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Buying Into A China VIE. What Me Worry?

By Dan Harris on Posted in Uncategorized

Years ago, we here at China Law Blog made clear our views on VIEs and nothing about those views has changed.  For that reason, and becuase VIEs have little to nothing to do with most companies doing business in China, we stopped writing about them years ago.  In a nutshell, we don’t like them, don’t trust them, and don’t do them.  Quite frankly, our malpractice insurance just isn’t high enough for the massive risks we see in these investment vehicles.  We simply believe that when push comes to shove, China’s courts simply won’t enforce the contractual agreements that are necessary to support such a structure.

Seems we are not alone in this assessment and we now have company from a Chinese court.  Sue-Lin Wong just did a story on VIEs for the International Herald Tribune/New York Times and because both Steve Dickinson and I were quoted in it, I cannot resist retreading old ground here and again writing about VIEs.

The NYTimes story is entitled China Court Ruling Could Threaten Some Foreign-Invested Companies and it comes on the heels of a recent ruling by China’s Supreme People’s Court holding that “contracts used by non-Chinese citizens to gain access to sectors of the Chinese economy that are protected from foreign investment were invalid.”  Ms. Wong nicely explains why V.I.E.’s exist at all:

Sectors the Chinese government considers sensitive, including finance, media, technology, the Internet and education, have long been largely off-limits to foreign investment. To get around that, some of the biggest companies in the country founded by Chinese people, including the Internet giants Baidu, Alibaba, Tencent and Sina, create variable interest entities, or V.I.E.’s, that give overseas investors de facto control over companies technically owned by their Chinese partners, as Neil reported. V.I.E.’s account for differing proportions of these companies’ income and assets, ranging from several percent to as much as 100 percent.

V.I.E.’s have for the most part worked just fine and this likely will not change, until there is a problem.  And that itself is the problem.  To make up a Yogi Berra quote, there is no problem with V.I.E.’s until there is a problem.  Problems arise if the Chinese partners decide they don’t want to follow the contracts any longer because, for example, they already have the money and know-how they were seeking, as has happened in several instances. When that happens, the foreign party most likely has no legal recourse.  China Law Blog’s own Steve Dickinson is quoted on the biggest problem with V.I.E.’s:

“Chinese law has a very clear provision. A contract written to avoid the requirements of Chinese law is void and the court will not enforce it,” said Steve Dickinson, a partner at Harris & Moure and a co-author of the China Law Blog.

In other words, they almost certainly are not legal.  Though some are seeking to distinguish this recent Supreme Court case because it involved a type of company structure that predated V.I.E’s, Steve isn’t buying that:

“This group of people will distinguish the recent Supreme People’s Court ruling because it was an earlier set of documents, not entirely the same as the V.I.E. structure,” Mr. Dickinson predicted. “But what the court said is that any contract that is designed to avoid the clear requirements of Chinese law is void from the very first step. That is what the V.I.E. is.”

I then chime in to explain why despite the risks V.I.E formations just keep on coming:

“Accountants, lawyers and stock brokers make a ton of money off IPOs so they have no incentive to slow them down,” said Dan Harris, a China lawyer with Harris & Moure and a co-author of the China Law Blog. “They have every incentive to keep the V.I.E. structure going.”

Of course it is not just Steve and me who view V.I.E’s with such trepidation.  Andrew Gilhom, head of Asia analysis at Control Risks describes them as a way for foreigners “to make some money for a few years but ultimately it’s kind of open season.”

Does this mean that all V.I.E’s are going to disappear or be sued out of existence?  Absolutely not, because as the article rightly notes, it is “unlikely that the Chinese government wants to turn the V.I.E. structure into a huge issue”:

“They don’t want all the U.S.-listed stocks suddenly tumbling and companies failing and panic,” Mr. Gilholm said. “I don’t really see any signs that they are going to proactively go out and across the board say that all these structures have to be unwound.”

But what is to stop one or two at a time to encounter major problems?  What do you think?

If you want to learn more about VIEs, I suggest you read the following China Law Blog posts:

And the following China Hearsay posts:

And the following China Accounting posts:

And the following China Finance posts:

If you read all of the above, you will probably know more about VIEs than anyone else alive. If you are going to read just one post, make it “Explaining VIE structures.” Oh, and just to give you more to read, I also recommend you read the Silicon Hutong post, “VIEs, The Long Resolution.” In that post, David Wolf talks of how the Chinese government likes to “boil its frogs slowly, not all at once,” and he then talks of how VIEs are on the wrong side of where China wants to be going. I could not agree more. I do not see VIEs disappearing overnight; instead, I see foreign companies involved with VIEs suffering a very long and very gradual squeeze out.

What do you think?

 

 

Doing Business In China. Not So Bad After All?

By Dan Harris on Posted in China Business

Those of us who constantly deal with China have a tendency to complain about what it takes to get things done there.  We do that because in our minds, everything should happen pretty much instantaneously.  Certainly my law firm’s clients would prefer that and therefore so would I.

But I read a Wall Street Journal article today that did a great job of putting the difficulties of doing business in China in somewhat stark perspective.  The article is entitled, “Andy Puzder: Of Burgers, Bikinis and ObamaCare” and it is an interview with Andy Puzder of fast-food chain, Carl’s Jr., who explains why Carl’s Jr. will not be expanding in California.  As part of his explanation, he compared the time it takes to open a venue in various places, including Shanghai:

Consider how long it takes for one of his restaurants to get a building permit after signing a lease. It takes 60 days in Texas, 63 in Shanghai, and 125 in Novosibirsk, Russia. In Los Angeles, it’s 285. “I can open up a restaurant faster on Karl Marx Prospect in Siberia than on Carl Karcher Boulevard in California,” he says.

