This Q&A provides country-specific commentary on Practice note, Structures: international joint ventures, and forms part of our international joint ventures transaction guide.
There are two legal structures for joint ventures: the equity joint venture (EJV) and the co-operative joint venture (CJV), each governed by a separate law and implementing regulations. Each of these laws had been amended to bring China's joint venture rules in line with the requirements of the World Trade Organisation (WTO).
The vast majority of joint ventures are either EJVs or CJVs.
The corporate form of an EJV is a limited liability company in that a legal entity is formed to which the parties contribute capital and take equity interests in proportion to the size of their investment. An EJV will have limited liability.
Investors control the operation of the EJV company directly through their appointees to the board of directors. There are no shareholder meetings.
Parties to an EJV share the EJV's net profits in accordance with the ratio of their capital contributions to the company after payment of taxes and contributions to the required EJV funds.
There are two types of CJV:
The first type is often referred to as a "co-operative" enterprise and is very much like the EJV in that a legal entity in the form of a limited liability company is created. A board of directors manages the co-operative entity and only certain major matters are referred to the investors for decision.
In the second type of CJV, no legal entity is created and all aspects of business relations between the parties are set out in the joint venture contract. Instead of a board of directors, a joint management committee manages the company. This type of CJV is often called a "contractual joint venture" or a "non-legal person cooperative joint venture". The use of this second form of CJV is restricted, as government authorities are reluctant to approve a venture that does not result in the establishment of a legal person formed under PRC (People's Republic of China) law.
Variable arrangements for profit sharing remain one of the distinguishing features of CJVs. Profits from a CJV may be shared in any manner specified in the joint venture contract. Provided the contractual provisions are clear, the parties may choose to share net profits, gross revenues or products manufactured or produced. A reasonable method for the payment of taxes and operational expenses must also be stipulated. Furthermore, the parties' profit sharing ratio in a CJV may vary during the term of the CJV.
One important advantage of CJVs compared to EJVs is that the foreign party of CJVs may recover its investment before the expiry of the term of the CJV, provided that both parties agree, that all fixed assets of the CJV will belong to the Chinese party upon the expiry of the term of the CJV. The mortgage of CJVs' assets requires a unanimous consent of the board of directors or the joint management committee of the CJV. EJVs do not have equivalent unanimous consent.
Both EJVs and CJVs are approved and established with a specific scope of business and a limited duration.
To establish a joint venture, a number of approval procedures must be satisfied. In practice, the approval process often begins during the initial stages of discussion, with the letters of intent and a preliminary feasibility study being submitted for review by the Chinese side to its higher authorities . A foreign investment project will be examined and approved by local or central government officials, depending on a number of factors including the total amount of the investment and the industry involved.
The main steps in the approval process include:
Preliminary approval for project establishment, including consent from relevant industry departments and planning authorities.
Approval of the feasibility study report by the State or local planning commission, including the operations and financing of the project.
Formal approval of the signed joint venture contract and articles of association by the Ministry of Commerce (MOFCOM) or its local counterpart.
Issuance of the business licence by the State or local Administration of Industry and Commerce.
According to a regulation issued by the National Development and Reform Commission (NDRC) in 2004, the first and second steps (see bullet points 1 and 2 above) have been merged into one: the submission and approval of a project application report. This regulation has been implemented in most localities of China.
In general, the foreign party is required to contribute at least 25% of the joint venture's registered capital (that is, the equity contributed by the parties and registered with the government authorities). The registered capital represents the parties' equity investment in the joint venture and is to be distinguished from the concept of total investment amount, which represents the sum of registered capital plus external borrowings. PRC authorities recently moved to clarify the legal status of FIEs in which the foreign party's contribution to the joint ventures registered capital is less than 25%. In such instances, the FIE's business licence will read "less than 25% foreign equity".
In principle, there is no upper limit, save that establishment of a 100% foreign-owned FIE, may be restricted or prohibited in certain industry areas.
Industries or service sectors in which foreign investment is restricted or prohibited are identified by the NDRC and the MOFCOM in the Foreign Investment Industrial Guidance Catalogue (Catalogue), which was last amended in late 2007. The Catalogue divides industries and services into "encouraged", "restricted" and "prohibited" categories. Those not listed are generally regarded as "permitted". Under the encouraged category, foreign investment is rewarded with certain benefits; both joint ventures and wholly foreign-owned enterprises (WFOEs) may be allowed. Under the restricted category, WFOEs are sometimes not allowed and, for joint ventures, the percentage to be held by the foreign party in certain industries is limited to 50% or less. Under the prohibited category, foreign investment is barred completely.
Certain minimum equity requirements are imposed on both EJVs and CJVs. These requirements are
Minimum equity as a percentage of total investment
Up to US$3 million
50% or US$2.1 million (whichever is higher)
40% or US$5 million (whichever is higher)
Over US$30 million
33.3% or US$12 million (whichever is higher)
In projects where the total investment amount is over US$100 million the level of registered capital may be permitted to be somewhat less than 33.3%
Investment in an EJV or CJV is not evidenced by the issue of share certificates. However, capital contributions in the form of tangible in-kind contributions (such as equipment, components, etc.), which are subject to valuation and inspection of PRC authorities, and intangibles (such as technology and know-how rights) are acceptable for both EJVs and CJVs. Contribution in the form of non-cash assets shall not exceed 70% of the total capital contribution. Contributions in the form of services may be acceptable for CJVs.
