Milk scandal leaves sour taste for foreign investors
China's contaminated milk powder scandal, like its previous food safety problems, contains many lessons for foreign investors, as well as others. Those lessons also apply to foreign investment in other Chinese industries, and in other countries, too.
New Zealand's Fonterra Corporation, the world's largest trader in dairy products, has undoubtedly learned much from its 43 per cent ownership of a China venture with the Sanlu Group that became China's biggest producer of baby milk formula. Its Sanlu venture's sale of melamine-tainted products has led to horrific human suffering, financial disaster for the partners and further damage to China's reputation.
This latest food tragedy may make some foreign investors conclude that the risks of manufacturing in China outweigh the potential rewards. Yet, such is the allure of the China market, most multinational firms will probably want to maintain their interest. The challenge is how to do it better.
Fonterra's fiasco should stimulate foreign joint venturers in China to consider following the example of the many multinationals that have established wholly foreign-owned enterprises (WFOEs) there. Or, in situations where Beijing does not permit a WFOE, the foreign firm may seek to negotiate a dominant ownership interest and other arrangements that will allow it to control the joint venture's management.
If government policy or business considerations preclude it from controlling the venture, the foreign investor must review the adequacy of its participation in the day-to-day management. The investor should try to obtain new contractual guarantees from its partner. At a minimum, it must improve its knowledge of how its partner is running the operation.
As the Fonterra case illustrates, learning the truth is only half the battle. What, then, should the foreign investor do? Obviously, it must immediately raise any matter that threatens public health with relevant local officials, as well as its partner. But how long should it rely on unconvincing assurances that the matter will be properly handled?
Should it 'blow the whistle' to its own government or to China's central authorities? Should it assure Chinese government action by 'going public' via the media? And what will be the foreigner's future in China if it averts the kind of tragedy and economic disaster wrought by Sanlu but alienates its partner and officials?
Fonterra's China business may not survive the scandal. Moreover, the victims' claims for the deaths, hospitalisation and other harm suffered have yet to be reckoned with. Fonterra reportedly insists it did the right thing by 'working within the system' for weeks after belatedly discovering that the products of its China venture were being poisoned.
China's legal system, or even New Zealand's, may reach a different conclusion. It is not clear whether the Communist Party's central Political-Legal Committee, which controls the nation's courts, will allow them to deal with the issues of liability and compensation.
Yet, if the victims will not have access to the courts, a party and government obsessed with 'harmony' and 'social stability' will have to resort to some other institution for processing their claims. The Ministry of Health has promised to pay for all the victims' hospital expenses, although doubts have already arisen about the scope and reliability of its pledge. But will the ministry or some other agency provide compensation for other losses, such as death, and the pain and suffering of the victims and their families, as permitted by previous court decisions? And will the government seek reimbursement from the offending milk companies?
So Sanlu and Fonterra, and other Chinese and foreign investors in China's milk industry, are likely to be called to account, perhaps even beyond the bounds of the usual understanding of corporate limited liability. Foreign investors, beware.
Jerome A. Cohen is co-director of NYU's US-Asia Law Institute and Adjunct Senior Fellow at the Council on Foreign Relations in New York