Hong Kong: Joint Ventures in the PRC

Last Updated: 26 September 1995
This article is intended to provide a general guide to the subject matter. Specific advice should be sought about individual circumstances. Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.

This article examines the laws, regulations and approval process and documentation applicable to equity joint ventures and cooperative joint ventures in the PRC.

1. Equity joint ventures and cooperative joint ventures - essential differences

There are two kinds of joint ventures in the PRC: equity joint ventures and co-operative joint ventures.

The essential difference between the two is that:

(I) with an equity joint venture, the investors' capital contributions, in cash or in kind, must be capable of being expressed in monetary terms, and the risks and profits must be shared according to the capital contribution ratios. An equity joint venture will be established as a legal entity separate from its investing parties;

(ii) with a cooperative joint venture, the contributions of the investors need not be expressed in monetary terms, and so, the risks and profits need not be shared strictly according to capital contribution ratios. A cooperative joint venture need not be established as a legal entity in the PRC separate from its investing parties.

2. Equity joint ventures

2.1 Legal framework

The equity joint venture is governed by a substantial body of published law. The Law of the PRC on Sino-Foreign Joint Equity Enterprises (the "Equity Joint Venture Law") promulgated in July 1979 and the Regulations for the Implementation of the Equity Joint Venture Law (the "Equity Joint Venture Regulations") promulgated in September 1983 are the principal pieces of legislation for equity joint ventures in the PRC. In addition, the Interim Provisions on Guiding the Direction of Foreign Investment ("Foreign Investment

Guidelines") promulgated in June 1995 may have bearing upon the approvals required with regard to the establishment of an equity joint venture.

Both the Equity Joint Venture Law and the Equity Joint Venture Regulations provide that equity joint ventures shall take the form of a limited liability entity which enjoys rights and obligations in accordance with PRC law and within the scope of its business licence (as issued by the State Administration for Industry and Commerce ("SAIC")) and articles of association. In return for each party's contribution to the joint venture, a capital contribution certificate in the equity joint venture is issued to each party to reflect the value of their ownership of a share of the venture's registered capital. As far as limits on liability are concerned, the legislation provides that each party to the joint venture is liable to the extent of the capital subscribed by it and that the profits and losses of the joint venture shall be shared by the parties to the venture in proportion to their contributions to the registered capital.

2.2 Capital requirements

The concepts of authorised capital, issued capital and shares are not used in the PRC. The concept employed in the capitalisation of equity joint ventures is "registered capital". Under the Equity Joint Venture Regulations, registered capital is defined as the total amount of capital contributed by the parties and registered with the PRC authorities at the time of the venture's formal establishment. Registered capital is usually expressed in Renminbi, although it may also be denominated in a foreign currency if the parties so agree.

Registered capital represents the parties' equity in the venture, and is to be distinguished from the concept of "total investment", which represents the sum of registered capital and external borrowings.

Capital contributions may be in cash or in kind (including intangible rights), subject to certain limits on in-kind contributions. Often, the PRC party will contribute land or site-use rights. There are detailed rules on the valuation of in-kind contributions.

There are other requirements with regard to the valuation and timing of the capital contributions. These are set out in the Circular of the Ministry of Foreign Trade and Economic Cooperation ("MOFTEC") concerning Issues related to the Further Strengthening of the Examination and Approval of Foreign Funded Enterprises and Control over their Registration (see article under the same title), and, inter alia, prescribe different time scales for the contribution of the capital, depending on the size of the total registered capital of the joint venture.

Subject to the requisite notification formalities, registered capital may be increased by board approval, but not reduced. The parties' liability to further contribute to an increase in registered capital (not necessarily pro rata to their original capital contribution ratios) can be contractually agreed, or predetermined in the joint venture contract itself.

The Equity Joint Venture Regulations provide the other investors with a pre-emptive right to purchase the interests of any party who no longer wishes to participate in the venture. If the other parties do not wish to do so, their interest may, provided prior MOFTEC approval has been obtained, be assigned in whole or in part to a third party.

2.3 Minimum equity requirements

The Equity Joint Venture Law requires the foreign party to contribute no less than 25 per cent of the registered capital. Regulations introduced by the SAIC, in addition, impose certain minimum debt-equity ratios on equity joint ventures as follows:

						Minimum equity
Total Investment				(% of Total Investment)

Up to US$3 million				70%

US$3-10 million				50% or US$2.1 million
						(whichever is higher)

US$10-30 million				40% or US$5 million 
						(whichever is higher)

Over US$30 million				33.3% or US$12 million 
						(whichever is higher)

2.4 Management

The Equity Joint Venture Law and Equity Joint Venture Regulations provide for a two-tiered system of management:

(a) the board of directors, which is "the highest authority of the joint venture"; and

(b) the managerial staff which is "responsible for daily management".

Board members (minimum three, no maximum) are appointed by the parties to the joint venture and hold office for an initial term of four years. The Equity Joint Venture Regulations provide that in deciding the seat distribution, the parties' capital contribution ratios may be referred to, but commonly the PRC party may insist on an equal distribution of seats.

The Equity Joint Venture Regulations specify a number of fundamental decisions which the board must take unanimously, including amendments to the articles of association (regarding which, please see below), termination, increase or assignment of registered capital and merger.

