Investment disputes disappoint almost everyone caught up in them. We are often asked to review an investment or shareholders’ agreement, or to step into a dispute that has already begun.
Two Ways It Goes Wrong
Sometimes the business fails. The money is gone, and the investor may be left carrying personal liabilities as well.
More often the business does well and the investor still sees nothing. The company is profitable but no dividend is ever declared. A minority shareholder asks to inspect the books and is refused. The investor — by now both disappointed and angry — sues, intending to hold the operating party, and the person actually controlling the company, to account.
The PRC Company Law does protect minority shareholders against majority shareholders and de facto controllers. But those provisions are drafted at a level of principle. They are general by design, and in practice they are difficult to use: few investors obtain a satisfactory result through litigation, and some lose outright.
The problem is not the law. Even an ordinary sale contract is full of traps if it is drafted carelessly, and the law has never been able to do this work on its own. The problem lies with the people using it — with investors, and quite often with their lawyers, who do not take investment contracts seriously enough, and who do not bring enough knowledge and experience to them.
An Investment Contract Should Not Be Simpler Than a Car Purchase
The contracts we sign in ordinary life are not as simple as they look. Buy a car and the main contract may run to two or three pages — but the manual that comes with the car is a thick book. A construction contract, a technology development agreement, an ordinary sale of goods: each describes in detail what is being exchanged, and on what conditions. Specification, quantity, quality, price and the mechanics of payment, technical standards, inspection standards.
When a dispute arises, those are the terms that let the decision-maker work out who was right and who was wrong, and allocate responsibility. If the question turns on something technical that the decision-maker cannot assess, an expert can be appointed to assess it.
Terms of that kind — describing the subject matter, the conditions and the detail of the transaction — are what we call commercial terms. They stand opposite the legal terms: the provisions on notices, governing law, dispute resolution and liability.
Commercial terms are what allow a court or tribunal to understand what the parties were actually trying to do, on what terms and in what circumstances, and therefore to judge the dispute accurately. Without them, even an ordinary commercial contract leaves the decision-maker with nothing to work from but trade custom, industry practice and the purpose of the contract — and a result that is usually some distance from what the parties expected.
Now consider the difference in scale. An ordinary sale of goods concerns something standardised and delivered once, and still needs all of that. An investment or joint operation is neither standardised nor finite. It runs for years. The sums at stake run from a few million renminbi to hundreds of millions. If the contract is thinner than the paperwork for buying a car, then frequent disputes — and no basis on which to argue them — should come as no surprise.
What a China Investment Contract Usually Leaves Out
Most investment and joint venture contracts drafted in China cover much the same ground: the project, the capital contributions and equity split, the powers and procedures of the shareholders’ meeting, the powers and procedures of the board, the rules for appointing officers. Most of that is copied from the Company Law. A more elaborate contract will add financing, approval thresholds for the use of funds, non-compete obligations and information rights.
All of that is enough to let an organisation function. None of it captures why these particular parties agreed to invest together, on what basis and on what conditions. When a dispute arrives, the decision-maker has little to work with and the investor’s position is difficult to defend.
Yet the parties will almost certainly have discussed the operating detail during the negotiations. What the investment is premised on. The market conditions they assumed. The profit forecasts they were shown. The operating policy, the business model, the plan and the schedule. And then the operating and financial budgets: costs and overheads, financing costs, marketing spend, and how the budget will be managed and controlled.
Those are the matters that formed the basis on which the parties contracted, and the purpose they had in mind. They contain the substance of the bargain. They are the key commercial terms of an investment contract, and they should find their way into the document in some form. Put them there and a future dispute looks different: the decision-maker can form a view of the rights and wrongs, and the dispute becomes one that can be resolved rationally rather than merely fought.
The Objection, and the Answer
An investment contract is not a sale of goods, and the market does not stand still. Nobody can design complete commercial terms for a business that will run for years at the moment of signing. Many questions of real substance have to be left to the operator’s commercial judgment. That is unavoidable, and a contract that tried to remove it would be worse, not better.
But it does not follow that nothing should be written down. Agreeing the foundational and conditional matters still does real work:
- It gives a standard against which to test whether the decisions of the majority shareholder or the management were reasonable.
- It provides a basis for renegotiating control if the assumptions behind the investment fail.
- It provides a basis for readjusting who holds which management authority.
- It informs the design of the other clauses of the contract.
- And when a dispute arrives, it provides the basis on which right and wrong can be judged.
There is a sequence here that matters. Settle the commercial terms first: work out what the parties are actually agreeing about, and how much each part of it matters to each of them. Only then decide the legal terms — and in particular the voting thresholds, so that the matters which matter most require the widest consent, and the routine ones do not.
Do it in that order and the rights, obligations and responsibilities of each party can be arranged coherently. Each party knows what it is responsible for. And if the arrangement later breaks down, the decision-maker has something to decide on.
Do it the other way round — start from a template, allocate the percentages, and leave the business to look after itself — and you have a document that looks like an investment contract and behaves like a bet.
Practical Takeaway
If you are entering an investment or joint venture in China, communicate more about the business, not less. Every statement, promise and assurance the other side makes about how the business will run — the forecasts, the market assumptions, the operating plan, the budget — should end up in the contract in some form. More often than not, the investor’s difficulty is not that the other side lied, but that nothing was ever written down.
And when you instruct a lawyer, look for one who will think about the business. Drafting a China investment contract properly takes commercial judgment as much as legal technique: thinking through the operating detail, understanding the basis on which the client is entering the deal, and building commercial terms that fit it. Checking whether the legal clauses are fair and reasonable is the easier half of the job, and the less useful half. The harder work — and the more valuable — is asking whether the contract is fair and reasonable once the commercial terms are properly on the table.
This article is general commentary, not legal advice.