The compounded effect of the pandemic, lockdowns and increased geopolitical tensions have slowed down the Chinese economy. Overall foreign direct investment (FDI) flowing into China was significantly affected. Notwithstanding this, there has been a notable increase in FDI from certain countries (Germany and countries from the Middle East in particular) and in certain sectors, including manufacturing, hi-tech, auto (electric vehicles (EVs) in particular), and petro-chemicals.

In 2022, the overall China (domestic) M&A market fell to its lowest level since 2014 at USD486 billion (source: China M&A 2022 review and 2023 outlook issued by PwC China), a 20% decrease from 2021 levels. The decline would have been larger but for a number of mega deals by state-owned enterprises (SOEs) as part of their mixed ownership reform. The domestic M&A market was primarily driven by government policies, with a strong focus on supply chain integration, industrial upgrades, mixed ownership reform, and distressed assets disposal.

Capital raising and investment by PE institutions were not immune from these trends, coinciding with a less active IPO market. In the first half of 2023, the overall equity investment market continued the downward trend (source: China VC/PE Market Review 2023 H1 issued by Zero2IPO Research).

Whilst the polices on China outbound investment managed to remain unchanged, overall Chinese capital outflow continues to decrease, except for investment in certain sectors including traditional and renewable energy, technology, advanced manufacturing and healthcare. As a result of global supply chain restructuring, Chinese investors have been shifting their investments into Mexico, South East Asia, central Europe and Latin America, mostly in the form of greenfield investment (instead of M&A).

Certain sectors have witnessed increased activity by foreign investors:

• New energy vehicle (NEV) and battery sector – foreign investors continue to have a strong interest in China’s NEV and battery industry, evident by the international automobile manufacturers’ follow-up investment (over USD10 billion) on expanding their NEV related business in China during 2022. The growing market demand for electric vehicles (EV), advanced battery technology, and the transition towards cleaner and more sustainable transportation have been driving the surge of foreign investment in the sector. Notably, well-known German car manufacturers announced headline deals in tandem, by making (strategic) investment and form joint ventures with leading Chinese EV companies and EV battery players. Chinese EV exports have also recorded phenomenal growth.
• Hydrogen energy sector – with increasing global focus on de-carbonisation and searching for clean energy alternatives, investment in hydrogen energy has gained momentum in China too, attracting foreign investment in hydrogen production, storage, and application throughout the value chain.
• Petroleum and petrochemicals – despite the renewable energy push and growth in the sector, the demand for petroleum, petrochemicals, downstream refining, and liquefied natural gas (LNG) remains robust in China, notable transactions including landmark joint venture deals such as the Sino-Aramco Huajin project and Sinopec-INEOS series JV projects in China.

China’s commitment regarding transitioning towards cleaner energies and reducing dependence on fossil fuels has played an important role in attracting foreign investment in those sectors. Geopolitical factors including the Russia-Ukraine war have disrupted global energy supplies and prompted China to diversify its energy sources and establish more secure supply chains, attracting investments in energy sectors that provide alternative and sustainable energy solutions. China’s technological advantages in the areas including battery manufacturing, hydrogen production, and electric vehicle development have also positioned the country as a desirable destination for foreign investment.

The new Foreign Investment Law (FIL) took effect on 1 January 2020. Amongst other matters, the FIL repeals the old FDI law and regulations. The FIL provides for a five-year transition period whereby those legacy FDI structures (EJVs (sino-foreign equity joint ventures) and CJVs (co-operative joint ventures)) that were only available to (and legally permitted for) foreign investors under the old regime must now adapt to the Company Law regime and other suitable structures. As a result, foreign investors are now entitled to use the same corporate structures for their investments in China as Chinese (domestic) investors do.

Generally speaking, foreign investors and their Chinese partners have the following (limited) options for their joint ventures:

• the limited liability company (LLC);
• the unincorporated (or contractual) joint venture or strategic alliance; or
• the production sharing contract (only used in upstream oil and gas exploitation collaboration).

Partnerships and joint stock companies (JSCs) are rarely used, due to their more rigid and regulated governance structure, joint and several liability (in the case of partnerships) and higher scrutiny and compliance burdens (in the case of JSCs).

LLCs

Chinese LLC structures share many commonalities with the equivalent structures in offshore jurisdictions, including:

• clearly defined governance structure by law (Company Law);
• limited liability of shareholders and the rule of “piercing the corporate veil” rarely applied in practice;
• fewer disclosure and compliance requirements, making them private to shareholders and easier to establish and operate; and
• unless contracted out under the by-laws, statuary pre-emptive rights automatically apply to equity transfers by shareholders.

One difference to note is that shareholders of Chinese LLCs hold equity interests (instead of shares) in the company, and the Company Law currently does not offer different classes of equity (securities) making Chinese LLCs much less flexible and accommodating than their offshore equivalents.

Unincorporated JVs

Unincorporated joint venture structures, whilst popular in many offshore jurisdictions (in particular for resources projects) for their structural flexibility and tax efficiency, are rarely used for joint ventures in China. Chinese partners appear to be generally less comfortable with complicated joint venture documentation, and regulators generally prefer an incorporated structure thanks to their clearly defined legal features (as a matter of statuary law and courts’ interpretations).

Foreign investors should take note of the rigidness and certain grey areas of Chinese JV structures and how that may affect their business objectives.

Thanks to the previous legal restrictions, foreign investors were legally required to form JVs with their China partners if they were to invest into certain “restricted” sectors, and their equity interests were capped by law. This old regime is now largely (but not completely) replaced by the negative list regime introduced by the FIL (ie, no approvals required or restrictions imposed unless in those limited sectors as set out on the list; please refer to 3.1 Regulators for further detail of the Negative List).

Recent deal trends indicate that foreign investors prefer to set up JVs in China, driven primarily by commercial considerations such as fast access to well-established brands and distribution channels, supply or value chain integration, joint R&D, and quick expansion of production capacity.

National and Provincial Regulators

The primary regulators (including their competent provincial and local counterparts) for the establishment and operations of the JV include the following:

• The State Administration for Market Regulation (SAMR), responsible for supervision of market activities, including company incorporation and registration; the SAMR is also the authority responsible for competition (antitrust) filings.
• The Ministry of Commerce (MOFCOM), regulating domestic and cross-border economic co-operation, including monitoring foreign investment through the information reporting system established under the FIL; it was the key regulator approving any form of FDI under the old regime.
• The National Development and Reform Commission (NDRC), responsible for formulating and implementing long-term strategies, plans, and policies for economic and social development, including approving major projects by reviewing economic and feasibility studies and development plans and monitoring the performance of the investment activities; both domestic investment and FDI projects are subject to the NDRC’s approval or verification if they are categorised as manufacturing/production or infrastructure investment (refer to the Negative List comments below).
• The State Administration of Foreign Exchange (SAFE), the agency responsible for supervising all foreign exchange-related activities, and monitoring inbound and outbound capital flows, implementing regulations for foreign exchange administrations and managing China’s foreign exchange reserves.
• The Ministry of Ecology and Environment (MEE), responsible for ecological environmental protection administration and supervision.

JV entities must obtain special licences or permits from relevant regulators for carrying out business operations in certain industries. For instance, food production licences issued by the General Administration of Quality Supervision, Inspection and Quarantine (AQSIQ) are required for carrying out business in the food production industry.

Key Legalisation

Primary statutory provisions which may become relevant for JVs in China include:

• the Foreign Investment Law (FIL) and its implementation rules, establishing the fundamental framework regulating foreign investment;
• the Special Administrative Measures (Negative List) for Foreign Investment Access (2021 edition, the Negative List for Foreign Investment); on sectors not on this list, the Negative List for Market Access (2022 revision) will apply to both domestic and foreign investors (together with the Negative List for Foreign Investment, collectively known as the “Negative List”);
• the Company Law (2018 revision);
• the Partnership Enterprise Law (2006 revision), which governs unincorporated JVs with partnership structures;
• the Anti-Monopoly Law (2022 AML), establishing the Chinese antitrust/competition regime;
• the Foreign Exchange Administration Regulations (2008 revision) issued by SAFE, regulating foreign exchange transactions in China; and
• other industry-specific licensing and permitting laws and regulations as they may apply, such as the Environment Protection Law (2014 revision), the Law on Environmental Impact Assessment (2018 revision) and its implementation rules and the Consumer’s Rights and Interests Protection Law (2013 revision).

The primary laws and regulations regulating anti-money laundering (AML) activities include:

• the Anti-Money Laundering Law;
• the Counter-Terrorism Law;
• the Criminal Law (Article 191, money laundering as a criminal offence); and
• the Anti-Telecom and Online Fraud Law.

The primary regulators include:

• the People’s Bank of China (PBOC), the primary regulator that promulgates regulations for all financial institutions and certain non-financial institutions (AML reporting entities);
• the Chinese Banking and Insurance Regulatory Commission (CBIRC); and
• the Chinese Securities Regulatory Commission (CSRC).

