Matter note: shareholders' agreement terms for a Mainland China joint venture

Shareholders' agreement terms for a Mainland China joint venture require a careful separation between the offshore holding layer – typically governed by Hong Kong or English law – and the on-shore joint venture entity, which operates under Mainland Chinese law. The governing-law and forum clause is the single most consequential provision in the structure, yet foreign counsel routinely under-draft it. The matter described here illustrates the cost of that gap, and the route taken to close it before the joint venture's operational phase began.

The window for corrective drafting in any joint venture closes faster than most principals realise. Once the yingyezhizhao (business licence issued by Mainland China's market-supervision authority) is issued and capital contributions are made, restructuring the governance terms is commercially and legally expensive. This note explains what went wrong in the first round of drafting, how the problem was identified, and what a more defensible structure looks like from the perspective of international and cross-border counsel.

The situation: a mid-market manufacturing joint venture straddling two systems

The client was a mid-market European industrial group with existing procurement relationships in the Pearl River Delta. The proposed joint venture would manufacture specialised components in a Mainland Chinese city and distribute them through channels reaching both the domestic Chinese market and European customers. The foreign partner held a minority interest – slightly below fifty per cent – through a Hong Kong intermediate holding company. The Mainland partner was a state-linked enterprise.

In our cross-border corporate practice, this ownership profile is common. The use of a Hong Kong intermediate holdco above the waishang touzi qiye (foreign-invested enterprise, the Mainland-registered entity through which foreign capital participates in a domestic Chinese business) is the standard structural approach. It preserves access to treaty benefits, facilitates dividend remittance, and keeps the external-facing governance documents at a level where Hong Kong or English law can govern them without direct conflict with Mainland company-law requirements.

The difficulty in this matter was not the corporate structure itself. It was the drafting of the shareholders' agreement at the Hong Kong holdco level, and its interaction – or lack thereof – with the joint-venture contract and articles of association at the Mainland entity level.

What was the core problem with the first draft?

The first version of the shareholders' agreement, prepared by the client's European corporate counsel, contained a standard governing-law clause nominating English law and a dispute-resolution clause providing for arbitration seated in London. On its face, this looked unremarkable. For a joint venture between two non-PRC parties with no assets in Greater China, it would have been entirely conventional.

For this joint venture, it created three compounding problems. First, the agreement purported to govern the conduct of the Hong Kong holdco shareholders – including call and put options, drag-along rights, and deadlock-resolution mechanisms – without acknowledging that any exercise of those rights would require corresponding action at the Mainland entity level. There is no automatic pass-through. A forced transfer of shares in the Hong Kong holdco does not, by itself, alter the registered shareholding in the Mainland entity. That requires a separate approval process through the relevant Mainland authorities.

Second, the dispute-resolution clause provided for London arbitration but was silent on enforcement. An award from a London-seated tribunal is enforceable in Hong Kong under the New York Convention, which applies to Hong Kong. But if the assets – including the interest in the Mainland entity – needed to be reached in execution, the route is considerably less direct. In our practice, we regularly see enforcement plans that look coherent at the contractual drafting stage but are practically ineffective when the assets are in the Mainland. The arbitral-award mutual enforcement Arrangements between Mainland China and the HKSAR, which permit simultaneous enforcement applications following the 2021 amendment to those Arrangements, apply to Hong Kong-seated arbitral awards. They do not extend to awards from other seats.

Third, the joint-venture contract at the Mainland level – a separate Chinese-law document, required by Mainland regulatory practice – was drafted in isolation from the offshore shareholders' agreement. The two instruments were inconsistent on deadlock, on the transfer-approval timeline, and on what constituted a material breach. A dispute that started under one document would quickly bleed into the other, with no agreed bridge between the two sets of terms.

How was the issue identified?

The client came to us during the negotiation phase, before execution. A transaction adviser reviewing the overall deal structure flagged the enforcement gap and recommended that international counsel review the governance documents with the specific cross-border enforcement question in mind.

That review identified the three problems above within a short initial assessment. It also identified a fourth issue that had not been raised by either side's corporate counsel: the drag-along mechanism in the shareholders' agreement was drafted so that the drag right attached to a share sale at the Hong Kong holdco level. But the economic substance of what was being dragged was ultimately the interest in the Mainland entity, and any such transfer required regulatory approval under Mainland foreign-investment rules. The shareholders' agreement imposed a contractual timeline for completion of the drag that was shorter than the regulatory approval process typically permits. In practice, the drag right as drafted was unenforceable in the sequence in which it would actually need to be exercised.

This is a category of error that experienced cross-border counsel encounter regularly. The contractual mechanism is sound in isolation, but it has not been mapped against the regulatory sequence in the relevant Mainland jurisdiction.

What was the route taken, and where was the turning point?

The approach we recommended proceeded in stages. The first stage was to establish a clear layered-governance principle: the shareholders' agreement at the Hong Kong level would govern the relationship between the offshore shareholders, and it would do so under Hong Kong law. The joint-venture contract and articles of the Mainland entity would govern the on-shore entity under Mainland law. The two instruments would be connected by a carefully drafted consistency clause and by cross-references that acknowledged – but did not attempt to override – the Mainland approval requirements.

The second stage was to revise the dispute-resolution architecture. The shareholders' agreement was revised to provide for arbitration seated in Hong Kong, administered under the HKIAC Administered Arbitration Rules (the rules of the Hong Kong International Arbitration Centre, the leading institutional rules for Greater China-related disputes). This was a deliberate choice. A Hong Kong-seated award is enforceable in the Mainland through the mutual-enforcement Arrangements that have operated in stages since 1999 and were extended by the 2020 Supplemental Arrangement. The interim-measures Arrangement, in force since 1 October 2019, also allows a party to a Hong Kong-seated arbitration to apply to Mainland courts for interim measures before or during the arbitral proceedings – a practically important step in any joint venture where operational assets are on the Mainland side.

The turning point in the negotiation came when the governing-law and seat question was put to the Mainland partner. The Mainland partner's counsel initially resisted any offshore arbitration. The position was resolved by separating the issue. Disputes arising under the joint-venture contract at the Mainland entity level would be resolved under a Mainland arbitration clause, using a recognised Mainland arbitral institution. Disputes arising under the shareholders' agreement at the Hong Kong holdco level – principally disputes between the offshore shareholders – would be resolved in Hong Kong. This separation is workable in practice, and it reflects the layered structure of the transaction itself. It also gave the European partner an enforcement route against the offshore shareholding that did not depend on Mainland court proceedings.

The drag-along mechanism was rewritten with a condition-precedent approach. The drag right would crystallise on the happening of a trigger event, but completion of the drag transfer was expressly conditional on receipt of all required Mainland approvals. The timeline for completion ran from the date of the last required approval, not from the trigger date. This aligned the contractual mechanism with the regulatory reality without eliminating the commercial protection the drag right was designed to provide.

Transferable lessons from this matter

The most transferable lesson from this matter is structural: the governing-law and forum clause in a Mainland China joint venture is not a boilerplate provision. It determines the entire enforcement architecture, and it needs to be tested against the regulatory sequence before execution.

Foreign counsel working from a standard European joint-venture template will almost always produce a first draft that is internally consistent but externally defective – that is, defective at the boundary between the offshore shareholders' agreement and the on-shore regulatory requirements. The template was written for a different fact pattern. The instruments, the approval authorities, and the enforcement routes are all different in the Greater China context.

The second lesson concerns sequencing. The shareholders' agreement and the joint-venture contract need to be drafted together, or at minimum reviewed together for consistency. In practice, they are often drafted by different teams, sometimes in different languages, with no shared brief on the critical interface points. The result is inconsistency on the provisions that matter most when a dispute arises: deadlock, transfer restrictions, and material breach.

The third lesson is about the seat of arbitration. For joint ventures with assets or operations in the Mainland, a Hong Kong seat provides an enforcement route – through the mutual-enforcement Arrangements – that a European or North American seat does not. That advantage is material. The Mainland Judgments in Civil and Commercial Matters (Reciprocal Enforcement) Ordinance (Cap. 645), in force from 29 January 2024, has further strengthened the Hong Kong-to-Mainland enforcement corridor for civil and commercial judgments, though the arbitral-award Arrangements remain the primary route for contractual disputes of this kind.

In our cross-border corporate practice, we have acted on a number of matters where the governing-law and forum clause was the point at which the joint venture either held together under pressure or began to come apart. The drafting choices made at the outset are difficult and expensive to reverse once the joint venture is operational.

For further perspective on shareholders' agreement terms in other offshore and common-law joint-venture contexts, our guides on shareholders' agreement terms for Cyprus joint ventures and shareholders' agreement terms for United Kingdom joint ventures address the comparable questions in those jurisdictions.

The sequence above describes the standard approach. Your matter turns on the specific documents, the jurisdictions actually engaged, and the order of regulatory approvals – which is where the route is won or lost.

For a structured review of your shareholders' agreement and the cross-border enforcement architecture for a Mainland China joint venture, write to us at info@lockhartyip.com.

If an earlier draft, structure, or negotiation produced an adverse result or has stalled, a second read can identify the structural error and the routes still available before execution.

To discuss how the HKIAC arbitration architecture and the mutual-enforcement Arrangements apply to your joint venture position, contact info@lockhartyip.com.

Related practices

• Corporate Counsel – cross-border corporate governance, joint ventures, and entity maintenance in Greater China
• Disputes & Arbitration – enforcement of awards and judgments across the Mainland–Hong Kong boundary

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This publication is general information and does not constitute legal advice. For advice on your situation, contact info@lockhartyip.com.