The purpose of this entry today is to highlight some important aspects on the protection of the minority interest when structuring an investment in China.
The choice of foreign investors on the most appropriate form of investment to be adopted in China mainly depends on their business strategies, financial resources available, nature of the investment, the availability of the proper human resources, and on the degree of familiarity the foreign investor has about the market. As seen, direct foreign investments in the classical sense may take the form of a Representative Office, Equity Joint Venture (http://blawg.lehmanlaw.com/wordpress/?p=1730), Contractual Joint Venture, Wholly Foreign-Owned Enterprise (http://blawg.lehmanlaw.com/wordpress/?p=1686 ) , and Foreign company limited by shares (http://blawg.lehmanlaw.com/wordpress/?p=1745). From the perspective of foreign investors, each of these figures offers different opportunities and advantages because of their peculiarities. So when an investor must decide which instrument to adopt, he must always carefully weigh the pros and cons, and decide in light of the circumstances in which he is operating.
In delineating the instruments at the disposal of the foreign investor to operate a business in China it is necessary to devote a few words to the topic of 'minority interests protection'. In a joint venture it is possible to have only two 'venturers' with equal voting power, but when there is one party holding the majority of the investment one or more parties will be in a minority position and therefore capable of being outvoted on any occasion. In such a situation, in fact, there exists the possibility that the majority party will take advantage of its majority position to serve its own particular interests at the expenses of the minority interests. Although the parties may not address this issue in their initial discussion, it will be appropriate for the minority party to be afforded some protection from their interests being prejudiced by actions of the majority, and thus it would be wise to draft and to include some provisions in this sense in the articles of association.
In both companies and partnerships, it is generally true that the majority rules are somewhat inadequate. The protection will normally take the form of a series of acts which are not to be carried out without unanimous consent, or the consent of a particular minority. For instance, almost all modern corporate statutes incorporate some devices or arrangements to provide protection to the minority interest, such as for example: i) cumulative voting for election of directors of the board; ii) the right to require proper conduct of the business; iii) a higher percentage of votes required for adoption of certain categories of corporate resolution. Minority protection can generally be divided into negative and positive rights and, typically, a minority shareholder will negotiate protection which is a combination of the two. It is worth underlining that means as veto or 'blocking powers' are negative in character. They do not usually enable the minority to force any change of policy, and the majority could not be expected to agree to this, although through the minority's ability to refuse consent to a particular transaction, it may in practice be able to insist on the adoption of an alternative. On the other side, one of the most important positive rights of the minority shareholder may be the ability to appoint one or more directors of the board, albeit that such a right is of itself of limited value where the majority appoints the majority of the directors. In this case, the way out is to entrench the right to appoint directors into the articles of association as a class right: that is to say, the appointor is issued with a special class of share, which may be identical to all other shares apart from the right to appoint one or more directors.
To complete properly this brief description about protection of minority interests it is necessary to stress that it is equally vital to a proposed venture that the parties should agree their aspirations and objectives by setting down the parties' entire understanding in writing (in the 'memorandum of understandings'). It is also possible to carry on further negotiations concerning minority protection until agreement on the final documents is achieved, or in order to regulate other particular needs of the parties, which will also be stipulated in the joint venture agreement and contract). It should be clear that the question of 'minority protection' does not exist where the participants to a joint venture are only two and are equal. However, in this situation another problem may emerge: neither party is prepared to concede control, and the parties could find themselves in a deadlock since, in theory, no decision can be made unless both agree. Joint ventures are quite often established on this basis, but it is desirable to have some mechanism in place for resolving any deadlock when it arises. It also must be remembered that a deadlock can also arise in a multi-party joint venture where two combinations of parties with the same aggregate voting power continually oppose one another. To solve this situation or to minimize the disagreements, it is appropriate to insert in the joint venture contract and articles of association some very detailed provisions for the operation of the joint venture. It is also desirable, where a deadlock may thereby arise, to include in the final documents a specific procedure for its resolution. A smart and in "vogue" solution is for one or other of the parties to agree to temporarily surrender control to the other.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.