The primary obligations of AML reporting entities include:

• carrying out regular and on-going due diligence (KYC process) on their customers, including re-identifying their customers upon changes or in the event of suspicions being raised;
• assessing and classifying AML risks according to business and customer characteristics (eg, customer characteristics, geographical risks, products and services risks, and industrial/occupational risks) and monitoring AML risk classifications regularly including reassessment upon changes or in the event of suspicions being raised;
• retaining and maintaining records of their customers’ identity information and transactions; and
• reporting in a timely manner to the PBOC office and AML Data Centre any refusal to provide valid identity certificates by any customer, any suspicious transactions or transactions exceeding prescribed thresholds.

The Negative List for Foreign Investment specifies industrial sectors where foreign investment is prohibited or otherwise restricted, which is updated from time to time, with the latest version taking effect in January 2022 (with restrictions on 31 sectors, including sensitive sectors such as defence, telecommunications, and energy).

The Measures for the Security Review of Foreign Investments (NSR Measures) implemented in December 2020, empowers the regulators (eg, the NDRC, MOFCOM and the SAMR) to carry out reviews on foreign investments that may potentially impact national security. Under the NSR Measures, foreign investments in the following two categories must be cleared prior to closing or implementation:

• investment into military-related sectors (regardless of the percentage of foreign ownership); and
• investment into sectors which concern national security (such as important energy and resources, agricultural products, infrastructure and transportation, and key technologies) with actual or de facto control by foreign investors.

The Unreliable Entity List was introduced to restrict co-operation by Chinese entities with foreign entities perceived to be detrimental to Chinese national interests or in violation of normal market principles. Foreign entities on the list may face various restrictions and consequences, including restrictions on investing or doing business in China and legal penalties for breaches.

The following laws and regulations establish the Chinese antitrust regime:

• the Anti-Monopoly Law (AML, as amended in 2022);
• the Anti-Monopoly Review Guidance for Concentrations of Undertakings (as amended in 2018);
• the Rules of the State Council on the Threshold for Concentration of Undertakings Filings (as amended in 2018); and
• the Regulations the Review of Concentration of Undertakings.

An antitrust notification or filing must be made for transactions that constitute concentrations and exceeds the turnover thresholds.

The concentrations for AML purpose include:

• mergers between undertakings;
• acquiring control of other undertakings through the acquisition of equity interest or assets; and
• acquiring control of other undertakings, or the ability to exercise decisive influence over other undertakings, by contract or other means.

The turnover thresholds are met if in the last financial year either:

• the aggregate global turnover of all the undertakings to the concentration exceeds CNY10 billion and each of at least two of the undertakings to the concentration has a Chinese turnover of at least CNY400 million; or
• the aggregate Chinese turnover of all the undertakings to the concentration exceeds CNY2 billion and each of at least two of the undertakings to the concentration has a Chinese turnover of at least CNY400 million.

The regulators have step-in right and can demand the concerned undertakings to make a filing even if the thresholds are not met.

Listed companies generally use their subsidiaries (including newly established SPVs) as participants in JVs such that the JV governance structure and decision-making process will not be encumbered by the listing rules and JSC structure. Notwithstanding, transactions by their JVs may trigger disclosure by the listed parent under Chinese listing rules.

As a general principle, listed companies should make timely announcements if a material transaction having significant impact on their share price occurs, disclosing details on deal rationale, status, and potential impact and risk. Such material transactions include forming JVs by the listed companies and investment by the JV controlled by listed companies. If a material transaction exceeds certain monetary thresholds, it may require shareholders’ approvals, or even trigger the material asset restructuring (MAR) process, whereby prescribed documents must be submitted to the stock exchanges where the companies are listed for substantive review and approval.

Listed companies must also comply with continuous disclosure obligations regarding their material subsidiaries/JVs (in particular those with control). If listed companies do not have control over the subsidiaries/JVs, disclosure is only required for material events that may have a significant impact on the listed securities.

The FIL introduces the foreign investment information reporting system. The foreign investment information reporting system operates through the same enterprise registration system administered by the SAMR (including its provincial and local counterparts). In practice, foreign investors and foreign investment enterprises (FIEs) do not need to submit the same information to MOFCOM and the SAMR separately. Pursuant to the Measures on Reporting of Foreign Investment Information issued by MOFCOM, FIEs are required to submit information of their actual controllers through the enterprise registration system in the following reports:

• initial report at the time of establishment;
• change reports at the time of changing registration (as applicable); and
• annual reports for the preceding year through the National Enterprise Credit Information Publicity System between 1 January and 30 June of each year.

A few notable legal and regulatory developments in the past three years are set out below.

The Company Law is being amended, proposed new rules strengthen shareholder commitments, allowing equity transfer with more flexibility, and improving corporate governance.

