Introduction:
Investing in China can be enticing for many investors, given its status as one of the world’s largest economies and its potential for high growth. However, it is essential that investors approach the Chinese market with caution and be aware of the potential risks and challenges. In this article, we will discuss, with the accompaniment of a case study, some crucial considerations that investors should keep in mind before making investment decisions in China in order to protect their interests:
Political and Regulatory Environment:
China’s political system and regulatory landscape can significantly impact investment opportunities and outcomes. The Chinese government exercises substantial control over various sectors and industries through policies, regulations, and state-owned enterprises. Investors must stay informed about any changes in government policies, legal frameworks, and market regulations that may affect their investments.
Market Volatility and Risk:
Like any market, investing in China involves certain risks. China’s stock market, in particular, has experienced periods of volatility and unpredictability. Investors should carefully assess their risk tolerance and diversify their portfolios to mitigate potential market fluctuations. Thorough due diligence, market research, and analysis are crucial when selecting specific investment opportunities.
Intellectual Property Protection:
Intellectual property rights protection has been a long-standing concern for foreign investors in China. Cases of patent infringement, counterfeiting, and theft of intellectual property have been reported. Investors should be diligent in protecting their intellectual property assets and carefully evaluate the legal and regulatory frameworks in place to safeguard their rights.
Transparency and Corporate Governance:
China’s business environment may present challenges in terms of transparency and corporate governance practices. Investors should conduct thorough due diligence on companies they consider investing in and assess their governance structures, financial reporting practices, and adherence to international standards. It is also advisable to seek professional advice from legal and financial experts familiar with the Chinese market. In the case study below, the investor incurred losses due to the opacity of the Chinese partner’s activities which resulted in the investor being unable to ensure their shared contract was upheld and fulfilled.
Currency Risk and Capital Controls:
China’s currency, the renminbi (RMB), is subject to some level of control by the government. Investors should be aware of potential currency risks and fluctuations that may impact their investment returns. Additionally, China has implemented capital controls aimed at regulating cross-border capital flows. Understanding and complying with these regulations is crucial for investors seeking to repatriate profits or exit their investments.
Importance of Local Contacts:
Investing in China requires an understanding of its cultural nuances and language barriers. Engaging with local partners or professionals who possess knowledge of the Chinese market can help bridge these gaps. In this case study, as the investor was not physically in China and did not have contacts on the ground in China, he was not kept in the loop of his Chinese partner’s activities. As a result, the investor was unaware of the wrongdoings committed by his Chinese partner and was not able to take prompt legal action. Building relationships and networks in China can provide valuable insights and opportunities for successful investment.
Access to Reliable Legal Services:
Investors should establish a network of reliable legal service providers to ensure timely access to legal assistance where necessary, such as to enforce the fulfillment of contracts or further legal action. In the case study below, the wrongdoer has not compensated the investor any part of the damages ordered under the arbitral award, showing that a strong legal team and prompt intervention are essential for protecting the investor’s interest.
Conclusion:
Investing in China offers significant potential for growth and profit, but as illustrated by the case study below, it also comes with inherent risks and challenges. Investors should approach the Chinese market with caution, conduct thorough research, and seek professional advice. Understanding the political, regulatory, and cultural landscape, along with assessing risks associated with transparency, intellectual property, and currency fluctuations, is crucial. By staying informed and diligent, investors can navigate the complexities of investing in China and position themselves for long-term success.
Case Study: Dispute between parties in a joint venture contract in China
On 28 January 1991, through consultation and mutual agreement, Dayuan Import and Export Agency Co., Ltd. (hereinafter referred to as “Dayuan Company”) and Dezhou Biochemical Pharmaceutical Factory (hereinafter referred to as “Dezhou Company”) signed a Sino-foreign joint venture contract to jointly invest in the establishment of Dezhou Shengda Pharmaceutical and Health Products Co., Ltd. (hereinafter referred to as “Shengda Company”). The operating period of the joint venture was from 7 April 1992 to 31 December 2015. Since its establishment, the management of the company has been under the control of Dezhou Company. However, Dezhou Company has failed to fulfill the provisions of the joint venture contract (the “Contract”) and has wilfully infringed upon the legal rights and interests of the applicant and the joint venture, leading to severe financial losses for Shengda Company, rendering it unable to continue its operations. The facts are as follows:
According to the Contract provisions, the Dayuan Company and Dezhou Company were to jointly invest 4 million RMB in Shengda Company, with Dezhou Company contributing 3 million RMB. Dezhou Company’s investment was to include factory buildings and land, which, to this day, has not been actually delivered. In (month and year), Dayuan Company borrowed 3,494,803.12 RMB from Shandong Dezhou Baji Group Co., Ltd. (hereinafter referred to as “Baji Group”), claiming it was for the construction of a pharmaceutical building. This amount was included in the short-term loans of Shengda Company and resulted in a direct loss of 27.9364 million RMB to Shengda Company from wrongful accounting. Furthermore, Shengda Company has been paying rental fees to Baji Group since 1994. From 1994 to 2007, Shengda Company paid a total of 7.4094 million RMB in rental fees to Baji Group, causing a loss of 17.2843 million RMB.
Since July 1996, Shengda Company has borne the expenses and established a nationwide sales network for eye drops. In November 2003, without the consent of Dayuan Company and without a resolution from the board of directors of Shengda Company, Dezhou Company gratuitously transferred the network to Shandong Haishan Pharmaceutical Co., Ltd. (hereinafter referred to as “Haishan Pharmaceutical”), a joint venture between Dezhou Company and Baji Group. This resulted in massive losses to Shengda Company in the value of 24,549,188 RMB.
In September 2008, without obtaining the consent of Dayuan Company and without a resolution from the board of directors of Shengda Company, Dezhou Company forcefully transferred all the valuable assets of Shengda Company to Haishan Pharmaceutical, resulting in further losses to Shengda Company.
In summary, Dezhou Company, while managing Shengda Company, repeatedly breached the contract, infringed upon the legal rights of Dayuan Company, and caused massive financial losses of 23.6769 million RMB to the applicant. The applicant has not received any profits since 1998 and all its investments in the joint venture have been in vain. Therefore, to safeguard its legal rights, Dayuan Company initiated arbitration proceedings in China against Dezhou Company in accordance with the relevant provisions of the Contract.
The Arbitration Tribunal’s Findings
Issue of Applicable Law
Based on the provisions in the Contract and relevant laws and regulations, the Arbitration Tribunal under the China International Economic and Trade Arbitration Commission (“CIETAC”) found that the laws and regulations of the People’s Republic of China should be applied in this case.
Issue of Validity of the Contract
On 28 October 1991, Dayuan Company and Dezhou Company signed the “Dezhou Shengda Pharmaceutical and Health Care Products Co., Ltd. Enterprise Contract,” which is the Contract in this case. On March 25, 1992, the Shandong Province Foreign Economic and Trade Commission issued the Notice of Issuance of the Approval Certificate for the Chinese-Foreign Joint Venture “Dezhou Shengda Pharmaceutical and Health Care Products Co., Ltd.” with the approval of this contract and its articles of association. On 27 March 2007, the same authority issued the Reply Letter No. Lu Jing Mao Wai Zi [2007] 40, approving the change in the company’s operating period and confirming that the company’s contract and articles of association would be modified accordingly, with other content unchanged. Article 3 of the Law of the People’s Republic of China on Chinese-Foreign Joint Ventures states, “Joint venture agreements, contracts, and articles of association signed by the parties to the joint venture shall be submitted to the competent authority for foreign economic and trade affairs of the state (hereinafter referred to as the examination and approval authority) for examination and approval.” Article 14 of its Implementation Regulations states, “Joint venture agreements, contracts, and articles of association shall become effective after being approved by the examination and approval authority, and they shall be equally effective when modified.” Based on the aforementioned legal provisions, the Contract in this case has become effective after being approved by the examination and approval authority, and the original stipulated operating period in the contract had been approved to be changed to the period from 7 April 1992 to 31 December 2015. Therefore, the Contract in this case is valid, legally binding on the parties, and the parties should fulfill their respective obligations in accordance with the Contract.
