Despite a legal framework that has been in existence for more than twenty years, foreign investors still have some difficulty grasping the management control requirements of a sino-foreign joint venture in China.
The main misunderstanding is the assumption that holding the majority of the equity automatically grants control over the joint venture.
This is not the case. Such misunderstanding arises from both the regulatory framework applicable to the sino-foreign joint ventures and, more generally, to some peculiarities of corporate governance in China. The details are as follows:
- Sino-foreign joint ventures do not usually have a shareholders’ meeting. (A shareholders’ meeting traditionally allows the representation of the investors’ interests in proportion to their respective shares (or equity) in the company).
- The resolutions of the Board of Directors (whose composition indeed reflects the allocation of the company’s registered capital among the investors) on certain very important matters require that consent of all the directors (and, therefore, of all the investors). These are:
- changes to the articles of association;
- termination and liquidation;
- increase (decrease) of the registered capital; and
- merger or division.
- The resolutions of the Board of Directors are not directly enforceable. Their enforcement usually requires the intervention of the company’s legal representative or the general manager.
- Any limitation imposed by the Board of Directors on the powers of the legal representative, the general manager or of any other senior managers has an internal effect only and is not enforceable against third parties (including the administrative authorities).
- The legal representative of a sino-foreign joint venture (and note that this is applicable, more generally, to the legal representative of any Chinese company) may be appointed (directly or indirectly) by the minority shareholder. The legal representative has the authority to represent the joint venture and to undertake obligations on behalf of the joint venture, even if no express authorisation has been given to the legal representative by the shareholders’ meeting, the Board of Directors or the majority shareholder.
- The physical possession of the company’s chops, or official stamps (e.g. the company chop, contract chop, financial chop) gives control of the joint venture to the holder of the chops (or, more generally, to the company in question whether this is a joint venture or not). The stamp of the company chops on a contract or deed binds the company. Therefore, the legal representative, the general manager or the chief financial officer of the joint venture has controlling powers over the joint venture only as long as such person holds the company’s chops.
In sum, the mere holding of the majority (for instance 51%) of the registered capital does not guarantee the management control of a joint venture. In order to obtain such control, other factors are required. Firstly, the power to appoint and / or nominate the majority of the members of the board of directors, the chairman of the board of directors (or legal representative), the general manager and the chief financial officer is necessary. Secondly, the physical possession of the company’s chops is required.
It is also advisable that the joint venture contract and the articles of association cover all of these corporate governance matters and that the investors also adopt practical measures for their implementation.
It should be noted that having the majority of the equity, the legal representative and the company’s chops is still not enough to avoid the “deadlock” that can occur if another investor (or other investors) does not agree to any matter that must be decided by unanimous resolution of the Board of Directors. In terms of corporate governance, a lengthy situation of “deadlock” is one of the main risks of any sino-foreign joint venture.