The FIL came into force on 1 January 2020, overhauling the old FDI regulatory regime constituted primarily by the Wholly Foreign-Owned Enterprise Law, the Sino-Foreign Equity Joint Venture Enterprise Law and the Sino-Foreign Co-operative Joint Venture Enterprise Law. In addition to the changes on structures explained in 2.1 JV Vehicles, the Negative List for Foreign Investment is introduced such that only foreign investment in certain sensitive or critical sectors (31 in total) on the list are subject to substantive review.

The Anti-Monopoly Law was amended in 2022 introducing major changes, which include:

• establishment of the “safe harbour” regime;
• introduction of a discretionary “stop-the-clock” mechanism for merger reviews;
• enhanced penalties for violations, including raising the maximum fines for violations for both responsible companies and individuals and ensuring the violations will also be shown on a company’s credit record, which is publicly available;
• prohibiting monopolistic behaviour through new methods, including strengthening the oversight of M&A activities in the digital economy space (in line with the global trend);
• establishing a fair competition review mechanism.

In response to the geopolitical developments over the last few years, China has tightened scrutiny on issues of perceived national security:

• the NSR Measures were implemented in December 2020, authorising the regulatory authorities (eg, the NDRC, MOFCOM and the SAMR) to review and approve foreign investments that may potentially impact national security;
• the Measures for Cybersecurity Review and Measures for Security Assessment of Cross-Border Data Transfer were implemented to enhance the protection of critical information infrastructure and safeguard against cyber threats; and
• the Counter-Espionage Law came into effect on 1 July 2023, reinforcing the efforts of the Chinese government to safeguard data and information security in general and that relating to national security in particular.

The typical documentation used during the negotiation or preliminary stage of a JV is generally in line with the offshore practice:

• Confidentiality/non-Disclosure agreement (CA/NDA) – a mutual NDA is very standard at the start of the process to protect the confidentiality of confidential and sensitive information shared between the parties. This is particularly important if listed companies are involved.
• Memorandum of understanding/heads of agreement (MoU/HoA – some form of preliminary agreement is generally preferred by the JV partners, and this tends to be less formal and not legally binding (on the commercial terms). It typically includes key commercial terms (at very high level), transaction process details and standard boilerplate clauses on confidentiality, exclusivity, governing law, dispute resolution and language. Chinese partners rarely involve lawyers on this document.
• Term sheet – this is a standard document, which can be structured either as a stand-alone document or as a schedule to the preliminary agreement. The latter is more common in the Chinese market.
• Joint venture agreement (JVA) – depending on the context and preference, the JVA may refer to a joint venture agreement (in the form of transaction document), or a shareholders’ agreement. The former is preferred for a greenfield joint venture (project), which sets out the rights and obligations between the parties in respect of setting up JVs. In practice, a JVA may also incorporate terms that would typically be included in the shareholders’ agreement (which is not recommended).

The following provisions are typically covered at the pre-JV agreement stage which are also legally binding:

• Confidentiality – it can be drafted as a comprehensive stand-alone clause in the preliminary agreement or a simple clause incorporating the confidentiality agreement signed between the parties (if there were one).
• Exclusivity – market standard term is somewhere between 3–12 months with an extension mechanism; in the authors’ experience, this is less a concern in the context of greenfield joint ventures.
• Governing law and dispute resolution – these may be among the most contentious points for negotiations during the preliminary stage. Chinese partners generally insist on Chinese law and CIETAC arbitration, whilst foreign partners would propose Hong Kong law or English law and HKIAC or SIAC arbitration. The final agreement reached is likely to further impact on the same provisions in the definitive JV agreements.

There are no mandatory disclosure requirements imposed by Chinese laws in the context of JV negotiation and formation, unless the Chinese participant is a listed company. Please refer to 3.5 Listed Party Participants on the general introduction on the disclosure regime for listed companies. It is important to highlight that entering into a non-binding preliminary agreement (irrespective its form and name) may trigger disclosure under Chinese listing rules if the commercial deal documented in the agreement qualifies as a material transaction that may have an impact on the price of the listed securities.

Whilst it is not a disclosure point, we note that certain filings (containing required information) must be made to the SAMR on registration of the JV company, and to the SAMR and MOFCOM for the purpose of the foreign investment information reporting system explained in 3.6 Control/Ownership Disclosure Requirements.

