The Danone – Wahaha brouhaha

June 13, 2007 Posted by China Briefing Reading Time: 4 minutes

What began, as all partnerships do, with good intentions and dreams of profits, has come to bitter accusations, angry lawsuits and the very real danger of failure. The dispute between Wahaha and Danone, which continues to grow hotter and more contentious everyday, is threatening to derail a huge investment into the Chinese market by the French beverage and yogurt giant

As the International Herald Tribune reported, the Danone and Wahaha feud which, has exploded in recent weeks, began over two years when executives at Groupe Danone say they noticed something peculiar in the financial figures coming from their joint venture in China with the Wahaha Group.

After a lengthy investigation, Danone officials concluded that their closest partner in China, Wahaha’s longtime chairman, Zong Qinghou, was operating secret companies outside the joint venture – companies that were mimicking the joint venture and siphoning off millions of dollars.

Last week, after months of negotiation between Danone and Zong failed to resolve the dispute over those companies and who has the rights to the Wahaha brand, Danone filed a lawsuit in California against a company controlled by Zong’s relatives.

China Law Blog’s Dan Harris believes that this dispute is set to become a watershed moment in Chinese law and business (though he has no evidence to back this up). Indeed, many JV partnerships are watching this with more than a passing interest while frantically searching through their archives to find that original Articles of Association document.

More from IHT:

“This is a cautionary tale,” said Steve Dickinson, a lawyer based in Shanghai at Harris & Moure. “This is not a message that you can’t do business in China. But if you come to China and let the Chinese run the business without supervision, they can do this kind of thing.”

China’s business history is littered with thousands of cases of unhappy partnerships and broken dreams. One major Western oil company once told us, only partly in jest, that their JV was a win-win situation, meaning the Chinese won twice.

Joint ventures were the first business entity opened to foreigners and for a long time have been an unpopular vehicle for international investors looking to China for lower production costs or for market access. As Jeremy Gordon of China Business Services pointed out in a “rather minimalist” July 25 post:

Unilever China boss, Alan Brown, on the question of whether to have a joint venture (JV) or not:

“If you are working in a highly regulated industry, then JV partners are almost essential…If you are working in a highly deregulated industry, they can be a damn nuisance”.

As seen in “China CEO”.

In our April issue of China Briefing we wrote that when you invest in China, regardless of the type of entity you choose to establish, you have to pay a great deal of attention to the details. JVs require some fairly complicated documentation: various documents from the international business applying for the license, a feasibility report, articles of association to name a few. These are not merely administrative issues that need to be catered for, filled in as quickly as possible, translated and filed, but important decisions that could affect the long-term health of the partnership.

Jeremy Gordon:

It is no wonder that people try to avoid joint ventures these days! But for anyone that does, and who does not want their partner to have the last (wa) ha ha, this case is a reminder of the need for, amongst other things: engagement (at all levels, not just with the gatekeeper “big boss”); management oversight; crisis management; PR support; succession planning; and…a strong constitution.

Danone’s troubled Chinese venture is still expecting to resolve the dispute amicably with “government support and guidance” according to Emmanuel Faber, the man appointed to replace Zong after he angrily resigned as chairman last week. Faber is calling for a “channel of negotiation” to be opened between Zong and Danone.

From the Shanghai Daily:

“Before developing our business, it is about protecting the business. The business is under attack by unauthorized companies. Employees’ and distributors’ morals and unity are also undermined by Zong’s attempt to create emotional communication,’ Faber said

Zong posted a letter on the Internet last week stating that Danone officials had been made fully aware of the outside companies – partly funded by company employees he said – and that Danone wanted to acquire them cheaply.

From IHT:

“To put it seriously, they were trying to bribe me to infringe the interest of small shareholders to achieve the goal of a cheap acquisition,” Zong wrote. “When they failed the acquisition attempt, they used the media to spread rumors to attack me and my family, complained to the government and tried to ruin me.”

By filing in California, Danone is no doubt looking to move the jurisdiction of the case somewhere a little less biased than a Chinese court, and with good reason too as Zong has been stirring up nationalist sentiments in an effort to get the Chinese government to cancel all or parts if the contract.

Mei Xinyu, a senior researcher in the Ministry of Commerce, in an op/ed to the Shanghai Daily had this to say:

Two lessons are clear from this dispute. First, a Chinese company should learn to better protect its own stake. If it doesn’t want a foreign partner to take the controlling stake, it should never make a contract that unduly favors the foreign side. Second, while helping a domestic company better protect itself against possible (hostile) foreign takeover, Chinese regulators should pay more attention to the possible moral hazards on the Chinese side.

By moral hazards, Mei is referring to the instances of some Chinese managers eating into public assets to line their own pockets in the process of setting up a joint venture. As China Law Blog states, “Using a joint venture to enrich relatives is probably the oldest, the simplest, and the most common joint venture trick known to man.”

This is why you must conduct legal and financial due diligence on your potential JV partner. Some potential partners may interpret such enquiries as intrusive, or infer that you do not believe them. If they are keen to close a deal quickly, they may try to skirt round such issues. This part of the negotiation process therefore needs to be handled with patience and some sensitivity. However, reliable and serious partners will understand your need, and that of your foreign parent, for these issues to be confirmed. Indeed, if they are doing their job properly, they should also require similar disclosure and transparency from you.

As for Danone, they are hoping to find a win-win situation in which both sides benefit.

From IHT: