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Posts Tagged ‘China Law’

So there’s been an awful lot of speculation and rumours around VIEs of late. Starting with the continued EDU issues that I discussed at some length in my Tradingfloor column earlier, to some new rumours about issues for MNCs. It’s this latest rumour I find most interesting, and I think it’s a very interesting development if we put it in its proper context.

First of all we have to say that we currently have very few details about this crackdown, for instance we don’t know which AICs or MNCs are involved. We could indeed be looking at a situation similar to what we had with Buddha Steel where enforcement appeared to differ depending on where in the country you conducted your business. As we’re talking about local AICs here it’s entirely possible that we’re currently seeing different enforcements in different areas of the country.

But this is not the whole story, of course. What’s really interesting about this is that it seems to follow something of a pattern. It started off with the article discussing the issue of foreign influence in the restricted industries in China, then all was quiet for a good while before we saw some real movement when MOFCOM approved the Walmart takeover of Yihaodian with some reservations, creating what I called the restricted VIE.

This is now the next step in what appears to be a gradual campaign to limit the use of the structure. As Professor Gillis pointed out in his post they’re apparently staying away from the foreign listed companies as they are too high profile. What they do appear to be doing is targeting MNCs in particular. I think this is likely to be an attempt to rein in the most obvious foreign elements in the restricted industries, as they are very obvious examples of the foreign influence the article warned against.

While there are arguments that can be made about the supposed foreign influence many of the foreign listed VIEs are actually subject to (you’ll find most still have a heavy voting majority of Chinese nationals), it’s much harder to argue the same for an actual foreign company.

This is yet another issue with VIEs that will relate particularly to foreign companies. The structures used by the foreign companies are already less stable, in general, than a Chinese VIE due to the difficulties in aligning incentives when the VIE is held by an employee. You create a lot of potential issues with an employee held VIE, as the employee suddenly has an unreasonably strong negotiating position, and with very limited ownership in the foreign parent there are often strong incentives to take the VIE and run.

While the risk of the owners absconding with the VIE can be mitigated by properly structuring the assets etc. it’ll be very hard to deal with this new issue. It’ll be interesting to see how far authorities take these actions, but MNCs will certainly need to keep on top of the situation. Authorities are unlikely to relax the new restrictions against foreign elements anytime soon.

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In today’s post I’d like to have a quick look at GigaMedia, which is having some issues in China which on the face of it appear to be VIE related. The head of their Chinese operations has run off with the Chinese company, supposedly because he’s not a shareholder in the parent company and they wished to replace him. But let’s have a look at the situation as presented by the company’s SEC filings.

GigaMedia is a company registered in Singapore involved in online gaming and gambling, their main business areas seem to be SE Asia and China, with a JV in Europe focusing mainly on gambling.

In China the company conducts its business in the normal manner with a WFOE (T2CN Information Technology (Shanghai) Co., Ltd. (T2 Technology)) and three VIEs (Shanghai T2 Entertainment Co., Ltd. (T2 Entertainment), Shanghai T2 Advertisement Co., Ltd. (T2 Advertisement), Shanghai Jinyou Network & Technology Co., Ltd. (Jinyou)) holding the permits. All of these companies are managed through a BVI holding company (T2CN Holding Limited (T2CN)which the company owns about 67% of).

The precise ownership of the VIEs remains unclear as the company does not disclose this information. However, all the normal contracts appear to be in place according to the latest 20-F form: Shareholder Voting Rights Proxy Agreements, Exclusive Equity Transfer Call Agreements, Exclusive Technical Service and Consultancy Agreement, and Equity Pledge Agreements.

The filing also includes the normal reservations about the effectiveness of contractual control and the legal uncertainties surrounding VIEs, mentioning both MIIT and GAPP rules.

The first mentions of any issues surrounding the structure came in the company’s 2Q 2010 (6-K 2010-08-30), where it is mentioned briefly as:

“GigaMedia is now in a dispute with its former China head over his ongoing attempts to usurp company assets in China, including local company bank accounts and company operations. GigaMedia has filed legal action and is working aggressively with local police, courts and government officials to bring about a rapid resolution. GigaMedia’s China operations may be adversely affected by these illegal actions.”

This was followed by a more in-depth discussion about the issues in two separate 6-K filings (filed 2010-11-15, and 2010-11-26).