The process to set up a JV between Chinese partners, or between Chinese partners and foreign investors, now generally follows the same procedure as follows (unless the concerned sector is on the Negative List):

• verification of the investment by the competent local counterpart of the SAMR, MOFCOM and the NDRC (as applicable), if the sector to be invested in were on the Negative List);
• regulatory approvals/filing if triggered – antitrust clearance or national security review (only when foreign investors are involved);
• pre-checking and subsequent registration of the name proposed for JV company;
• apply for the business licence with the competent local counterpart of the SAMR (equivalent of incorporation certificate in other jurisdictions);
• company chops (seals) cutting and registration with local police;
• filing of the foreign investment information report to the SAMR and MOFCOM via the same system;
• tax registration, including basic registration with the national and local tax authorities, registration for general VAT, taxpayer status, VAT invoice (fapiao) registration;
• registration with the Social Security and Housing Fund;
• foreign exchange certificate registration in SAFE’s system via qualified banks;
• bank accounts set up (renminbi basic account and foreign exchange account); and
• applying for licences as applicable (import/export licence, environmental licences, food and beverage, etc).

The corporate governance structure of an incorporated JV generally takes the form of a Chinese LLC, which is regulated primarily by the Company Law. Such structure consists of shareholders’ meeting (as the highest authority), the board of directors (responsible for the company’s key decision-making) and the supervisor (small company) or supervisory board.

The unincorporated structure generally uses the joint working committee (JWC) as the key control and decision-making body. As a matter of contractual freedom, the partners have much more flexibility to structure the JWC to suit their participating interests allocation and control arrangements. The JWC consists of representatives nominated respectively by the participants in such numbers as agreed on the basis of their respective participating interest splits. Major decisions are generally approved through majority or unanimous approval in JMC meetings.

A typical corporate JV agreement (essentially a shareholders’ agreement plus the matching by-laws) shall cover:

• equity interests allocation and voting right;
• funding/capital contributions;
• meetings, quorum requirements and voting mechanics in respect of a shareholder meeting;
• composition of board, and meetings, quorum requirements and voting mechanics in respect of the board of directors;
• supervisor(s)/board of supervisors;
• annual programme and budget;
• financial affairs, accounting and dividend policies;
• transfer of equity interests and restrictions – eg, no encumbrance, pre-emptive rights and other exit mechanisms;
• non-compete clauses;
• deadlock resolution mechanisms;
• term and termination of the JV;
• dissolution and liquidation; and
• typical boilerplate clauses (confidentiality, governing law, dispute resolutions and notice, etc).

The decision-making in an unincorporated JV structure is dealt with through the JWC mechanism. An operator may be used to deal with daily operational matters, which can be appointed from among the participants or as an SPV set up jointly by the participants.

The decision-making in an incorporated JV structure shall be dealt with via appropriate demarcation of powers and authorities amongst the shareholders, directors, and supervisors:

• Shareholders’ control – the Company Law places greater weight on the shareholders than the board, and certain matters must be approved by an ordinary (more than half) or special (more than two thirds) resolutions by the shareholders.
• Legal representative – a legal representative is very important as a matter of Chinese law; they can bind the company even without the board’s prior approval. The controlling shareholder generally requests that one of its nominee directors be appointed both as the chairman of the board and the legal representative.
• Board of directors – it is important to carefully structure the board’s composition, quorum requirements, approval matters, and the voting requirements for different matters (ie, simple, majority or unanimous resolutions) so that the board can play an appropriate role, taking into account the equity holding allocation between the JV partners. It is also important to ensure that the legal representative’s role is reconciled with and subject to the board’s authority and direction.

Chinese JV entities are typically (and mostly) funded through equity contributions (cash and/or in kind) by participants, which can be made fully on incorporation, or in stages as per the participants’ agreement. In practice, in-kind contributions can bring complicated commercial (valuation) and legal compliance issues (if state-owned assets are involved).

Debt funding via offshore shareholder loans or corporate lending used to be restricted with strict debt to equity ratios (投注差). During the five-year transition period offered under the FIL, foreign-invested JVs are still entitled to opt between the “comprehensive macro-prudential quota” (宏观审慎额度) regime and the debt to equity ratio regime, in each case supervised by SAFE via qualified commercial banks.

It is advisable to avoid future equity funding uncertainty and potential JV equity structure change by (to the extent possible) carefully formulating the JV’s overall or mid to long-term business/capex budget and plan at the time of establishment; such budgeting to be reflected, as appropriate, in the registered capital amount (commitment) and the matters to be approved by the shareholders (majority or unanimous approval).

If the JV participants do commit for future funding beyond their equity contributions (registered capital) but are in default, or fail to make equity contributions towards the committed percentage of the registered capital amount, in each case at the time of a capital call, such failure can lead to consequences including claim by other participants for specific performance and/or damages, freezing of voting rights, dilution of equity stake, buyout or termination right, or voluntary liquidation.

