References & Cases
References & Cases
In November 2019, a leading German Auto Parts Company (hereinafter referred to as " German Auto Parts ") and a subsidiary of a large state-owned enterprise (hereinafter referred to as the " SOE Subsidiary ") signed an agreement in Changchun to set up a joint venture company (hereinafter referred to “ JVC ”), which focused on the development and production of specialized automotive parts and accessories, with both parties holding 50 per cent of the shares respectively.
Our team acted as the legal adviser of German Auto Parts and provided full cross-border legal services in this transaction, including the review and negotiation of transaction documents such as JV contract, articles of association, cooperation agreement, etc., and the design of the governance structure as well as the decision-making process of the JVC, in order to realise the consolidation of statements of German Auto Parts and the Chinese controlling party, and to satisfy the requirements of the two parties in respect of the management right of JVC.
There were four main issues encountered during the course of the project:
Firstly, after the establishment of the JV company, the Foreign Investment Law of the People's Republic of China (hereinafter referred to as “ Foreign Investment Law ”) came into effect, so the corporate governance and management model needed to be adjusted accordingly. The JV companies that regulated by laws and regulations prior to Foreign Investment Law did not have a Board of Shareholders, and the Board of Directors was the supreme authority, which made management easier, but lacked internal balances and error correction functions.
Secondly, German Auto Parts as well as its Chinese actual controller wanted to include the achievements of the JV in their scope of consolidation. Both shareholders of the JV are listed companies in their countries, and have disclosure obligations as well as the pressure to face the capital market pressure and to improve the company's performance. However, the accounting systems and regulations of the stock market in China and Germany are not the same, and it’s difficult to reach a solution that is acceptable to all parties.
Thirdly, there was the problem of the loss of state-owned assets. The shareholder of one party was a large state-owned enterprise, and whether or not the value of the enterprise's assets increases was an important consideration in the project investigation. Competition for control of the company was also the core objective, which was in conflict with the goal of German Auto Parts to obtain nominal control of the company. How to strike a balance in the middle and satisfy the very different demands of the two parties must be properly considered.
Fourthly, the two major shareholders of the listed company's claims on consolidation and compliance did not affect the normal operation of the current JVC. The demands on consolidation and compliance should pursuant to the healthy development of the company.
According to the JV Agreement (hereinafter referred to as the " Original Agreement ") signed in November 2019 under the Sino-Foreign Equity JV Law, the supreme authority of the JV Company was the Board of Directors, of which three seats were held by German Auto Parts and two seats were held by the SOE Subsidiary, and a number of essential issues had to be unanimously
approved by the Board of Directors. This arrangement did not meet the criteria of IFRS (for German Auto Parts) or ASBE (for Chinese actual controller) for an investor to exercise control over a subsidiary, i.e. whether the investor had effective control over the target enterprise, and therefore could not be included in the scope of consolidation.
At the same time, the supreme authority of the company should be changed from the Board of Directors to the Board of Shareholders pursuant to the Foreign Investment Law. This would bring it in line with the corporate governance common in Europe and the United States, and realize the separation of capital ownership and management rights. Based on that, it’s necessary to re-sign the JV agreement, articles of association, etc., in order to divide and demarcate the rights of shareholders and directors. With German Auto Parts acquiring a 49% relative minority stake in the company under the new JV contract, the question of whether German Auto Parts as a shareholder would be infringed upon by the larger shareholders was also a key concern for all parties.
Combining the project team's experience in handling foreign investment and corporate governance business, as well as the financial professional background of the team members, the project team proposed the following solutions to German Auto Parts:
- Adding an investment company, a concert party of the SOE subsidiary, as a minority shareholder, German Auto Parts holds 49 per cent of the shares, but 51 per cent of the voting rights and a majority of seats (3/5) on the board of directors, which provides cross-checks and balances.
- For those matters for which the Companies Law in China allows a priority by agreement, a large number of matters that would otherwise require a resolution by the Board of Shareholders are delegated to the Board of Directors and adopted by way of a simple majority resolution, whereas German Auto Parts had a majority of the seats on the board of directors, thus realising the rule that the Dax stock market in Germany exercised effective control over the JVC. At the same time, the Board of Shareholders retained the mandatory rights and obligations exclusively reserved for the Board of Shareholders under the Companies Act.
- Matters that are mandatory for shareholders' decision-making in the Company Law, such as amendment to the articles of association of the company, increase or reduction of registered capital, and company merger, division, dissolution or change of company structure etc., are interpreted as "protective powers" that can be exempted from control judgement, and did not affect the control of German Auto Parts over the JVC.
- Through the company's internal management system, the drafting of Board of Directors' decisions was stipulated as the joint authority of the general manager appointed by German Auto Parts and the deputy general manager appointed by the SOE Subsidiary, i.e., in the case of having both large and small shareholders, the Board of Directors was set up with a safety valve, thus subtly turning the matters agreed in the original contract to be resolved by the appointed personnel of the two parties. The situation of the majority shareholders infringing on the minority shareholders was then properly resolved.
During the development of the programme, we actively communicated with our auditors and deliberated on specific details, such as which management rules of the company's management would materially evade the monitoring of the Board of Shareholders and which would adversely affect the control of the company, which would lead to a negative result in terms of domestic approvals as well as in terms of the German listing regulator's determination of control.
The design of the solution fully considered the client's need to incorporate the JVC into the consolidated statements, and minimized the difficulty of renegotiating between the two parties during the change, while did not change the current corporate governance structure of the company, which greatly facilitated the project process.
After many discussions and adjustments among the client, lawyers and accounting registrars, the proposal was finally approved by the auditor of German Auto Parts and the auditor of Chinese beneficial owner [Ernst & Young Hua Ming], which satisfied the requirement of the two listed companies to consolidate the JVC into one statement. The JV contract was also successfully reviewed by the State-owned Assets Supervision and Administration Commission (SASAC), and the project was successfully approved and filed. In the end, the project was successfully implemented and executed, and was well received by the JV partners and the other party's lawyers.