A JV can be thought of as having both a heart and a mind. Its heart lies in the contract, which specifies the agreement between, and duties of, each party, while the mind lies in the Articles of Association, which determines how this is to be accomplished. They are equally vital and attention to detail is essential.
Both the JV Contract and Articles of Association are legally binding documents, meaning you may resort to the Contract to assert a right or claim damages against your partner, or your partner may make a claim against you. However, the legal binding effect of the JV Contract and Articles of Association is only between the partners who enter into this agreement, and the documents cannot serve as a defence against any third party or government authority. That is to say, if the agreement vested the compliance issue to one party in the JV, and non-compliance is detected later, both parties shall be jointly held legally liable. Nevertheless, it is arguable that the party who is specifically vested with the responsible for compliance issue should be liable for the whole responsibility.
Contractual JVs vs Equity JVs
There are two types of JVs in China, the Equity JV (EJV) and the Co-operative JV (CJV) (sometimes known as the Contractual JV). They may appear similar on the surface but have different implications for the structuring of your entity in China. Here we explore the differences, provide practical advice on structuring, tips on investment drawbacks, land use rights and profit distribution.
An EJV is a joint venture between Chinese and foreign partners where the profits and losses are distributed between the parties in proportion to their respective equity interests in the EJV, but the foreign partner shall hold more than 25% of the equity interest in the registered capital of the EJV. The company enjoys limited liability is a “Chinese legal person”.
The CJV is a very flexible FIE where Chinese and foreign investors have more contractual freedom to structure cooperation. It is a joint venture between Chinese and foreign investors where the profits and losses are distributed between the parties in accordance with the specific provisions in the CJV contract, not necessarily in proportion to their respective equity interests in the CJV.
In the past, CJVs took one of two different forms - a true CJV which did not involve the creation of a legal person that was separate and distinct from the contracting parties; and a legal person CJV in which a separate business entity was established and the parties’ liability was generally limited to their capital contributions.
In the case of a true CJV, each party was responsible for making its own contributions to the venture, paying its own taxes on profit derived from the venture and bearing its own liability for risks and losses. In contrast, a legal person CJV, the more prevalent form today, shares more of the characteristics of an EJV. The true CJV is rare today as few investors are willing to entertain the prospect of unlimited liability and the rest of this discussion only refers to legal person CJVs.