A deadlock event can occur either at the board level or the shareholders level, where one participant with veto right votes against the resolution, or the matter requiring majority or unanimous approval cannot achieve such voting result. Typical mechanisms to resolve such deadlock may include the following:

• No actions (plus escalation) – on occurrence of any deadlock event, the matter put for voting should not be pursued. This is the recommended approach, particularly for a relatively balanced equity holding structure (ie, 51:49 or 50:50). JV partners can also include an escalation mechanism, whereby any deadlock at the board level shall be first elevated to the shareholders for approval. Should a deadlock occur again, or the deadlock first occurs on a shareholder approval matter, shareholders shall appoint their respective senior executives to discuss in good faith with a view to reaching an agreement. If no agreement can be reached within specified days, the deadlock matter shall not be pursued.
• Option to buy out – on occurrence of any deadlock, one participant is entitled to acquire (at the price of fair market value or such other price/valuation methodology as pre-agreed) the equity interest of the JV partner who voted against the matter. This approach may be changed with a number of more complicated offshore variations, such as “Russian Roulette” and “Texas shootout”.
• External resolution – mandatory referral of the dispute to an independent mediator or arbitrator to resolve the deadlock matter, which is rarely adopted in practice.
• Dissolution – liquidating or winding up the JV entity (this is dramatic and usually a last resort mechanism).

Foreign partners should be aware that, in practice, the buyout option can be difficult to execute for legal compliance reasons. If the equity stake to be sold is held by an SOE, certain approval process shall be followed through with the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC) (including their competent local counterparts), the equity stake must be valued by a qualified appraisal institution based on audited financial statements and the sale price should generally follow such valuation, and the sale process must be carried out through a property right exchange.

Other documents arrangements may be required depending on the commercial arrangements proposed between the participants and between them with the JV:

• Transaction agreements: whether certain transaction agreements are necessary or preferable depends on the nature of the investment (greenfield, acquisition or subscription). A JVA setting out the terms and conditions how a JV is established and the obligations of each participant is preferable if the JV were to set up as a greenfield JV and the participants do not have some form of preliminary agreement in place. In practice, some JVAs may also incorporate terms that are typically set out in the shareholders’ agreement, although it may be advisable to separate them into different agreements. A share purchase/subscription agreement (SPA/SSA) is required if the JV were formed via equity transfer or subscription.
• IP licence agreements: a stand-alone IP licensing/transfer agreement may be required if any participant proposes to license or transfer (as the case may be) their intellectual property rights (IP rights) to the JV entity. Please refer to 8.1 Key IP Issues on the main terms and considerations of such an agreement.
• Other commercial agreements: commercial agreements such as distribution/supply agreements (for manufacturing business), off-take agreements (particularly for mining/resources projects) may be required if any participant proposes to have such commercial arrangements with the JV entity. Non-compete agreements or special voting/joint action agreements are also common on the market. Employment agreements with senior executives may also be required.

Under the Company Law, the board of an LLC shall comprise of three to 13 board members. Pursuant to Article 42, the voting right of shareholders at a shareholders’ meeting shall be exercised in proportion to their respective equity contributions, unless the shareholders have agreed on a different method for exercising their voting rights.

Subject to negotiation dynamics, participants generally ask for the number of board seats that fairly reflect their equity holding proportions. It is uncommon to give a participant more voting power than is proportionate to their relative equity holding.

Articles 147 and 148 of the Company Law set out the following general duties that directors owe to the company:

• abide by laws, administrative regulations and the company constitutional documents, be loyal to the company, and perform their duties with diligence
• not accept bribes or other illegal gains or encroach on company property
• duties of loyalty and diligence, including not misappropriating company funds, depositing company funds in accounts under the name of the director or other persons, doing certain acts without consent of shareholders or the resolution of the board, etc.

The Company Law is silent on how directors should weigh their duties to the JV against their duties to the JV participants as shareholders. Pursuant to Articles 149, 151 and 152 of the Company Law, the company and shareholders can sue for damages for a director’s violation of any laws and regulations and/or breach of duties. It is therefore advisable to include provisions permitting the directors to act in the best interest of their nominating participants.

While the Company Law sets forth the basic authority and powers of the board of shareholders, directors, and supervisors, the JV board is not restricted from delegating authority to subcommittees.

Article 21 of the Company Law provides that the controlling shareholders, actual controlling party, directors, supervisors and senior management personnel of a company must not use their influence to cause damage to the company, and they must compensate for losses to the company if the event of a breach of this duty. The Company Law also prohibits a number of actions by supervisors, directors and senior management personnel breaching their duties and abusing their powers for their own or others’ interests.

