(Bloomberg) — Arm Ltd., the chip designer owned by SoftBank Group Corp., accused the ousted head of its China joint venture of hurting its business there, escalating a dispute that’s becoming a test of Beijing’s willingness to protect foreign investment in the world’s second-largest economy.

The U.K. chip giant in June announced it was firing Allen Wu, the head of its Chinese unit, over undisclosed breaches of conduct, but the executive has refused to step down and remains in control of the strategically important operation. Rather than the peaceful, rapid resolution that both sides have said they want, the situation has deteriorated.

Wu has hired his own security and won’t let representatives of Arm Ltd. or his board on the premises, said a person familiar with the situation. He’s refused to hold a planned event to connect Chinese chipmakers with Arm Ltd. and avoided negotiations despite public statements to the contrary, said the person, who asked not to be named.

Wu is “propagating false information and creating a culture of fear and confusion among Arm China employees,” the U.K.-based company said in a statement. “Allen’s focus on his own self-preservation has also put China semiconductor innovation at risk as he has attempted to block the critical communication and support our China partners require from Arm for ongoing and future chip designs.”

Arm China disputed the claims in an emailed response to queries, adding that Wu was open to talks and there have been no disruptions in business engagement between Arm Ltd. and its China clients.China is the largest market for semiconductors and the U.K. firm relies on Arm China to conduct business with local customers, including Huawei Technologies Co. The country accounts for a large proportion of the company’s global revenue and resolving the conflict will be crucial to SoftBank’s reported plans to sell Arm, a lynchpin in the global smartphone and computing industry that the Japanese firm bought for $32 billion in 2016.

In early June, Arm China’s board – which includes representatives from Arm Ltd. and Chinese investors – ousted Wu for setting up an investing firm that competes with its own businesses there. He refused to accept the decision, saying it was invalid and has remained in control at Arm China’s headquarters in Shenzhen.

The intricacies of Chinese rules confer an advantage to Wu as the holder of key registration documents. As the legal representative of Arm China, Wu holds the company’s registration documents and the company seal, or stamp. Changing the legal representative requires taking possession of the company stamp — something Wu has refused to give up.

Arm Ltd. is responding to the latest salvo from Arm China, a public letter posted on its social media accounts that was ostensibly from 176 employees. It called on Beijing to protect the business and said the U.K. company was going directly to customers and threatening to amend or cancel contracts if they didn’t stop dealing with Arm China. The letter said the Chinese venture had the exclusive rights to sell Arm’s products in the country.

Both parties are arguing that the longer things drag on the worse the impact will be on the Chinese chip industry, which relies on Arm’s technology. They also urged the Chinese government to intervene and resolve the disagreement. If and when authorities in the world’s most populous country get involved, their actions could provide a major indicator of Beijing’s willingness to uphold the rights of overseas investors on its soil.

Any response by Chinese authorities will also be closely watched amid deteriorating ties with the U.K. Beijing has clashed with Boris Johnson’s government over its condemnation of a new security law imposed in Hong Kong and also attacked a ban on the use of Huawei components in British 5G networks.

The Arm China ordeal may make foreign companies think twice about investing in China, said Alex Capri, a research fellow at the Hinrich Foundation.

“It reflected very poorly on the Chinese semiconductor scene. It just shed the light on that it is not a level playing field and it is a very dangerous environment for foreign companies, certainly in the tech sector,” Capri said. “Companies may find it so risky to operate in China that they will very painfully decouple.”

SoftBank bought Arm Ltd., which then operated under a different name, in 2016, initially gaining full control over the Chinese subsidiary. It sold more than half of Arm China in 2018 to an investment group and now owns 49% through Arm Ltd. The consortium that bought 51% of Arm China includes China Investment Corp., the Silk Road Fund and Singaporean state investment firm Temasek Holdings Pte.

Now, the Japanese firm is considering selling the U.K. company either through a private deal or public stock listing, people with knowledge of the matter said earlier this month. Nvidia Corp. had made an approach about a potential takeover, while overtures by SoftBank to Apple Inc. failed to result in any interest in a deal for the chip designer, Bloomberg News has reported.

Arm’s technology underpins the most important component in almost all of the world’s smartphones and is making headway in other markets such as personal computers and servers. The company sells chip designs and licenses the fundamental technology that allows chips to communicate with software to companies that prefer to design their own.

(Adds comments from Arm China in fifth paragraph.)

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