Joint ventures have long been a traditional vehicle for investing in China, but numerous recent legal developments make this a complex undertaking. In this article we look closely at common questions foreign investors have when forming business entities in China, focusing on the China-Foreign joint venture a popular foreign investment classification. We will walk you through the joint venture formation process, how to build solid partnerships with local business partners, and achieve win-win outcomes.
Foreign investors can choose between three business forms for their joint venture in China: LLC, corporations, and partnerships. LLCs are usually preferred because of the simplified registration, flexible shareholder structure options, well-developed case law, and limited liability for shareholders. Therefore, this article will focus on China-Foreign JVs organized as LLCs.
Forming a joint venture entity in China calls for process different from a wholly foreign owned entity since the joint venture involves another party. Therefore your starting point is to perform due diligence on potential business partners, vetting their reputation, financial condition, and capabilities.
You will also need to get an appraisal in addition to due diligence on non-monetary capital contributions such as technology or land. Assuming the due diligence report on the potential China business partner raises no red flags, you’ll then enter into a joint venture agreement, draft an articles of association, and ancillary agreements such as technology licenses and distributorship plans. Only one of these documents needs to be filed with the business registrar: the articles of association.
China JVs Must Use Three Layers of Management
China’s Revised Governance Law is New and Untested
Structure China JV voting rights to avoid deadlock
China JVs Can Choose Whether to use Supervisors
Key Issues in China Joint Venture Negotiations
China JVs Must Use Three Layers of Management
The JV’s governance structure determines how the partners will make decisions; companies in China generally now use three layers of governance. The shareholder meeting is the supreme authority within the company, and is vested with power to make material decisions and appoint or remove both directors and supervisors. The board or executive directors reports to the shareholder meeting and is responsible for business operations except for those reserved to the shareholders meeting. The management team is comprised of the president and executives, and is responsible for day-to-day management. They are appointed by directors.
The supervisors have authority to inspect company records and books to provide oversight of director and executive performance; they can move to remove them if they violate the law, articles of formation, or a shareholder resolution. The revised China Companies Act allows smaller companies to decide against using supervisors and instead use an audit committee. Foreign shareholders in China-Foreign JVs exercise management power through the selection process for directors, supervisors, and executives, and with statutory and contract rights, such as right to inspect records and cast votes. The China Foreign Investment Act of 2020 provided a grace period that allowed joint ventures to use the board of directors as their supreme authority, but China wants all entities to eventually transition to making the shareholders meeting their supreme authority and update their government filings.
China’s Revised Governance Law is New and Untested
The legacy Joint Venture Act statute and regulations used a governance approach very much different from current China Companies Act of 2024. The differences are striking; traditional China joint ventures did not have a shareholders meeting and instead used two layers of governance, that being the directors and executives, and all power vested in the board. Parties to a joint venture need new strategies for structuring their governance structure that differ from the legacy two-layer governance system.
Let’s review how the legacy China joint venture system expiring in 2025 works. The legacy joint venture blends the roles of shareholders and directors, and instead of having directors elected by shareholders, the directors are appointed by shareholders. These directors would often simultaneously hold roles as agent for the shareholder and as a corporate officer, leading to conflicts of interests where the joint venture and shareholder goals were not aligned.
China’s Joint Venture Act also required unanimous approval for some business decisions, for example amendments to the articles of formation, entity dissolution, or registered capital change. The China Companies Act on the other hand, make such decisions the purview of the shareholders meeting and require a two-thirds super-majority for major business decisions.
Since things have changed so much in recent years with the revised China law, some thought needs to be put into how joint ventures are structured now. Key decisions are making the shareholders meeting the supreme authority in the entity, delineating shareholder/director powers, setting board size and rules of order, whether to use supervisors, deciding on a statutory representative, and whether to include an employee representative. There are three places where current China joint ventures differ substantially from traditional practice that deserve close attention.
Management power must be clearly separated in a China JV
China’s revised JV regime requires learning a new governance process because it requires establishing separation of powers within the entity, but parties under the new law are not working from a complete blank slate. The revised China Companies Act is relatively clear about how it expects you to separate power between the shareholders and board of directors, and its governance procedures also require that the JV’s Articles of Formation clearly delineate shareholder and board powers. Even better, matters not proscribed by the Act may be tailored to the operating needs of a particular joint venture.
