the same time, the Articles of Association (AOA) shall be amended and updated as well. According to the requirements of Company Law, only the Board of Shareholders has the right to amend the AOA and pass the resolution. As AOA’s amendment shall be deemed as a major voting item, the resolution shall be passed by shareholders holding two-thirds or more of the voting rights. While both the JV agreement and AOA of JV shall be amended at the same time after the renegotiation, normally, only the AOA shall be refiled with the local government authority.
All JV partners involved in the renegotiation should pay careful attention to and make suitable provisions for the following crucial legal terms in the official JV agreement to safeguard their own interests.
In Chinese JVs, establishing a correct proportion for voting rights is fundamental. Although voting rights are normally based on the ratio of capital contribution, the shareholders can agree otherwise based on mutual agreement. For example, shareholders bringing in branding trademarks and technical expertise can demand bigger voting rights than their capital contribution.
Thus, paying attention to an equal distribution of voting rights that is conducive to effective decision-making is the first important step when renegotiating the terms of a JV.
Profits are the goal of any investment. Thus, the mechanism for distributing profits across shareholders has great significance to the JV partners.
When renegotiating the terms of a JV, similarly to the voting rights situation, it is important to discuss dividends rights and the mechanism according to which they will be set and distributed to each partner.
Major roles within the business
Keeping key positions accountable is one of the keys to a company’s success. When renegotiating the terms of a JV, discussing top executive roles such as those of legal representative, chairman, CEO, CFO, and the CTO becomes as important as discussing rights of vote and profits.
Major partners in the JV will want to hire familiar people from their team and place them in relevant C-suite positions, so everybody should be clear about the terms of this selection process.
Finding the proper partner and forming a successful JV takes time. In the run-up to achieving an agreement, an adequate time for relationship development is required. It will also take some time to do due diligence. Joint ventures that succeed do not happen overnight.
Long-term collaboration will provide partners with the biggest rewards since the shareholders involved will be motivated to foster a relationship that culminates in enduring advantages or future profits – rather than pursue short-term, one-time arrangements that are unlikely to last. This is also the main reason why renegotiating terms of the agreement in a JV is not such a common phenomenon when shareholders have taken their time to know each other and their business and explored all the angles of their cooperation.
Still, it is essential to keep in mind two key aspects for building a successful JV that will not require much adjustment later. One is to design and reach a clear, well-thought, and prospective JV agreement to conclude a business relationship professionally, and effectively, and avoid or at least minimize future disputes between the JV partners. Second, information is the key. It is imperative to be informed about the company one may want to form a JV with, especially when the parties joining are minor shareholders or foreign investors – as in, they should make sure to conduct all the necessary prior research and clearance on that business, to avoid facing challenging issues along the way.
China Briefing is written and produced by Dezan Shira & Associates. The practice assists foreign investors into China and has done so since 1992 through offices in Beijing, Tianjin, Dalian, Qingdao, Shanghai, Hangzhou, Ningbo, Suzhou, Guangzhou, Dongguan, Zhongshan, Shenzhen, and Hong Kong. Please contact the firm for assistance in China at firstname.lastname@example.org. Dezan Shira & Associates has offices in Vietnam, Indonesia, Singapore, United States, Germany, Italy, India, and Russia, in addition to our trade research facilities along the Belt & Road Initiative. We also have partner firms assisting foreign investors in The Philippines, Malaysia, Thailand, Bangladesh.
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