Gigamedia had felt the need to change leadership in China, there’s no mention of why they felt this need, but their former China head, Wang Ji, would be offered a senior consulting role or possibly be chairman of the board for the Chinese company. While he at first went along with the plans he suddenly changed his mind and starting from July 2010 he categorically refused to step down from any of his current posts.

The specifics of the situation were described as follow:

“GigaMedia believes that Wang Ji currently has in his possession, among other things, the company seals, financial chops and business registration certificates of T2 Technology and GigaMedia’s VIEs.  Wang Ji also has in his possession all documents, records and data and tangible property, including license agreements, trademark and domain name documentation, held in the offices of T2CN’s wholly-owned subsidiary, T2 Technology.  The company seals, financial chops and business registration certificates of T2 Technology and GigaMedia’s VIEs are necessary for the respective entities to declare dividends and approve service fee payments to GigaMedia, among other things. These documents are necessary for GigaMedia to run its online games business in the PRC.  Under PRC law, the company seals, financial chops and business registration certificates are essential for entering into contracts, conducting banking business, or taking official corporate action of any sort.  Consequently, GigaMedia has not been able to register the resolutions removing Wang Ji from his position as a director of T2 Technology and as the legal representative, executive director and manager of T2 Entertainment.  In short, Wang Ji has effectively usurped control over T2 Technology and T2 Entertainment’s operations and accounts.”

The company further stated that any adverse resolution in this case would likely have “a serious material adverse effect” on the company. Hence they had proceeded to file lawsuits against Mr. Wang in the PRC, Hong Kong, Singapore and the British Virgin Islands.

The filing finished off by stating that the company had not registered its equity pledge, and as such felt that they were highly unlikely to be able to get these contracts enforced in court.

The second statement further clarified the importance of the situation by stating that:

  • GigaMedia’s revenues attributable to its online games business in the PRC totaled approximately US$10 million, which represented approximately 20% of GigaMedia’s total consolidated revenues for the six months ended June 30, 2010.
  • GigaMedia’s proportionate share of the total assets of the entities held by T2CN was approximately US$32 million, which represented approximately 11% of GigaMedia’s total consolidated assets as of June 30, 2010.
  • GigaMedia’s equity in the income from continuing operations before income taxes of the entities held by T2CN (exclusive of amounts attributable to the non-controlling interest) was approximately US$0.6 million, which represented approximately 1% of GigaMedia’s total income from continuing operations before income taxes for the six months ended June 30, 2010.

The company also disclosed that they were considering writing off the entire investment in the entities held by T2CN since they had lost control of the company and were unable to gain access to any financial information regarding the entities.

When the 4Q 2010 results were filed (6-K 2011-05-06), the company had deconsolidated T2CN and completely written off the entire investment. Where they had previously seemed confident of a reasonably swift conclusion to the dispute, they now admitted to a bleaker outlook:

“While management continues to believe that its general legal position is sound, as a result of recent setbacks that have delayed the progress of the litigation against Wang Ji and the increasing complexity of the ongoing litigation, it is now impractical for the company to estimate with any degree of certainty the timeline for the eventual resolution of the dispute or the likelihood of a successful outcome.”

The latest mention of the dispute is in the 1Q 2011 report (6-K 2011-05-26), where new developments are briefly referred to:

“Investments ongoing in new China platform while continuing to pursue all means to resolve the dispute in connection with the China-based business T2CN.”

Well to be honest I’m a bit shocked, I was expecting to find a case revolving around the legality of a VIE structure, albeit one without properly registered documents and such. But what’s interesting to note here is that the conflict really seems to be one step higher than should be possible. The VIE contracts aren’t actually coming into it because somehow the former China head has managed to gain control of the WFOE, which is the entity to which all the VIE’s are supposedly contractually tied to.

This matter should be quite easy to deal with through normal procedures, as there should be no question who has authority over the WFOE, thus GigaMedia should be able to at least regain control over this entity. I’m not quite certain how the company has gone about things but it seems oddly suspicious that they’re unable to regain control over a WFOE.

I’m not quite sure what to make of a company that’s apparently unable to regain access even to its WFOE after many months and quite a lot of money spent on lawyers. I get the feeling there might be more to this story than the SEC filings suggest.

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