For example, under the traditional corporate law regime in China, certain material business decisions would require unanimous board approval, but under current law these powers can be granted to shareholders in the Articles of Formation. Powers usually exercised by the board of directors can be reserved for the shareholder meeting. Joint venture parties need to consider whether the shareholders or board will be responsible for approving certain business decisions, such as material contracts or initiating major litigation.
Structure China JV voting rights to avoid deadlock
Foresight is needed when structuring voting rights in China to avoid it causing contention. If handled poorly, it can lead to deadlock situations that compromise the entity’s ability to compete in the markets.
Parties can avoid disputes by taking advantage of the Act’s permissiveness for parties to tailor their Articles to achieve similar results as a traditional China joint venture agreement, under which each party appoints director that each cast a single vote. Consider that the Act’s default provisions where two-thirds majority vote requirement for certain decisions may not provide for a realistic balance of power in a two-party joint venture.
The voting provisions for a joint venture in China should instead be dictated by the business fundamentals, in particular each party’s stake in the venture. Under the default rules in a China joint venture with a major shareholder owns 75% and minority owner has 25%, a minority shareholder would not have any control over material decisions. To restore that power, minority shareholder therefore should ask that a 75%+ vote be required for material decisions.
China JVs Can Choose Whether to use Supervisors
Your China JV will need to decide whether a board of supervisors should be set up; the 2024 Act provides flexibility to appoint a sole supervisor or a board of at least three supervisors. A supervisory board must fill at least one third of its positions with employee representatives, for example a three-member board must have at least one. Some joint ventures want to have each shareholder party appoint one supervisor, but this arrangement is non-compliant with the 2024 China Companies Act.
You need to decide whether to use a board of supervisors and be in compliance. Smaller entities or those with few shareholders are allowed to simply use a sole supervisor instead of a full board. While there is limited guidance on who qualifies as small enough, having few shareholders is a reliable justification. Larger JVs, having 300+ employees, can circumvent the board of directors employee representative requirement by setting up a board of supervisors comprised of one-third employee representatives, which is compliant with statutory protections for employee interests.
Partnering with state-owned enterprises requires additional governance planning; SOE involvement implicates state owned capital approval and appraisal rules and special requirements resulting from capital contribution or sale of equity, and they may also have governance requirements such as forming a labor union at the shop level, or submitting to government sovereign wealth fund oversight.
Key Issues in China Joint Venture Negotiations
Attorneys in China agree that capital contribution amounts and deadlines, funding conditions, and damages for breach must be carefully defined in a China JV. Therefore, agree on a currency type and provisions for exchange rate fluctuations, then designate procedures for selecting directors, supervisors, and executives along with rules of order for how decisions are made at meetings.
Make provisions to handle shareholder and board disagreements to prevent deadlocks, such as escalation to the highest level of authority, designating an acceptable internal or third party to resolve disagreements, buyout provisions at an agreed price, or winding up the joint venture if resolving disagreement is not possible. Agreeing on these points in advance can facilitate business, reduce disputes, and improve governance throughout the JV’s life cycle.
JV parties in China generally use lock-up and right of first refusal provisions in the agreements. Minority shareholders typically want more rights than provided by the statute, looking for access to work sites, equipment, offices, and staff. This is in addition to the minimum default positions for right to inspect records, copies of governance documents including the articles, minutes, and resolutions; and access to financial statements and books. Parties will negotiate vigorously over the China JV non-compete provisions, and will ask for restrictions on business activities, geographical area, and term. They often demand broad applicability, extending the provisions to affiliates and JV parties’ relatives.
Anti-trust compliance is implicated by ancillary business transactions with the joint venture for activities such as supply, equipment loan, licenses, technologies, and distribution. The ancillary transactions must be structured in such a way as to have the JV as its central nexus, which can be done by planning them as an integrated part of the business venture as a whole, ensuring that the deal structure, conditions, covenant cross default and cross termination provisions are not isolated from the overall JV plan.
Protect Financial Investors with Protection Provisions
Use voting provisions that will enable financial investors to have a say in material business decisions but without being in control of business operations, but analyze whether a financial investor’s veto rights could disrupt the company’s day to day business management.
JVs with several financial investors can designate them as a separate share class, so that vetoing material decisions requires a simple or two-thirds super-majority of the financial investors. Chinese financial investors often demand including an earn out or redemption provision be included, which if triggered can require the founder or JV to repurchase shares or pay damages. These earn-out and redemption provisions could be unreasonable, and the counterparty’s counsel should closely review calculation method, assess feasibility of performance, and consider capping liability. You should also review to verify the provisions’ legal compliance and enforceability even if on the investor side.