Negotiating the joint venture agreement, draft contract and articles of association

In the 1980s it was common for the designated JV partners to negotiate the detailed terms of the JV in the form of a non-binding joint venture agreement which was then submitted to the local reporting authorities for approval, together with the Chinese version feasibility study.

Following approval, possibly with some amendment, the two sides would then reconvene, convert the joint venture agreement into a draft joint venture contract and, at the same time, draft the articles of association (or 'statutes' as they were sometimes called) for the joint venture company. As the incidence of JV negotiations multiplied and the pace of joint venturing quickened, many local authorities, notably the Commissions of Foreign Trade and Economic Cooperation (COFTECs) in major cities, relaxed the procedure and permitted the partners to proceed direct to the drafting of the joint venture contract and articles of association. Today, use of the preliminary joint venture agreement is generally limited to very complex or contentious projects where some intermediary clarification is helpful or the parties prefer a more protracted negotiation. In the sections which follow, it is assumed that the parties proceed direct to the contract stage.

The use of advisers

At this point, the senior management of the foreign party entering into formal JV contract negotiations needs to select its negotiating and drafting team and to decide how it will conduct the negotiations within the framework of standard Chinese practice. Normally, the principal Chinese party (always referred to as 'Party A' in the documents) will prepare a first draft of the joint venture contract and the articles of association which it will submit, in advance of negotiation, to the principal foreign party (invariably referred to as 'Party B' in a bilateral agreement).

Perhaps the first issue to address is the force and practice of Joint Venture Law. The principal applicable law on equity joint ventures (and other forms of foreign investment also) is published in Chinese and in English in a single volume, entitled Investment in China, compiled jointly by the Foreign Investment Administration and China Economic and Trade Consultant Corporation of MOFTEC (see also the reference list of relevant laws at the end of Chapter 3.2 'Foreign Direct Investment Vehicles'). The laws set out clearly (and generally, unambiguously) the content and principal clauses which must be included in both a joint venture contract and the articles of association. Many of the detailed clauses which appear in the first drafts submitted by Party A are culled direct from these laws, but the English language is usually not identical. One reason why the wording is often different is that copies of Investment in China with the official English translation are not generally in circulation among Chinese companies.

Variations of substance to the standard clauses of the Joint Venture Law, other than those dealing with the scope of the business, investment and registered capital contributions, scale of production, export content and the specific responsibilities of the parties, are not generally allowed by the authorities. Therefore, a commonsense approach to these secondary clauses is to incorporate them in the joint venture contract and articles of association as drafted, and translated, in the law unless either party has some major objection. Taking this approach to its logical conclusion, foreign companies negotiating a JV for the first time may be tempted to conduct the negotiations on a 'do it yourself ' basis without external advisers, but such a course of action exposes the investor to unnecessary risk.

At the other extreme, the foreign investor may wish to engage a law firm to advise on the legal documents and to participate in the negotiations. There are a number of leading international law firms with offices in China, with experienced foreign and Chinese staff authorised to practise law in China. However, involvement of western law firms in joint venture negotiating sessions can be counter-productive and an 'offstage' involvement may be preferable. In most JV negotiations the Chinese party will not involve an external Chinese lawyer unless a western law firm is introduced. Mega- projects involving billion dollar investment, international financing or major infrastructure projects are a different matter where the contractual documents are susceptible to western legal drafting, but the routine equity joint venture does not involve international law and the contracts are rigidly controlled by the standard Chinese framework.

Joint venture contract negotiators are well advised to concentrate on substance rather than form. However forcefully they may seek to interpose tightly drafted clauses in western legal language, the final product will still contain wording through which the proverbial 'coach and horses' could be driven in a western court of law. Essentially, what matters is that the joint venture contract and articles of association are written in trans-parent business language, which is as unambiguous as possible to both parties.

