The Fake China Joint Venture, Made Real Through Marriage?

Posted by Dan on December 21, 2009 at 07:28 AM
Discussion: Comments (14) : TrackBacks (0) : Linking Blogs : Add to del.icio.us

Just got this email, which is not too dissimilar from other emails and phone calls I have previously received:

Like I said before, I'm really enjoying your series on China Law Blog on starting a business in China. It's something I might try myself someday.

I'd be really interested in hearing about a foreigner starting a local Chinese company through a Chinese spouse. I know this is fairly common (I know of several people who have done it this way), but I'm curious about the details. I hear the registered capital must be of a certain amount, or else it doesn't make sense for the Chinese company to "hire" the foreigner to run the business. And, of course, there are also visa considerations. Then, I guess there's the ugly possibility of what divorce means to the company... but I think that's pretty clear. (If partnerships become possible in the future, will foreign management hires be able to become full partners in this kind of business?)

I'd really love to see a blog post on this angle. Please keep my request anonymous, though... no need to make my employer nervous! :)

Great questions.

Earlier this year, we wrote on what we call the fake China joint venture, which is really nothing more than someone wanting to set up an illegal business arrangement as a way of avoiding the fees and costs involved in forming a real joint venture or Wholly Foreign Owned Entity (WFOE). In that post, we talked about the following as a typical situation:

Caller: I've got this great website and it is exactly what China wants/needs. And I've been working on developing it with some Chinese tech friends of mine and we want to take it legal so we can start getting VC (venture capital) funding for it. Here's our plan. Now I know that the old/truly legal/expected/usual way to do this is for me to form my own company and then form a joint venture with my Chinese partners, but I also know that will cost a lot of money. So our plan is for the Chinese company to own the website and then we will have an oral agreement (or a written agreement) that I really own half of it.

Me: Listen, my firm has been contacted at least twenty times after these situations have gone bad and I am aware of at least another twenty times where the same thing has happened, and let me tell you, these arrangements (it is NOT proper to call these joint ventures) virtually always end the same way. They end with the Chinese company booting you out completely and leaving you with no recourse. Protecting foreign companies in legitimate joint ventures is difficult enough, but it is pretty much impossible under the scenario you are describing. We had a guy who paid us a lot of money once for us to do everything we could to try to get "his" multi-million dollar business back. Guess what, we could not even come close to getting it back. Every Chinese lawyer we talked to about suing to get it back told us we had no chance of winning at all. I mean, just listen to the argument we would need to make to the judge:

Your honor, my client knew that China's laws are very clear on what foreign companies must do to operate legally in China, but he thought these very clear laws should not apply to him because, well because he is an American tech company and he was just too smart/too poor to bother to comply with the very clear laws. So instead, he had this great method for completely circumventing China's very clear laws. His idea was to not form a company, but rather, have his Chinese friends form the company and he would have a little side deal with that company. Well, that side deal has now gone bad and my client wants you to go against China's very clear public policy on how foreign business is to be done in China and enforce this unwritten side deal.

What do you think of that argument?

Caller: (long pause) I understand things could go wrong with that kind of arrangement, but would you be willing to draft the contract between me and the Chinese company?

Me: No. I can't do that. I can't draft a contract that I know will never work. I just can't. Give me a call if you ever want to do this legally, in a way where you actually have a chance of profiting from your work down the road.

We then referred readers to the following:

For more on this, check out "China SMEs, Own If You Want To Own." To get a feel for how difficult it can be even with a fully legal joint venture, check out this article by Steve Dickinson in China Brief, entitled, "Avoiding Mistakes in Chinese Joint Ventures." and this Wall Street Journal article I wrote, entitled, "Joint Venture Jeopardy."

UPDATE: In, "Private Equity, Venture Capital and ‘Fake’ China Joint Ventures," China Hearsay very nicely maps out the way these deals are typically done (using an offshore holding company) and notes that you might have legal recourse in the rare instances where your Chinese partner has "huge assets offshore" in a country in which you can sue and win:

You can tie up the Chinese founders in 100 different contractual knots, but unless those founders have huge assets offshore (real assets, not equity in the holding company) that you can go after in a dispute, they can always tell you to piss off and kick your ass out of the business.

But back to the email and what can happen to a business started through/with a Chinese spouse?

Here are some thoughts:

1. If the marriage works and the business works, then it is all good.

2. If the marriage works and the business fails, the business fails.

3. Because my firm does not represent Chinese nationals seeking to form Chinese domestic businesses (it would not make any sense for them to retain us for this sort of thing), we are not very knowledgeable about this and so I do not know what sort of minimum capital would be required for such a business to hire a foreigner.

4. If the marriage fails and the business works, what happens? This is the key question and I do not know the answer. The business belongs solely to the Chinese spouse, so the question then becomes a Chinese family law issue. What happens under Chinese divorce laws to something that can legally be owned only by the Chinese spouse?

5. What about China's new laws on the "Establishment of Partnerships within China by Foreign Enterprises and Foreign Individuals," set to go into effect on March 1, 2010? These new measures will allow foreign enterprises and individuals to form partnerships with Chinese enterprises and individuals, but it is very hard to say at this point what impact those new laws will have. But, my hunch is that the fees and costs of setting up one of these partnerships legitimately will be roughly the equivalent of setting up a WFOE or a Joint Venture, so I do not see them solving the problem of the foreigner who wants to set up a China business on a shoestring.

The race for best blog in the ABA Journal competition is really heating up and time is running out for me to beg and plead for you to vote for the China Law Blog as best blog in its category. I therefore strongly urge all of our readers to click here and register on the site and then click here and vote for China Law Blog in the "geo" category. Your vote really does count and it will be much appreciated. Thanks.