After a sharp decline in the first quarter of 2020 due to COVID-19 lockdowns, China’s economy bounced back to grow in the second quarter and keeps growing in the third quarter pursuant to the National Bureau of Statistics. China, with its epidemic-free economy environment, is again proving to be very attractive for foreign investors looking for growing markets.
Establishing joint ventures with local Chinese companies used to be a default route to market when Chinese law made this mandatory for many industry sectors. But even now when most businesses can legally be set up as wholly foreign-owned enterprises partnering with a local company may be the preferred way to expand into China especially for those investors who need land, factories, and in particular local connections or sales networks to succeed.
Finding the right structure for the partnership is therefore crucial to avoid the well-known traps Chinese joint ventures can turn into for foreign investors. Some thought must be spent on the resolution of potential disputes, usually dealt with in the dispute resolution clauses in the project agreements, such as joint venture contract, technology and trademark license agreements, supply and service agreements etc.
1. Governing Law
Investors who are not familiar with Chinese legislation prefer to adopt their home jurisdiction law as the governing law for the joint venture ("JV"). However, such practice is not in line with the provisions of the PRC Contract Law, as well as related provisions in the new PRC Civil Code to be effective from 1 January 2021: both laws require Sino-foreign joint venture contracts in China to be governed by Chinese law. In practice, this means Chinese courts can refuse to recognize any litigation or arbitration result adopting non-Chinese law as governing law, for instance in procedures for the enforcement of foreign judgements or arbitration awards in China.
If there are reasons to have foreign law governing the JV relationship or some of its parts the parties may agree to enter into an additional agreement in another jurisdiction (Hong Kong for example) to govern the overall relationship or just some parts of it. While such dual layer approach can raise difficult legal questions about the relationship of the two agreements it does give the parties the right to bring their dispute to resolution in that secondary jurisdiction under the respective local law.
According to the provisions of PRC Civil Procedure Law and Interpretation of the Supreme People's Court on the Application of the Civil Procedure Law, cases related to Sino-foreign joint venture contracts are under the exclusive jurisdiction of PRC courts, and the parties involved may not agree on the choice of jurisdiction of a foreign court, unless the parties agree on the choice of arbitration.
It is important that the above principle will also apply to license, service, lease or other agreements if they are regarded as integral parts of the joint venture contract. However, this does not mean that all these agreements shall adopt the same dispute resolution method. For example, the joint venture contract may use arbitration while an IP license agreement can adopt litigation in a PRC court as its dispute resolution method. Both choices are in line with the principle set forth above.
Compared with litigation in China, arbitration is more acceptable by foreign investors in regard to language, time, neutrality and confidentiality but it needs to be ensured that the arrangement chosen is valid and enforceable also in the context of a China joint venture.
o Validity of arbitration clause
A PRC court shall not accept an action initiated by one of the parties if the parties have concluded an arbitration agreement, unless the arbitration agreement is invalid. However, there is no compulsory legal proceeding in China to check the validity of an arbitration agreement before the first hearing of the arbitration tribunal or litigation. If the parties object to the validity of the arbitration agreement, they may apply to the arbitration commission for a decision or to a court for a ruling. If one of the parties requests for a decision from the arbitration commission, but the other party applies to a court for a ruling, the court shall give the ruling.
Additional attention shall be paid to the governing law used to solve the dispute, controversy or claim arising out of or in connection with a JV contract: that chosen law will not automatically become the applicable law for the court in China to decide the validity of arbitration clause. A separate principle is used for PRC local courts to decide the applicable law in relation to the validity of arbitration clauses pursuant to the “Circular of the Supreme People's Court on the Issuance of the Minutes of Second National Foreign-Related Commercial Maritime Trial Work Meeting”:
(1) Where the law governing the validity of the arbitration clause is explicitly stipulated in the contract, such law shall be applied;
(2) Where the place of arbitration is agreed in the contract in which no law governing arbitration validity of the arbitration clauses is provided, the law in the country or region of place of arbitration shall be applied;
(3) Only when no law governing the validity of the arbitration clauses or place of arbitration is agreed or when the agreement upon place of arbitration is ambiguous shall the law in the place of the court (i.e. the laws of PRC) be taken as the law governing the validity of the arbitration clauses.
o Enforcement of arbitration award
The Convention on the Recognition and Enforcement of Foreign Arbitral Awards as adopted in 1958 in New York (“New York Convention”) came into force in China on 22 April 1987 which makes it easier to enforce foreign arbitration awards in China.
In accordance with the reciprocity reservation declaration made by China upon its accession to the New York Convention, China will only apply the New York Convention to the recognition and enforcement of arbitral awards made in the territory of another contracting state, which include Denmark, France, America, Germany, UK, and others. It’s important to check whether the country selected by both parties for arbitration is included in the contracting country list of the New York Convention.
Although China has loosened its administrative management rules for foreign entities to invest in China, there are still some practical issues to be observed when cooperating with Chinese companies for the establishment of joint ventures, and careful consideration shall be made to possible scenarios of a breakdown of the relationship. Even if in the end formal dispute resolution proceedings are not employed the possibility of invoking these can create the crucial leverage for a foreign investor to succeed in negotiations.