The success of the JV will depend on a strong, enduring relationship between the partners. If mutual understanding and respect fail, the joint venturer should question what the remedies are. Chinese contracts always provide for 'the resolution of disputes through friendly consultation' and, if that fails, by arbitration. Arbitration in China has a good record with arbitrators often finding in favour of the foreign party. Under a judicial system such as China's where there are no formal case law precedents to which courts can refer, litigation is hazardous and an unattractive course of action. If the partnership relationship fails in China and becomes confrontational, the ultimate recourse is to walk away.

However, in the context of negotiating an acceptable joint venture contract and articles of association drafted in layman's language, the foreign partner can benefit from the services of external advisers in three respects:

As noted at the initial discussion phase, competent translation both of the written word and through a skilled interpreter. (To achieve unambiguity it is crucial that the Chinese and English versions have the same meaning, particularly since the contract will specify that 'in the event of any discrepancy between the two versions the Chinese version shall prevail').
As a member of the negotiating team, an experienced consultant or staff member who has been through the whole process of a Chinese JV negotiation and the start-up of operations, and can input from experience what problems are likely to arise from contract omissions, loose wording or inadequate provisions for the management of the JV.
As an adviser, an experienced China consultant, preferably Chinese, having good working relationships with or connections to the relevant departments of the approval authorities concerned , who can check out the key points which arise in negotiation on ad hoc basis.

The third role cannot be performed in respect of sensitive issues without excellent connections. Foreign trade support groups having any foreign political association will not be effective in this field.

During the course of the negotiations, the foreign partner may also need to take advice on taxation or accountancy issues. The bigger international accountancy firms all have audit offices in China, mainly in Beijing and Shanghai, and their expert advice is readily available.

The negotiation process

JV contract negotiations are best conducted in the same city as the approval authorities to whom the draft contract and articles of association have to be submitted for preliminary approval. Therefore, if the Chinese partner is part of a national corporation the negotiations are better held in Beijing where the relevant ministries are located so that informal opinion may be sought on the issues of substance. Whatever other ministry may be involved in the subsequent approval process, MOFTEC for major joint ventures or the appropriate local COFTEC will certainly be involved, since all foreign investment projects require ultimate MOFTEC endorsement.

Assuming that the foreign party has studied the draft contract and articles of association (and taken advice where appropriate) in advance of discussion, the actual negotiating sessions are likely to take less than seven days. The negotiating procedures are well defined. As for the original set of meetings, the representatives of the two parties will be ranged either side of a meeting room table with up to ten Chinese representatives present. The composition of the Chinese team may vary from day to day, but the same key members are likely to attend each session under the leadership of a designated chief negotiator .

In spite of the apparent formality , the climate of the discussions should be quite relaxed. If the parties have reached a high degree of unanimity on the structure and financing of the JV during the joint feasibility study work together, there will be a presumption on both sides that the JV will go ahead. This does not mean to say that no serious differences of opinion will emerge in the course of formal negotiation, but a conducive atmosphere of mutual sincerity and flexibility will have been created. On many points of detailed drafting, the focus of discussion is more likely to be on satisfying the legal requirements and state policy guidelines, rather than resolving differences between the parties.

The work of amending the draft documents will be carried out methodically, beginning with the recitals and clause 1 of the joint venture contract and proceeding to the end of the contract before turning to the articles of association. Discussion of the articles is generally more straightforward than negotiation of the contract for two reasons:

many of the articles are a repetition of clauses in the contract; and
the contract is effectively a partnership agreement involving the relative detailed responsibilities of the parties, while the articles are concerned more with the ground rules and procedures for the management of the JV company.

There are practical points of Chinese negotiating style, of which foreign party negotiators should be aware. First, there is no merit in allowing discussions to stall on any single point at issue; it is quite acceptable for either party to say: 'Let's come back to this subject tomorrow and go on now to the next point.' Provided that the foreign party has explained its point of view clearly and answered any questions on its stance, the delay is usually helpful. It gives both negotiating teams an opportunity to refer to their superiors for instruction or to develop an alternative to overcoming the obstacle . Where appropriate, it also allows time to take soundings from the relevant department authorities.

