It is inevitable that, since foreign. investment in. China began again. in earnest, some foreign. investors have fallen out with their Chinese partners and some have quit their investments altogether. Recently, the incidence of such events has increased. The prudent investor, however justified his optimism, considers the possibility that this might happen, and provides for it before he makes his investment.
Dispute comes before a break. Almost all Chinese legislation provides for initial 'friendly consultations'. It is sensible, though, to put a time limit in documentation on this amicable discussion, in. case a solution. proves impossible to find and the next stage impossible to reach.
The next stage is to seek resolution. of the dispute before the courts or arbitration. Chinese courts are often suspected of delivering poor and partisan judgements. However, the Civil. Procedures Law prohibits parties from. submitting certain disputes to foreign courts. And, even if a foreign court judgment were obtained successfully China is party to few treaties for the enforcement of civil. judgments given by non-Chinese courts.
In most cases arbitration will be a preferable option. The Civil Procedures Law allows for a choice of arbitration. venues ,and governing law, and the relevant choice should be addressed in the joint venture or other appropriate con-tract. China is a party to the New York Convention on the Enforcement of Arbitral Awards and, although practice maybe less than perfect, has passed legislation recognising and seeking to uphold the principle that the Chinese courts should give effect to foreign arbitral awards covered by' the Convention. without demur.
What if a the dispute has gone too far? Previousjoint venture legislation made liquidation nearly impossible if only one party tivanted to liquidate, because of the requirement for a unanimous board resolution. -.Ihe passage in 1996 of Ioftec's Foreign. Investment Enterprise Liquidation Procedures mitigated this. VV-1-10n- -a joint venture is unable itself to organise its own. liquidation (termed 'Ordinary'. liquidation) because of dead-lock, the board of directors, investors or
creditors may apply to the approval authority for 'special' liquidation.
Special liquidation procedures also apply if the joint venture is legally ordered to close down, or if serious obstacles occur in the ordinary liquidation process. The main difference between the two is that an. ordinary liquidation is controlled through the board of directors' appointees, but in a special liquidation all control over the formation. of the liquidation committee and the liquidation process is handed over to the approval authority.
I.f the joint venture is insolvent, declaring bankruptcy with a Chinese people's court could force liquidation.. The Civil Procedures Law, which applies to foreign enterprises, provides basic procedures for corporate insolvency including the prioritising of creditors' rights. However, once the people's court has ruled on bankruptcy, control over the liquidation process is completely ceded to the relevant state bodies.
Looking after the assets
Preserving the value of assets is crucial to the liquidation process. Asset values and valuation methods should be accounted for in the joint venture contract and articles of association. The Liquidation Procedures give them priority failing which 'relevant regulations' and authorities become involved.. The 1991 Administration of State Asset Valuation Procedures introduces the possibility of government involvement if assets are owned by the state.
Foreign partners who license intellectual property to the joint venture should be careful about how it is valued on liquidation. Should. it have a value at all?
Extraction of capital by way of gradual distributions to the foreign party during the life of the joint venture is provided for in the Co-operative joint Venture Law Implementing Measures, subject to limitations. This may be preferable to trying to extract on. termination illiquid assets or assets denominated in the wrong currency.
A better solution might be to buy out the other partner. This option has come to the fore as more Chinese partners find themselves unable to provide the cash required for capital expansion. Buyout mechanisms should. be incorporated into the joint venture contract.
The recent Changes in Equity Interest in Fibs Provisions make clear that the acquisition by a foreign investor of all the interests of its partners is tantamount to establishing a wholly-foreign. on ned enterprise. In. such. cases, all the usual. restrictions and regulations for establishing this type of foreign enterprise .would apply including the possibility of being categorised as 'restricted' or prohibited'.
Under the Income Tax Treatments of Reorganisation of Foreign Investment Enterprises such as Mergers, Splits, Reorganisation of Equity and Asset Transfer Tentative Provisions, any gains from the sale of interests will be subject to a capital gains tax it. the transferor is a foreign enterprise located in China.
Gains from equity transfer can be reduced by distributions before the transfer; although this will lower the base cost. If the transferor is a foreign enter-prise located outside of the PRC, capital. gains are subject to a 20 per cent with-holding tax, with a 10 per cent credit for foreign enterprises in Special Economic Zones. Double tax treaties would. also reduce the effect of withholding tax.
Selling the equity
A joint venture party could also sell its equity, privately or publicly. In private sales, the transfer of an interest to a third party requires the approval of both the other shareholders and the approval authority, according to the Changes in Equity Interest in FIEs Provisions (though the approval of the creditors of the joint venture is not necessary). Alternatively, if the foreign party's interest is held in an offshore holding company, the transfer of those shares are free from restrictions.
A public sale would involve the con-version of the joint venture into a company limited by shares. joint ventures which have done this include Shenzhen Bicycle and Shanghai Pilkington.
Of course, as a last resort, a foreign party could just walk out of the joint venture, with a view to saving time and expense. This however would almost certainly give grounds for breach of contract claims. In addition., the foreign party may have continuing credit obligations such as guarantees, and could lose confidential information and intellectual property.
F1ie slifiel,ls is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For turther details, contact Matthew Cosans through its offices in Hong Kona (tel: +852 4o 3400) or Beijing (tel: +8b 10 6470 e33S) or hg e-wail: fn osatsffreshf'ields.com