Today I’d like to go through some of the interesting points which have been raised regarding VIEs these past few days. Even though there has been a lack of new developments there have been many thoughtful views expressed. While I assume most of my readers would have read these excellent posts already I’ll go through some of them before offering my own thoughts on this very interesting topic.
… overall I believe the VIE issue is overstated and being kept in the news in part by lawyers using scare tactics to market their services and by investors talking up their short positions. There are many reasons to be cautious about the risks related to China investing, but the VIE issue is not nearly the most important.
Compared to which Steve Dickinson at the China Law blog offered this view on the latest VIE developments:
None of this is actually new. These risks have long been known. However, the clarity of the Regulations means it is now nearly impossible to claim that Chinese law on these issues is ambiguous or unclear. Where Chinese law says that ownership by foreigners is restricted or prohibited, the law means what it says. Foreigners who invest in violation of the law are making a bet that the violation will be ignored. This is extremely unlikely in today’s China. Such bets are sucker’s bets and should avoided at all costs.
So, at first glance, two very different views, and I bet they would get into a serious argument if the opportunity arose. But I actually think that their fundamental conclusions are both right but are merely coming at the issue from two very different perspectives. Bill is a Internet and finance guy, and is looking at the market, firms’ access to capital, and what the government is likely to do.
Steve, on the other hand, is a corporate lawyer. He is looking at potential risk, at what might go wrong, and what is/is not a technical violation of the law.
When Bill says that we shouldn’t worry about the government going after Chinese listed firms in the U.S. that use the VIE structure, I think he’s right. All the inside chatter on that issue seems to indicate that the government will grandfather in those companies even if it adopts a new enforcement strategy.
And when Steve says that VIEs are rubbish, he’s of course right. These things are illegal in that their purpose is to deliberately skirt foreign investment restrictions. I don’t actually agree with him on what the M&A rules mean (I think it’s too early to tell), but I definitely agree with his overall legal opinion.
Stan also goes on to talk about the general enforceability of the contracts as the main risk in VIEs, and here I couldn’t agree more. In fact, it seems like everyone is pretty much in agreement that the risk of a general government clampdown on listed VIEs is extremely unlikely, the danger lies more towards a GigaMedia-like issue where the enforceability of contracts becomes the main sticking point.
But does this really mean that listed companies with VIE structures won’t be affected by this at all?
Dan Harris has this to say regarding the issue of enforceability:
Whether or not existing VIEs are shut down (and at this stage we tend to agree with Bishop that they generally very likely will not be), the reality is that they have now been deemed illegal and that cannot help but have a major and game-changing impact on them. As mentioned above, VIEs are a structure that allows foreign companies to control the Chinese entity via various contracts. Now that those various contracts have been declared illegal, it will be difficult/impossible to enforce those contracts in Chinese courts. In this VIE structures, many of the contracts involve foreign countries and foreign country enforcement so their illegality in China may be minimized to that extent. However, even outside China, the party seeking to avoid enforcement of a contract will, in many cases, still be able to argue against enforcement based on China’s having made the structure illegal.
Here’s where I think the real issue lies, but I don’t think it’s entirely confined to future deals and PE/VC investors. This could for all intents and purposes have a deeply negative impact for listed companies as well.
In order to consolidate VIEs one has to show that the listed company not only receives the economic benefits and takes the economic risks of the venture, a second condition is to show that the VIE is in fact controlled by the listed company. If the contracts, which are put in place to establish this control, are indeed deemed illegal and unenforceable, fulfilling the second part of the consolidation requirement becomes decidedly more difficult.