Yes, there are some local requirements. In both EJVs and CJVs with the status of a legal person, the board of directors is the highest decision-making authority of the joint venture. For contractual CJVs, the joint management committee is the highest decision-making authority. For both EJVs and CJVs, the chairman of the board or the general manager (as specified in the Articles of Association of the company) is the legal representative of the company.
With the amendments to the PRC Company Law that came into effect on 1 January 2006, a supervisory board is now also required. A supervisory board consists of at least three members, except in small-scale ventures where one or two supervisors may be permitted.
At least one-third of the supervisory board must be representatives of the staff and workers of the venture. The supervisory board is given a number of functions and powers by law, which include the right to:
Inspect the financial affairs of the company.
Supervise the acts of the directors and senior managers.
Propose the removal of, or take legal action against, directors and senior managers who violate the law, or the company's articles of associations or rules.
Decisions of the supervisory board must be adopted by a majority of its members. In both the CJV and EJV, a general manager is usually appointed for the day-to-day running of the joint venture. The appointment of the general manager and other management posts is made by the board of directors or the joint management committee. The parties may adopt a management structure that suits their business needs.
There is no specific legal requirement for local managers and no restriction on foreign management. However, there is policy in favour of localising management. As a matter of policy, the relevant industry authorities of certain industries require the legal representative of EJV and CJV in the relevant industry be a Chinese national.
For EJVs, the distribution of seats on the board generally follows the ratio of investment contributions, and the number of directors representing a party is to be determined by reference to that party's equity ratio. For the first type of CJVs (co-operative joint venture), the distribution of seats on the board is subject to the negotiation of the parties. Such distribution does not necessarily reflect the equity proportion of the parties in the CJV.
A representative of the labour union has the right to attend board meetings when relevant issues are discussed, but does not have the right to vote on such issues.
Currently no procedures are available for foreign investors to directly form a partnership, as the term is defined under PRC law, with domestic entities. MOFCOM submitted draft Measures on the Administration of Foreign Invested Partnership Enterprise to the State Council for review in early 2007. The draft measures set out the approval procedures for the establishment of foreign invested partnerships.
Generally, a PRC natural person does not have the legal capability to form a foreign invested joint venture with foreign parties. Natural person investors are sometimes seen in government-approved projects in China, for example when an entity is being converted from a domestic company into a joint venture. In some projects, the Chinese natural persons will form a company in a foreign jurisdiction to function as the foreign investor to the joint venture (i.e. investor in the EJV or CJV). This approach has encountered difficulties as a result of foreign exchange regulations issued in early 2005.
As mentioned above, contractual CJVs are rarely used. EJVs and CJVs are commonly formed as limited liability companies, and investors are liable to the venture to the extent of their subscribed contribution capital to the venture, as stated in the joint venture contract.
As mentioned above (see Question 8), a foreign investor cannot directly form a partnership with domestic entities. In China, a partnership is more likely to be used for the establishment of an investment fund due to tax considerations.
For an equity joint venture or an incorporated co-operative joint venture (see Question 1), the parties' liabilities to the joint venture are limited to their capital contribution.
For an unincorporated co-operative joint venture, the parties have unlimited legal liabilities for the joint venture's obligations. While sharing similar characteristics with a partnership, an unincorporated co-operative joint venture is nonetheless separate and distinct from and could not be categorised as a partnership under PRC law.
While it is possible for domestic entities to form a limited partnership amongst themselves, PRC law has yet to allow foreign investors to form a limited partnership with domestic entities.
A foreign investor interested in venture capital projects may form an unincorporated foreign invested venture capital enterprise (FIVCE) with domestic entities. An unincorporated FIVCE shares similar characteristics with a limited partnership. In particular, all investors of the unincorporated FIVCE bear joint liability for the debts of the enterprise, unless it is provided in the FIVCE agreement that the "requisite investor" (similar to a general partner in a limited partnership) shall bear unlimited liability for the debts of the enterprise, and that the other investors (similar to limited partners in a limited partnership) will only be liable for the debts of the enterprise to the extent of their investment.
Foreign investors are not permitted to form limited partnership with domestic entities (see Question 13).
In the venture capital sector, foreign investors are permitted to form an unincorporated FIVCE, which shares similar characteristics with a limited partnership. In order to establish an unincorporated FIVCE, generally foreign investors must obtain:
Consent by the Ministry of Science and Technology.
Approval of the Ministry of Commerce (total committed capital over US$100 million) or its counterpart at the provincial level (total committed capital up to US$100 million).
Depending on the project, registration with the State Administration for Industry and Commerce or its local branches.
Domestic limited partnership
The establishment of a domestic limited partnership must be approved by and registered with the State Administration for Industry and Commerce or its local branches. In certain business sectors, approval of the applicable government regulators must also be obtained.
As indicated in Question 13, foreign investors are not permitted to form limited partnership with domestic entities.
Domestic limited partnership
A domestic limited partnership must have at least one general partner, which cannot be a wholly state-owned enterprise, a listed company, or a non-profit public institution or social organisation. In addition, a limited partner in a domestic limited partnership cannot be the managing partner, and cannot represent the limited partnership to the public.
See Question 11.