Day-to-day management is normally undertaken by the managerial staff comprising a general manager assisted by one or more deputy managers. The general manager is required to implement board decisions and has power, within the scope authorised by the board, to represent the joint venture in its business dealings, hire and dismiss personnel and generally to manage the business.

Posts at board and managerial level may be held concurrently.

2.5 Term and termination

The term of the joint venture will usually be fixed by the parties, usually between 10 to 30 years. The Foreign Investment Guidelines stipulate that for certain industries, joint ventures must have a definite term whereas in other industries joint ventures may have the option whether or not to fix a term. The parties may extend the term, subject to approval from the relevant authorities.

3. Cooperative joint ventures

3.1 Legal framework

The legal framework applicable to cooperative joint ventures is not as comprehensive or developed as that which governs equity joint ventures. Although the law of the PRC on Sino-Foreign Cooperative Enterprises (the "Cooperative Joint Venture Law") became effective in April 1988, no detailed regulations implementing its general guidelines for the establishment and operation of such joint ventures have been published to date. In the absence of detailed implementing regulations the rules governing equity joint ventures are often applied to cooperative joint ventures. Given this lack of specifically applicable regulations, cooperative joint ventures are largely defined by contract, which is why they are also known as contractual joint ventures.

Cooperative joint ventures are the most common form of joint ventures in PRC and can take several different forms. The first type (a "true" cooperative joint venture) does not involve the creation of a legal entity separate and distinct from the contracting parties. In such a case each party is responsible for making its own contributions to the venture, paying its own tax on profit derived from the venture and bearing its own liability for risks and losses. The parties' rights and liabilities, risks etc. are clearly stipulated in the underlying contract. It is more akin to the western partnership concept.

The second type (referred to in this note as a hybrid) combines the characteristics of the true cooperative joint venture above and the equity joint venture. The hybrid is a cooperative joint venture that is registered as a legal entity separate from its investing parties.

As far as the parties' limits on liability are concerned, the position for cooperative joint ventures is not entirely clear. The Cooperative Joint Venture law merely provides that the parties are to bear risks and losses in accordance with the terms of the cooperative joint venture contract. However, vis-a-vis third parties, it is unclear whether the parties have limited or unlimited liability. It is probable that they have unlimited liability. Whether a hybrid cooperative joint venture which registers itself as a legal person separate from its investing parties creates a wall of limited liability for such parties is also not expressly stated in the law, but here the balance of probability is that it does. For further discussion of this point, see the article headed "Corporate entities in the PRC", under the section on "Foreign investment enterprises".

3.2 Capital requirements

The parties' capital contributions to a hybrid cooperative joint venture company may be in cash or kind as is permitted in equity joint ventures. The parties' contributions to a cooperative joint venture are treated as separate contributions to the venture rather than part of the venture's registered capital, although hybrid cooperative joint ventures may be, by analogy to equity joint ventures, subject to the same regulations governing minimum equity-debt ratios as those in the equity joint ventures.

The profit sharing structure of a cooperative joint venture (whether a hybrid or the cooperative joint venture) which is set by contract rather than capital contribution ratios, offers far more flexibility than in equity joint ventures. For instance, a foreign party could negotiate a higher profit share in earlier years to offset a high initial outlay.

See also paragraph 2.2 above.

3.3 Management

The Cooperative Joint Venture Law provides that a cooperative joint venture shall either have a board of directors or a joint management office. Typically, a hybrid cooperative joint venture might adopt a management system which closely resembles that of an equity joint venture. In the case of a true cooperative joint venture, the management structure is generally headed by a joint management office and thus is more flexible than that of an equity or hybrid joint venture. Since no separate legal entity is formed, a true cooperative joint venture has no general manager as such, although the parties usually appoint a member of the Chinese side as the project's legal representative. (The foreign side can not be the project's legal representative because cooperative joint ventures are not awarded legal person status under Chinese law.)

3.4 Term and termination

The situation of the same as for equity joint ventures (please see paragraph 2.5).

4. The documentation and approval procedures for a joint venture

4.1 Outline of documentation

This usually consists of the following documents: a letter of intent/memorandum of understanding (which is not legally binding, but required by the PRC party to seek preliminary approval to go ahead with the project from its "department-in-charge" and relevant authorities); a joint venture agreement (which again is not formally binding on either party); a feasibility study (which although not legally binding, is required by the PRC party to "sell" the project to the relevant PRC approval authorities and will form the basis for the allocation to the joint venture of materials which are subject to state control); and a joint venture contract and articles of association (which are both legally binding). The Joint Venture Regulations sets out detailed provisions with regard to the issues that must be addressed in both the joint venture contract and articles of association, and also provides that the formation of a joint venture contract, its validity, interpretation, execution and the settlement of disputes under it shall be governed by PRC law.

4.2 Approval procedures

As a matter of law, a joint venture project must have been approved and included in an annual state or local plan before the PRC party is authorised to conduct negotiations with the foreign party. The approval process, which begins with the letter of intent and ends with formal approval by the MOFTEC of the signed joint venture contract and articles of association, will vary depending on the complexity of the project, negotiations between the parties and, significantly, the connections of the PRC and foreign parties. The minimum, however, is a matter of several months.

Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.

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