Resolving foreign shareholder withdrawal from Sino-foreign JVs

Sino-foreign joint ventures (JVs), including equity JVs and contractual JVs, form a business collaboration of Chinese and foreign investors in corporate management. But as new disputes have recently emerged, the issue of whether and how to withdraw from JVs has become a significant issue for foreign investors.

Owing to their large quantity, JVs often lack standardisation in their operations. Poor management and flawed regulations have led to institutional problems, resulting in substantial cases of judicial litigation and arbitration.

With implementation of the Foreign Investment Law, the organisational structure, setup and activity criteria of JVs are regulated by the Company Law.

The authors of this article analyse the prevention and resolution of disputes arising from foreign shareholder withdrawal, proposing a trinity practice model of prevention, control and remedy to effectively resolve disputes in accordance with the Company Law and other regulations.

Economic factors

In the post-pandemic era, the global economy endures increasing downward pressure. In tandem, due to poor management and ineffective investment, there is a growing trend of JV shareholders seeking to withdraw.

If parties to a JV agree to withdraw due to economic concerns, available dispute resolution includes external equity transfers, self-dissolution, compulsory liquidation and bankrupt liquidation, among other avenues.

JVs have a higher degree of personnel compatibility than China-funded enterprises under the Company Law. The board of directors has overall decision-making, executive and supervisory powers to discuss and decide on all major issues, while its members are appointed and removed through negotiations between the parties.

If there is a divergence in corporate governance philosophy or unequal distribution of interests, the absence of a shareholders’ meeting and deliberative mechanism that allows directors to directly represent the shareholder decisions can escalate a board deadlock straight into a corporate deadlock.

Therefore, operating JVs should promptly adjust their internal deliberation and voting procedures to prevent decision-making disputes when shareholders withdraw due to economic factors.

The methods are as follows: repositioning the board to clarify its independent executive role; forming a shareholders’ meeting under the Company Law and distributing voting rights, which protects shareholders’ interests while creating a buffer for normal corporate governance in case of a board deadlock; and establishing a supervisory board or supervisors to oversee business operations.

International trade frictions

In recent years, as trade tensions between China and the US intensified, an increasing number of foreign investors affected by shifting national or international policies have decided to unilaterally withdraw from JVs.

The enclosed nature of JVs adds complexity to this process, requiring shareholders to obtain the consent of all other shareholders to transfer equity internally or externally, making withdrawal a more intricate challenge.

Accordingly, existing JVs should actively leverage the flexible equity transfer provisions of the Company Law to establish well-defined conditions for equity acquisition and dissolution in their articles of association.

For example, in the event of a corporate deadlock, a shareholder is entitled to request that the other shareholders acquire its equity at a fixed or fair price. Meanwhile, shareholders should also avoid new disputes and risks that may arise from the lenient conditions for equity transfers provided by the Company Law, and add clauses to the JV contract to protect the rights and interests of minority shareholders, such as the tag-along right.

If a foreign shareholder is unable to withdraw through equity transfer, request for share repurchase or self-dissolution, it may seek to withdraw legally by filing a lawsuit to dissolve the company, or apply for compulsory liquidation directly, in accordance with the Company Law and relevant judicial interpretations.

It should be emphasised that, even if the parties to a JV agree to the unilateral withdrawal of a foreign shareholder through negotiation, meticulous attention should be paid to the statutory procedures for reducing the registered capital to avoid improper withdrawal due to unlawful procedures, which may lead to disputes.

In addition, in the absence of a valid shareholders’ meeting resolution, the matter of capital reduction is neither justiciable nor enforceable, and the convening of a shareholders’ meeting and capital reduction procedures, as a matter of corporate autonomy, still require internal consultation.

Shareholder disputes

Shareholder disputes in JVs can easily escalate into a corporate deadlock. In light of this, besides adjusting internal deliberations and voting procedures, and devising conditions for equity acquisition and dissolution in the articles of association, JVs should establish an effective system in their articles of association or JV contracts for appointing and replacing legal representatives, and also jointly manage the company’s certificates and seals to avoid shareholder disputes over corporate control.

Furthermore, parties to JVs should maintain balanced operational control by adjusting the equity structure and faithfully fulfilling obligations of loyalty and diligence, to fully utilise the positive effects of a high degree of personnel compatibility.

In the event of a withdrawal dispute arising from a shareholder dispute, apart from negotiation and judicial withdrawal, JVs and foreign shareholders may – under the Foreign Investment Law and its implementing regulations, as well as the Work Measures for Complaints of Foreign-Funded Enterprises, by the Ministry of Commerce – file complaints against the administrative authorities and their staff for their administrative behaviour, or report investment environment problems.

They may also report their problems to the government and relevant departments through other legal means.

Conclusion

Through the integrated legal regulation of domestic and foreign enterprises, the Foreign Investment Law has created a freer and more equal market environment for external capital, while making the legal environment for dispute resolution more complicated and volatile.

Sun Shaosong is a partner at Guantao Law Firm. He can be contacted on +86 186 0128 1139 or by email at sunshs@guantao.com
Niu Yue is a paralegal at Guantao Law Firm. He can be contacted on +86 188 1319 5266 or by email at niuyue@guantao.com