The Company Law remains silent on conflict of interests between the duties directors may have towards the company and their nominating JV participants, without explicitly defining the duties of loyalty of directors, supervisors, and senior management personnel. Article 180 of the second revision draft of the Company Law (the “Draft CL”) (published on 30 December 2022 for public consultation) requires that supervisors, directors, and senior management personnel take measures to avoid conflicts of interest and not to abuse their positions for improper interests. It is unclear how this restriction will be interpreted in practice. Nevertheless, neither the Company Law nor the Draft CL prohibits a person from taking a seat on the JV company board as a consequence of their position in the JV participant. Indeed, this is very common in practice.

When setting up a JV entity in China, the participants should consider, as a threshold consideration, whether the IP rights should be contributed to the JV entity as participants’ (in kind) equity contributions, or assigned or transferred to the JV entity after its incorporation (using the capital contribution by participants to purchase), or licensed (with or without consideration) to the JV entity.

If any IP right is to be contributed as in kind equity contribution, the participants need to work out the valuation issue, due diligence logistics, transfer arrangements, and state-owned assets related compliance issues (for state-owned participants). The participants should enter into appropriate transaction agreements to effect such transfer, including the relevant terms and conditions. Such approach may not be a preferred option if confidentiality of the IP right is a concern, or if the IP right involves mostly trade secret/know-how.

In any event, JV participants will need to consider in their agreement how future developments arising from the use of the IP rights by the JV entity should be funded, owned, transferred or licensed.

If certain IP rights are to be acquired by, or licensed to, the JV entity post incorporation, a separate assets acquisition agreement or a licensing agreement (instead of a JVA/shareholders’ agreement) is required between the participant owning the IP rights (including their affiliates) and the JV entity. Such agreement will normally be signed and takes effect upon the incorporation of the JV entity, which can also include appropriate conditions precedent before the transaction is consummated.

Typical IP licensing agreement generally include the following key commercial terms:

• type of IP rights being licensed (ie, patent, trade mark, copyright, trade secret/know-how);
• scope of licence (territorial scope, exclusivity or non-exclusivity);
• entitlement to modifications, improvements, and granting back;
• restrictions (including if there are sub-licensing rights);
• royalty-free licence, or royalty fees and tax liability; and
• term and termination.

As a matter of Chinese law, technologies can be imported or exported freely, provided that the related contracts should undergo registration (which does not affect the validity of the technology import/export), except for certain categories of restricted or prohibited technologies.

Compared to using IP rights as an (in kind) equity contribution or assigning IP rights to the JV entity after its incorporation, licensing is a preferred option for the following reasons:

• valuation of IP rights is always challenging;
• additional due diligence may be required if IP rights are to be transferred;
• the SAMR may not accept certain IP rights as an equity contribution;
• if the IP rights are owned by SOEs, complicated and time consuming compliance process must be carried out (auditing, statuary appraisal and public auction through property right exchange);
• potential loss of secrecy protection for know-how;
• potential requirement for additional capital spending by the JV on IP rights;
• less tax efficient (compared to royalty payment under licence); and
• more complicated documentation and deal process.

The global trends on ESG developments have substantially increased the awareness of stakeholders in China. Listed companies and companies with global presence are under increased pressure to take actions implementing ESG commitments. Indeed, listing rules of Chinese stock exchanges and SASAC’s regulations now ask listed companies and SOEs to disclose their ESG compliance actions.

There have not been any court decisions on this yet, and there are not yet any material regulatory consequence for not taking ESG compliance actions in China.

At this stage, there is no need for JV participants to proactively take any actions or implement any measures on ESG. However, if participants involving Chinese listed companies as controlling shareholders, or foreign participants that are publicly listed, advice should be sought from legal counsel in the relevant jurisdictions on ESG-related compliance requirements (including disclosure obligations), and if applicable, appropriate commitments and arrangements must be included in the shareholders’ agreement.

As part of the policy shift to support the Chinese government’s official commitment to reach a carbon peak by 2030 and carbon neutrality by 2060, a series of ESG-related regulations and policies were promulgated in recent years, but systematic and uniform regulatory standards are yet to be adopted in China. Most regulations are on disclosure requirements of ESG information of listed companies or companies in specific industries. A non-exhaustive list includes the following:

• The Code of Corporate Governance for Listed Companies (revised by the CSRC in 2018) provides a chapter named “stakeholders, environmental protection and social responsibility”.
• The Standards for the Contents and Formats of Information Disclosure by Companies Making Public Offering of Securities No 2 - Contents and Formats of Annual Reports (effective on 28 June 2021), requires that all listed companies disclose information relating to “environmental and social responsibility” in their annual reports and information on administrative penalties imposed due to the environmental issues during the reporting period in their annual and half-year reports. It also encourages listed companies to voluntarily disclose measures adopted to reduce their carbon emission during the reporting period.
• Both the Shanghai Stock Exchange and Shenzhen Stock Exchange listing rules require all listed companies to publish Corporate Social Responsibility (CSR) or ESG reports since January 2022, which shall include information regarding protection of staff, environmental pollution, quality of commodities and community relations, problems and inadequacies in the performance of social responsibilities, measures for improvement, etc. The Shanghai Stock Exchange’s guidelines also delineate further requirements for companies in certain industries or that have been involved in significant incidents.
• The Administrative Measures for the Mandatory Disclosure of Environmental Information by Enterprises (effective on 8 February 2022) issued by the MEE requires companies that have committed environmental violations (such as listed companies, bond issuers and pollutant dischargers) to disclose environmental information on a mandatory basis through a yearly environmental report.
• The Opinions on Further Improving the Policy Environment to Strengthen the Support of the Development of Private Investment issued by the National Development and Reform Commission (NDRC) in November 2022, which expressly states the necessity to improve the investment system in support of green development, to evaluate investment projects in terms of ESG, and to guide private investors to pay more attention to the environmental impacts and social responsibilities.
• Other policy documents targeted at specific industries, such as the Insurance Asset Management Association ESG Due Diligence Management Proposal which encourages institutions related to insurance asset management to incorporate ESG factors into their investment decision-making system, to actively engage in supervising ESG management in the invested companies, and to disclose ESG information.

For an unincorporated JV structure, participants set out the termination events in the JVA, including the liquidation procedure as they commercially agreed. The participants shall follow their contractual terms to bring the JV to an end, and distribute assets after paying off the creditors.

For a corporate JV structure (eg, an LLC or JSC), a company can be dissolved voluntarily, or as requested by shareholders on occurrence of certain events.

Typical voluntary dissolution events under the Company Law include:

• shareholders decides to dissolve the company via a special resolution passed by shareholders with more than two thirds of voting rights;
• expiry of the JV term, or occurrence of any dissolution event, as set out in the articles of association (AoA); and
• it becoming necessary to dissolve the company to accommodate the merger or split of the company.

A JV company may be forced to be dissolved, if certain events occur and any shareholder (or shareholders in aggregate) holding more than 10% of voting right applies to dissolve the company through the courts. Under the Company Law (including the relevant judicial interpretations), such events may include the company (i) being in financial distress and unable to sustain its operations; or (ii) failing to call general meetings over two years or failing to pass resolutions on general meetings due to inadequate votes, which failures have rendered the company inoperable.

On occurrence of any dissolution event, the company shall be liquidated taking the following steps:

• establishment of a liquidation committee – within 15 days from the occurrence of any dissolution event, the company should establish a liquidation committee;
• announcement and notification of creditors – the liquidation committee is required to publish information about the proposed dissolution and notify creditors of the company;
• carry-out liquidation activities – the liquidation committee is responsible for accounting for the company’s assets, preparing a balance sheet and a list of assets and liabilities, handling any outstanding business related to the liquidation, and paying taxes and fines (if any);
• distribution of company assets – the liquidation committee should then prepare a liquidation plan to be approved by the general meeting of shareholders, shareholders’ assembly, or the court; and
• preparation of liquidation report – once the liquidation is completed, the liquidation committee should prepare a liquidation report, which is then submitted to the general meeting of shareholders, shareholders’ assembly, or the court for confirmation (the report is also submitted to the company registration authority to apply for deregistration of the company and publicly announce its termination).

After completing the foregoing process, the company needs to cancel its tax registration, enterprise registration, social insurance registration, and other relevant registrations.

For an unincorporated JV structure, participants can freely transfer assets between them as per their agreement as set out in the JVA, unless the assets are encumbered for the benefit of a third party or the other participant(s). Creditors to the JV do not (necessarily) have priority to be paid unless security interests or encumbrances were granted over the assets. There would be no differences between the assets contributed to the JV and the assets originated from the JV, unless the participants have different arrangements agreed in the JVA.

For an LLC (JV) structure, a company in liquidation continues to exist but cannot carry out any business operation unless the activity is necessary for the sole purpose of liquidation. The company’s assets cannot be distributed to its shareholders before the creditors’ outstanding debt are fully paid off. Any assets contributed or transferred to the company become the company’s assets. The shareholders do not have any direct right or claim to such assets unless the company is dissolved, and subject to the distribution priority as prescribed by the Company Law: liquidation expenses, employees wage, social insurance premium, legal indemnity, outstanding tax and debt.