It is also perfectly acceptable for the foreign team, when faced with an unfamiliar point or doubt, to ask for an intermission in the discussions to caucus outside the meeting room. If this device is shown to be effective in removing roadblocks , it is possible that the Chinese team may employ the same expedient, although the 'common line' among the members of the Chinese negotiating group is likely to have been well rehearsed.

Understandably, the Chinese party will be concerned to broaden the scope and nature of Party B's responsibility, not only in terms of the export sales commitment but also in terms of training, continuing technical support and management expertise. As an argument for the provision of support at Party B's cost, Chinese negotiators are skilful at emphasising the superior nature of the foreign partner's 'advanced technology' and expertise which is always flattering and is usually effective in drawing out the maximum commitment which the foreign partner is prepared to make. The foreign negotiating team should take particular care to ensure that the scope of each responsibility is clearly defined in terms of quantifiable limits (eg maximum days, weeks, etc of management time in each specialised and general function).

As an important side issue, the foreign negotiating team should also be aware that the manager whom the Chinese partner intends to nominate as general manager of the JV will probably be a member of the Chinese negotiating team, very possibly the chief negotiator. The right to nominate the general manager lies with the majority shareholder in any JV and, in the case of a 50/ 50 JV, it is normal for the general manager designate to be Chinese, even if there is a temporary foreign general manager at the outset. The contract negotiations are therefore a test for prospective general managers and a first opportunity for the foreign partner to assess candidates in action. Although the nomination of general manager is not usually made until after registration of the joint venture company and before the first board meeting, the foreign negotiating team should be at pains to identify the likely candidate during negotiations and, if it considers him unsuitable as a general manager, to find a way of making more senior Chinese management aware of its concern after the successful conclusion of negotiations.

The formal negotiations continue until the joint venture contract and the articles of association have been drafted in both languages, and are signed by both parties. Of course, these documents are not yet legally binding as they lack the formal approval of the authorities; they may also be signed by both parties subject to the ratification of the boards of directors of both companies. It is also wise to draft and sign a further memorandum, to which the draft contract and articles are appended, which records the closing position and sets out the actions which each partner will take in the interval before approval and signature of final binding contracts.

The senior foreign negotiator must have his company's authority to sign the draft documents on the spot, with the understanding that there will be no provision for further negotiation, except in respect of amendments which the approval authorities wish to be made.

Contents of the joint venture contract and articles of association

A checklist of the contents of a standard equity joint venture contract is included at the end of Chapter 3.2. Expertise and guidance on interpretation of standard wording or drafting hints can be provided by an accredited joint venture consultant or professional adviser as discussed earlier in this chapter.

Certain specific issues relating to the commitments and responsibilities of the partners to the joint venture company, rather than to each other, are normally incorporated in separate agreements which are ratified by the JV board of directors at the first board meeting. The substance of these agreements, if not the complete detail, is covered during the joint venture contract negotiations and the parties may prefer to include the draft agreements in an appendix to the joint venture contract. There is not usually an absolute requirement by the approval authorities that the supplementary draft agreements are annexed to the main contract. However, in the interests of banishing ambiguity or uncertainty there is merit in inclusion.

The supplementary agreements which are most common are:

export sales agreement between the JV and Party B; (a domestic market sales agreement between the JV and Party A is less common, as the JV is usually responsible for the sales of its own products/services in the home market);
technology, patent or copyright licence between Party B and the JV;
training agreement between Party B and the JV, covering training outside China and subsequent on- site training in China;
lease from Party A to the JV in cases where Party A retains the land use right and leases an existing facility to the JV; and
consultancy agreement between Party B and the JV to cover the continuing provision of foreign experts and/or management support.

For identification purposes the joint venture contract may include schedules which provide technical process and product specifications and details of patent, copyright or other intellectual property registrations.

The joint venture articles of association are roughly similar to the memorandum and articles of association which are standard under English company law, although provisions for the operating management of the company are more detailed in the Chinese version.

One innovation in Chinese articles of association is provision for the formation of a preparatory group or preparation committee, whose members are drawn from both parties and whose function is to carry out the necessary preparatory work for the start-up of the JV following receipt of the formal certificate of registration from MOFTEC.