Legal and Financial Due Diligence

You must conduct comprehensive due diligence on your potential joint venture (JV) partner. If you fail to do so, your entire China business may be at risk. Some of the basics you can actually do yourself-other investigation may require professional assistance.

The bottom line here is-take your time, know what you are getting into, and if you are uncomfortable, go elsewhere. Don't be rushed.

Business license

Details of who is actually in the Chinese company, and details of their limited liability must be obtained.

Ask for a copy of their business license. It will list (in Chinese) details of the legally responsible person (Legal Representative), the registered address, the amount of registered capital (which is also the limited liability) and the period of the license. It is quite common for the actual legally responsible person not to even be the person you're dealing with. License periods may not be consistent with liabilities. Check this out and make sure they can deliver what they say they can.

Capital verification report

This is issued by a Chinese independent Certified Public Accountants (CPA) firm, confirming the fact that the registered capital as identified on the business license was in fact paid up. If the registered capital has not been paid, not only does this mean your partner has not actually capitalized his business, but it also means he has not complied with limited liability requirements.

Land use rights

If land is to be injected as part of an asset in a JV, then you need to see Land Use Rights certificates to establish if your partner owns it or not. Land and any buildings injected should also be valued by a third party valuer-these must be China-approved Asset Appraisal Offices. Other assets such as equipment and so on can best be valued by your own people, and compared with the Chinese valuation.

These relate to the status of the land on which your Chinese partner has its premises. Do they own it? Two types of land use rights exist:

Allocated Rights-these are issued to a venture for a period of years (check the timeframe) but only give the right to use the land. It means any buildings that are erected on it will ultimately benefit the landowner, not your company. Additionally, if the agreement over the land is between the Chinese partner and the landlord directly and the Chinese partner defaults on the rental, you can be thrown off the land. Check this out.

Granted Rights-again, issued for a period of years, but these give title to the land during this timeframe. Of course it costs more to "buy the land"-but if such rights are issued in your JV name, you may use these to raise loans in China (giving the Granted Rights as security) and even profit from any sale of the rights later on. If injecting land as part of JV equity, your Chinese partner must provide Granted Land Use Rights and ownership proof, otherwise the gesture is meaningless.

Accounts and tax issues

Copies of filed accounts can be difficult to extract from your partner. If in doubt, ask for an independent CPA firm to conduct an "Asset Appraisal Report," which will provide a private confirmation of assets and the close-to-true picture.

It is also vitally important to ensure that the new JV maintains accounting transparency, because:

- The State Administration of Taxation (SAT) places all foreign invested enterprises in China under Category 1, the highest, in tax bureau monitoring and assessments. You cannot afford to have a lack of accounting transparency, no matter what your partner's previous attitude to this was.

- Criminal action in your home country. As many countries crack down on fraud and transparency issues (especially the United States-remember the implications of the Sarbanes-Oxley Act), you could be held responsible back home for criminal liability if accounts folded into your parent operations from China were subsequently found to be fraudulent. If you are named as a director of the China entity then this becomes even more of an issue.

- Fines-the SAT can levy up to five times the amount of unpaid tax in late payment penalties. Foreign expat managers can be and are jailed in serious cases of tax evasion, if caught.

Financial and secretarial compliance

It is vital to remain in compliance in both accounting and the corporate secretarial aspects of your new JV business. Be aware of:

Trademarks/patents

Have they been registered in China? If not--get them done. Was it your agent who registered it or your parent company directly? Check it's been done and where ownership lies.

Business licenses

Are they up to date? You should have annual renewals as well as other pertinent licenses and permits-tax registration certificates, export licenses, customs and foreign currency registrations and so on.

Tax filings

These need to be conducted on a monthly basis, audits annually. If you are not conducting such filings-you are not in compliance. Outsource this or get in at least quarterly checks to ensure all is in place and where it should be.

Reporting also should be to a professional standard and maintained. An inability to provide accounts, audited accounts or on-going documentation is a sign that all is not well. Ensure your reporting and checking systems are in place to prevent this sort of occurrence.

In Issue No. 45 we will conclude the series of articles on JV investment in China.

The author is with Dezan Shira & Associates-www.dezshira.com