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Exploring Mandatory Joint Venture System in China

By Gauri Gupta

Vivekanand Institute of Professional Studies, GGSIPU

A Joint Venture (JV) is a business arrangement in which the partners create a new business entity or official contractual relationship, and share the interest and operational costs, management responsibilities, profits and losses.

During to the roll out of China’s ‘Open Door’ policy over two decades ago, JVs were the initial investment vehicles used by the foreign investors, not by choice but by obligation.

China is involved in two kinds of JVs i.e. Equity JVs (EJV) and Contractual JVs (CJV).

Both the investment vehicles require the drafting and agreement of a contract between the foreign partner and the Chinese partner, specifying the responsibilities, rights and interests of each partner in detail. The EJV has the division in accordance with the ratio of equity interests, the division in a CJV is up to the partners to decide.

India has inherited the English Common Law System. Shareholder’s agreement and the articles of association (bylaws) of the JVs company form the basis of the JVs. In India, the JVs can exist in the form of companies, partnerships or joint working agreements.

Under the Indian law, it is possible to strike a perfect balance of power between the JVs partners. It depends on the control which is exercised by the partners and the capital being infused in the JVs. The control is exercised at two levels – Board of Directors & Shareholders. All the JVs not falling with in the Reserve Bank of India’s automatic route requires approval of the RBI, the Foreign Investment Promotion Board (FIPB) or any other concerned industry ministry, depending upon the quantum and the nature of foreign investment, regulatory restrictions cannot be avoided. Partnering with an individual and organisation is a strategic partnership which involves the sharing of various resources between the parties and will hopefully result in the sharing of greater partner

The major disadvantage with respect to the JVs in China are as follows:

  1. Lack of knowledge among the foreign investors in regards to the Chinese business – on the regulatory, legal, economic and social fronts.

  2. The cost and complexity of the documents required for the establishment of a JVs.

  3. The conflict of interests between the parties and the divergent management styles between the partners along with the technological and intellectual property vulnerability is also a major setback.

  4. Potential of dispute over division of profits of the JV.

Benefits of entering in a JV with a Chinese Company:

A JVs involves a give and take from both the parties. Finding the right local partner with the right amount of resources and expertise is the major factor that is to be considered when partnering up. If done successfully, it presents the following advantages:

  1. Gain more insider knowledge and expertise in the region.

  2. Simpler handling of the complicated bureaucratic procedures.

  3. Greater access to a massive market and any existing distribution network.

  4. Sharing of all the risks and expenses with the partner,

  5. Greater access to local resources and cheaper labour.

  6. Strengthen a company’s position and win even more market share.

  7. Open up new business opportunities outside the company’s core business.

China’s strict commercial laws dictate that western corporations wishing to do business in China may have to partner with a Chinese entity upon arrival.

Foreign investors often seek 51% ownership of the JVs, assuming that this will give them the right to elect the board and thus, control the company. However, the actual control is based on – firstly, power to appoint and remove the JV’s two key managers: General Manager and Legal Representative and secondly, control over the Company’s seal or conveyance of power to enter into binding contracts.

Comparing JVs in India & China

Foreign investors increasingly believe that China’s economic and legal development makes it difficult to rely on the guidance from the local partner. The factors that make the establishment of WFOEs attractive in China include the security guaranteed to the Intellectual Property Rights along with the ability to develop own internal structure and the access to China’s largest market. Foreign companies establishing a whole owned subsidiary in India can do so by establishing a wholly owned subsidiary in India do so by setting up a private limited company. Regulations governing the private companies in India are stipulated in the Companies Act. A minimum of two shareholders are required to form a private limited company.

China’s Policies and Regulations

China’s entry to the WTO in 2001 helped liberalize China’s trade environment to some extent although many entries are still heavily regulated. China severely restricts the involvement of foreign companies in certain sectors. Any foreign company looking to set up local production in China should first consult the China’s foreign investment catalogue. Regulation is becoming more stringent. Environmental problems caused by poor environmental regulatory enforcement and widespread pollution in years gone by have led to the introduction of much tighter environmental legislation. Foreign companies are now required to go through lengthy environmental assessments before gaining permission to produce locally.

Government regulations have a significant impact on the timeline and costs of market entry, and companies are advised to examine the implications of such regulations prior to committing to the market. For example, in the medical and pharmaceutical sectors, long product or clinical trials may be required, which result in a longer sales cycle than may be the case in other countries. It is also worthwhile noting that just because a product has previously been approved by regulatory authorities in Europe or the US does not automatically guarantee that the same product will receive approval in China.

Many experts claim that the Communist Party of China follows a framework of “state capitalism.” China has come a long way to develop its market – capitalist – economy. It did open up for foreign investment and did allow the firms to complete internationally and overseas. The Chinese Government still owns a major part of the various companies and ventures in the state.

Indian economy is based both on the ideologies of capitalism and socialism. Being a developing nation, it is important that the government takes into consideration the demands and desires of all sectors of the economy. Although there has been a shift towards capitalism, government ownership is still prominent in many sectors of the Indian economy.

India being a democratic nation has to take into consideration the needs and aspirations of all sections of the society. It cannot favour a particular set of people, and deny the necessities to others. One of the most prominent way to put forth this is that India, has various political parties each representing the interests of different sections, as a result of which the demands of people are not suppressed.

China, on the other hand, has a particular party that comes to power every year. This leads to the concentration of power in the hand of a single party and thus, it acts according to its own whims and fancies. The government in such cases becomes tyrannical and tends to focus more on its growth and development rather than of the nation and its citizens.

The strategies of India and China in relation to the JVs System is similar. However, in case India adopts strategies which are exactly the same as that of China, the nation would not be able to grow. India has been focusing both on its development along with fulfilling the demands of its citizens.

Therefore, it is critical to spend time researching and understanding the regulatory environment prior to making any decision to enter the market. Besides this, it is also essential to understand how the economy and the government of a particular nation works. Having entered the market, it is important to constantly monitor for any changes to legislation or regulations and how these could affect your business.

China appears to offer business actors sufficiently satisfactorily tools to enable them to successfully carry out their economic activity through the establishment of JVs. Certainly, such tools would need to be carefully used in the light of the specific needs of the concerned businesses and in the understanding that the surrounding economic environment and jurisdiction present some distinctive features. The above article has tried to showcase the main characteristics and peculiarities distinguishing the JVs system in China along with the issues foreign investors encounter while entering the Chinese market. It also focuses on how the different ideologies lead to the different ways in which the economy of a nation is developed.

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