Board of Directors in Chinese Joint Ventures: Role and Requirements

Joint ventures in China represent the country's strategic approach to global economic integration. These collaborations offer a unique platform for foreign investors to access the Chinese market, navigating its regulatory frameworks and cultural nuances more easily.

Contributing Advisor

Vivian Mao

Partner

In turn, Chinese firms gain invaluable insights into international business practices, technological advancements, and expanded market reach. This symbiotic relationship has contributed significantly to China's position as a global economic powerhouse, fostering innovation and driving competitive advantages in various sectors.

Increased importance of the Board of Directors' role

Traditionally viewed as a formal requirement, the Board of Directors' function has become more active and strategic. The Board's responsibilities now extend beyond mere oversight; they are actively involved in shaping the venture's strategic direction, ensuring compliance with both Chinese and international business standards, and mediating between the diverse interests of the joint venture partners.

This shift indicates a broader change in Chinese corporate governance, where Boards are increasingly seen as essential instruments in driving business success and sustainability. Their role in joint ventures highlights the need for a balanced approach that respects the partners' varied business cultures, legal systems, and market dynamics.

Introduction to joint ventures

Joint ventures, often referred to as Sino-foreign joint ventures, have been a cornerstone in China's economic strategy, particularly since its "Open Door" policy was introduced over two decades ago.

These ventures, partnerships between foreign investors and Chinese companies or individuals, stand as a testament to China's progressive integration into the global economy. Unlike Wholly Foreign-owned Entities (WFOEs), joint ventures necessitate a local partner, offering a unique blend of international expertise and local insight.

Initially, joint ventures in China were predominantly categorized into Equity Joint Ventures (EJVs) and Cooperative Joint Ventures (CJVs). EJVs were defined by a proportional distribution of profits and losses based on each party's equity share. At the same time, CJVs offered more flexibility in terms of control, profit, and risk distribution, not strictly tied to equity shares. However, significant legislative shifts occurred on January 1, 2020, when the distinctions between EJVs and CJVs were abolished, aligning them under the broader scope of the Company Law.

Legal and regulatory framework

Key regulatory bodies include:

• The State Administration for Market Regulation (SAMR), oversees market activities and antitrust filings; 
• The Ministry of Commerce (MOFCOM), which monitors foreign investment; 
• The National Development and Reform Commission (NDRC), responsible for major project approvals; and,
• The State Administration of Foreign Exchange (SAFE), supervises foreign exchange activities. 

Additionally, industry-specific licenses and permits are often required, depending on the sector of operation.

Several critical statutes anchor the legislative landscape for joint ventures in China. The Foreign Investment Law (FIL), effective from January 1, 2020, established a new framework for foreign investment, significantly overhauling the previous regulatory regime. This law, alongside the 2018 revision of the Company Law and the 2006 revision of the Partnership Enterprise Law, forms the backbone of the current legal environment for joint ventures.

Impact of regulations on the Board's function and effectiveness

These regulations significantly influence the function and effectiveness of Supervisory Boards in joint ventures:

• The introduction of the FIL, in particular, has created a more streamlined and transparent environment for foreign investors, impacting how joint ventures are structured and governed. The law emphasizes the Board's role in ensuring compliance with both Chinese and international standards and navigating the complexities of the Chinese market.
• Furthermore, the Anti-Money Laundering Law and associated regulations impose rigorous due diligence and reporting obligations on companies, directly affecting the Board's oversight responsibilities. The Board must ensure adherence to these regulations to mitigate risks and maintain the integrity of the joint venture.
• The Negative List for Foreign Investment, which specifies restricted sectors for foreign investment, also plays a crucial role. Boards must stay abreast of changes to remain compliant and adapt strategies accordingly.
• The Anti-Monopoly Law, especially its 2022 amendment, underscores the Board's role in ensuring competitive practices and navigating the intricacies of merger and acquisition activities.
• The Measures for the Security Review of Foreign Investments, implemented in December 2020, introduce additional layers of scrutiny. Investments in sensitive sectors like defense, telecommunications, and energy require thorough review and clearance, placing additional strategic and compliance burdens on the Board.

Detailed analysis of Chinese joint ventures

Types of joint ventures

Joint ventures (JVs) have undergone a significant transformation, especially following the implementation of the new Foreign Investment Law (FIL). This law has consolidated the previously distinct Equity Joint Ventures (EJVs) and Cooperative Joint Ventures (CJVs) into a more unified legal framework. The differences between the two vehicles are stated in the table below:

Comparative analysis of Chinese and international joint venture structures

Comparing Chinese joint ventures with their international counterparts reveals several distinctive features. Internationally, joint ventures often take various forms, including limited liability companies, strategic alliances, or partnerships, each with its own governance and liability frameworks.

This comparison table outlines the key differences :

Role and composition of the Board of Directors

In Chinese joint ventures, the board structure typically comprises 3 to 13 members, reflecting the equity contributions of the shareholders. This means the voting rights at shareholders’ meetings are often exercised in proportion to these contributions unless an alternative agreement exists among the shareholders.

The directors' duties, as outlined in Articles 147 and 148 of the Company Law, include:

• Adherence to laws, administrative regulations, and Company constitution; 
• Loyalty to the company; and, 
• Diligence in their responsibilities. 

The board of directors must also avoid illegal gains and protect company property. However, the law doesn't explicitly address how directors should balance their duties to the joint venture against their obligations to the shareholders who appointed them. Joint ventures should include bylaws provisions allowing directors to act in the best interests of their nominating shareholders.

The Company Law also empowers the JV board to delegate authority to subcommittees, thereby allowing specialized focus on various aspects of the venture's operation.

Conflict of interest considerations

The Company Law addresses conflicts of interest among the controlling shareholders, actual controlling party, directors, supervisors, and senior management. It mandates compensation for any company losses resulting from breaches of duty. The law, however, remains ambiguous on the specific duties of loyalty required of directors, supervisors, and senior management, especially in balancing interests between the company and the JV participants.

Registered personnel and governance structure

Joint ventures in China must adhere to a three-tier governance structure, as mandated by the Company Law. This structure encompasses the Board of Shareholders, the Board of Directors, and Supervisors. The Board of Shareholders, representing the highest authority in a JV, is composed of shareholder representatives and is empowered to appoint the Board of Directors. The Board of Directors, responsible for direct management, is typically composed of a mix of members, reflecting the diverse interests of the shareholders.

Under the new Foreign Investment Law (FIL), this structure has become more streamlined, bringing the governance of EJVs closer to global practices. The FIL necessitates that existing joint ventures, both EJVs, and CJVs, amend their structures and operating rules to align with these new requirements, promoting clearer and more balanced governance.

Comparison with global standards and practices

The following table explains the comparison of some key aspects between Join Ventures in China and their international counterparts:

Control dynamics and governance challenges

Control mechanisms

The landscape of control dynamics within Chinese joint ventures (JVs) is intricate, shaped largely by the Foreign Investment Law (FIL) and Chinese business practices. The FIL has introduced a foreign investment information reporting system, simplifying the process through the enterprise registration system administered by the State Administration for Market Regulation (SAMR).

Foreign investment enterprises (FIEs) need to submit the following documents:

• Initial reports at the establishment;
• Change reports when alterations are made; and,
• Annual reports through the national enterprise credit information publicity system.

Understanding and navigating these regulatory requirements are crucial for maintaining clear ownership and control structures in Chinese JVs. Foreign investors need to establish explicit control mechanisms from the beginning, as Chinese managers often perceive JVs as their domain, occasionally overlooking control issues related to ownership percentages. Therefore, reaching a mutual understanding and agreement on control structures with Chinese counterparts is critical, especially concerning the day-to-day operations of the JV.

Challenges

• In Chinese joint ventures, real operational control often does not align with majority ownership or control of the board of directors. Instead, the managing director and the company's general manager wield significant influence over operations, frequently with minimal board oversight.
• To truly govern a joint venture, foreign investors must secure the authority to appoint and oversee both the managing director and the general manager. This direct control is crucial, as the board's authority can be significantly diminished without it.
• A 51/49 ownership split, commonly believed to provide effective control, may not be viewed as fair or sufficient in the Chinese context. For more definitive control, foreign investors often prefer a 60/40 or 70/30 ownership structure.
• Discrepancies between legal control mechanisms and the Chinese partners' perception of fairness can lead to disputes. If Chinese partners feel disadvantaged by legal technicalities, they may take corrective actions, potentially causing internal conflicts.
• Establishing and maintaining control in Chinese JVs demands a nuanced approach that combines legal knowledge, an appreciation of Chinese business culture, and adept negotiation skills. Foreign investors must navigate both the legal framework of JV structures and the operational dynamics influenced by cultural factors to ensure effective governance.

Legislative and economic changes influencing joint ventures

This evolution in the legal framework reflects China's broader economic ambitions. The Company Law now allows joint ventures to take the form of a limited liability company (LLC) or a joint stock company, with a mandatory shift to a three-tier organizational structure. This change presents complexities, especially for companies with limited experience in China's unique business environment, which includes cultural differences and managerial and operational challenges.

The creation of a joint venture in China is a strategic decision often influenced by various factors. These include accessing restricted industries as per the Negative List, which mandates joint ventures, and leveraging the Chinese partner's local market knowledge, sales channels, and networks. A foreign company must typically own at least 25 percent of the joint venture, while foreign individual participation is more restricted.

The benefits of such ventures are manifold. They provide access to the existing workforce and resources of the Chinese partner, entry into sectors closed to WFOEs, and utilize existing sales and distribution channels. Moreover, joint ventures often require lower upfront investments than WFOEs, as operational and funding responsibilities are shared.

However, venturing into such partnerships requires careful consideration due to the intricacies of Chinese law and potential biases in dispute resolutions. Understanding and navigating these legal and cultural nuances is crucial for foreign companies seeking to establish successful joint ventures in China.

The dynamics of the Board of Directors within Chinese Joint Ventures (JVs) illustrate the complex interaction between China's global economic aspirations and its distinctive cultural practices, presenting a crucial route for foreign investment and mutual development. The introduction of the Foreign Investment Law (FIL) has significantly streamlined the process for foreign entities, mandating comprehensive disclosure of control that highlights the need for transparent ownership and governance models.

However, the actual governance within these JVs often diverges from traditional expectations of control, with significant authority residing not within the board but with the managing director and the general manager. This reality requires foreign investors to firmly establish control mechanisms and strategically appoint key positions to navigate the governance complexities inherent in Chinese JVs effectively.

Moreover, addressing the challenges posed by the separation between legal frameworks and cultural perceptions of fairness is essential. Achieving this demands a nuanced approach that harmonizes legal strategies with cultural understanding and adept negotiation, ensuring the success and growth of foreign partnerships in the dynamic and evolving Chinese market landscape.