Issue of Dezhou Company’s Investment
Dayuan Company claimed that Dezhou Company’s investment was to include a factory building equivalent to RMB 2.4998 million, but this investment has not been actually made so far.
The Arbitration Tribunal has ascertained the following facts through the hearing:
Article 12 of the Contract in this case stipulates, “The total investment of the joint venture is RMB 5 million, with a registered capital of RMB 4 million. Party A (Dezhou Company, as noted by the Arbitration Tribunal) contributes RMB 3 million, accounting for 75% of the registered capital, and Party B (Dayuan Company, as noted by the Arbitration Tribunal) contributes RMB 1 million, accounting for 25% of the registered capital.” Article 13 stipulates, “Party A and Party B shall contribute as follows…”.
On 3 June 1993, the “Internal Settlement Documents” bearing the stamp of “Shandong Dezhou Baji General Corporation Settlement Special Stamp” stated, “Pharmaceutical Building Payment” in the amount of RMB 3,494,803.12, with “Decrease Payee: Company Finance Department, Increase Payee: Biochemical Pharmaceutical Factory.”
On 30 June 1993, in the Joint Venture Company Meeting Document No. 125 (provisional voucher), it is stated: “Abstract: Construction of Pharmaceutical Building,” with the debit entry under “Fixed Assets” of RMB 3,499,803.12 and the credit entry under “Short-term Loans” of RMB 3,494,803.12, “Other Receivables Jinan Design Institute RMB 5,000.”
On 30 June 1993, in the Joint Venture Company Meeting Document No. 130 (journal voucher), it is stated: “Abstract: Pharmaceutical Building Loan Interest for June, RMB 3,494,803.12 x 1%,” with the debit entry under “Financial Expenses” for “Interest Expenditure” and the credit entry under “Short-term Loans” for “Company,” with an amount of RMB 3,494,803.
On October 26, 1993, Shandong Dezhou Tianjie Certified Public Accountants issued the Verification Report No. 30 (93) of Dezhou CaiSuo regarding Dezhou Shengda Pharmaceutical and Health Care Products Co., Ltd., which stated, “Based on the relevant documentary evidence and on-site observations provided by your company and the actual asset inventory, it is confirmed that your company’s actual capital is RMB 4,754,423, including: Party A (Dezhou Company, as noted by the Arbitration Tribunal) has an actual investment total of RMB 3,575,363, accounting for 75% of the total investment. The fixed assets amount to RMB 3,575,363, including 14 pieces of machinery and equipment, one Toyota car, 6 pieces of instrument equipment, and the Pharmaceutical Building Dormitory RMB 2,634,788.” The note adds, “Excluding the dormitory:…”
The Arbitration Tribunal found that under the Contract, Dezhou Company had the obligation to transfer the ownership of the factory building to the joint venture company (Shengda Company). However, Dezhou Company had not transferred the building. Pursuant to another provision in the Contract, Dezhou Company was liable to pay Dayuan Company a penalty of 15% of the value of the outstanding capital contribution, in addition to compensation for losses suffered by Dayuan Company as a result of Dezhou Companybreach of the Contract. The Arbitration Tribunal thus issued an arbitral award in September 2011, ordering Dezhou Company to pay Dayuan Company RMB 348,000 for its failure to fulfil its capital contribution under the Contract. To date, Dezhou Company has not complied with the arbitral award nor compensated Dayuan Company any damages for Dezhou Company’s breach of the Contract.
As can be seen from this case, there may be unique risks when investing in China or entering into joint ventures with partners in China. This article highlights some of the key considerations that foreign investors in China should take note of in order to protect their interests.