Shanghai isn’t bad.  Not bad at all.

Of course, this 63 day time frame has to be after the foreign company (in this case, Carl’s Jr.) has already established its WFOE in China.

What do you think?

China Law Conferences. In China.

By Dan Harris on Posted in Events, Legal News

Just got a listserve email from Dave Lyons (of DavesgoneChina/Mutant Palm fame) setting out a list of China Law Conferences that are scheduled to be held in China during the next year or so.  Becuase I am often asked about such things and because I seldom have a good answer about such things,  I am running Dave’s list.  If you are aware of any additional such seminars/conferences, please add them as a comment.

 

July 5-6, 2013

Law Risk and Management Strategy

The Law Association for Asia and the Pacific

Hong Kong

http://lawasia.asn.au/risk_management_strategies_conference_program_and_speakers

 

July 20-21, 2013

4th Intl Conference on Evidence Law and Forensic Evidence

Institute of Evidence Law and Forensic Science of China University of Political Science and Law

Beijing, China

http://icelfs.theiaes.com/en/announcement/0726/

 

September 16-17, 2013

China-Inside and Out: Antitrust, Intellectual Property and Other Regulatory Issues for Initiating and Operating Outbound and Inbound Investments

American Bar Association

China World Hotel, Beijing, China

http://www.americanbar.org/calendar/2013/09/china_-_inside_andout.html

 

September 19-20, 2013

8th European China Law Studies Association (ECLS) Conference: New Approaches and New Questions in Chinese Law

Oxford University, UK

http://ecls2013oxford.wordpress.com/

 

October 15-16, 2013

China-US Updates in Food and Drug Law

Food and Drug Law Institute (FDLI) Conference

Beijing, China

http://www.fdli.org/conferences/conference-pages/fdli-international-conference/overview

 

October 31-November 4, 2013

57th Congress

Union Internationale des Avocats

Macau, China

http://www.uianet.org/en/evenement/type-46987/57th-congress

February 28-March 1, 2014

Historical Origins of International Criminal Law

Forum for International Criminal and Humanitarian Law

Beijing, China

http://www.fichl.org/activities/the-historical-origins-of-international-criminal-law/

 

May 22-23, 2014

Antitrust in Asia

American Bar Association

Beijing, China

http://www.americanbar.org/calendar/2014/05/antitrust-in-asia–beijing.html

Doing Business In China. Seize The Day.

By Dan Harris on Posted in China Business

A friend of mine sent me an article today on how “mid-market” American companies are not doing enough to take advantage of money making opportunities in China. The article is entitled Still figuring out China and it starts out noting how America’s share of imports into China has shrunk from to 7% from 10% in 2000 and this shows “America is losing competitive ground to other countries in what is widely viewed as the biggest growth opportunity of the 21st century.”  My friend sent me this article (along with some others) after expressing strong frustration regarding his own company being too “chicken” to venture into China.

The article posits the following reasons for America’s lack of success in doing business with China:

  • Too much concern with China’s lack of IP protection
  • Anti-China sentiment
  • A lack of focus on China/a lack of support regarding China

I think all of the above are true and I will add one more. American companies tend to be more conservative about doing business internationally, particularly when it comes to countries very different from our own, like China. We are a big country and a big market and it is relatively easy to write off a complicated and difficult country like China.  The problem with doing that, however, is that by the time that country becomes “easier,” the companies that went in during more difficult times already have a massive leg up when it comes to things like name recognition and distribution, making it difficult to catch up.

Not saying all American companies should be looking at doing business in China.  Not at all.  But I do think too many American companies are ignoring great opportunities in China and like my friend, this frustrates me.

Are we off base here?  What are you seeing out there?

The New Era In China Product Supplier Relationships Requires New Contracts

By Dan Harris on Posted in Legal News

One of the themes we have been addressing for the last year or so is how the relationship between foreign companies and their Chinese product suppliers is maturing. A few months ago, in The New Role Of Written Contracts For Product Purchases In China we wrote of how rising product prices have increased the need for good contracts between foreign companies and their China product supplier and of how such contracts are becoming far more common.

There is an old saying that “good contracts make good partners” and that is even more true in a cross-cultural context, as we noted in China Contracts Make Sense:

A contract is the best way to make sure that you and the Chinese company with which you are contracting are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 30 days, it will say “yes” almost every time. But if you then put in your contract that the Chinese company must pay you a penalty if it fails to ship your product within 30 days, there is a very good chance the Chinese company will tell you that 30 days is impossible. At that point, you and the Chinese company should figure out realistic shipment dates and put that in the contract. You then know what is actually realistic to expect by way of shipment dates and you can act accordingly with your own customers. Spending the time to negotiate a contract with your Chinese counter-party, especially if that contract is in Chinese is the best way I know to achieve clarity before you lock yourself into a relationship.

With this increase in contracts between foreign companies and their Chinese product suppliers has come an increase in what I would describe as good relations between these two sides. Though I do not ascribe the increased use of contracts as the sole factor in the rising level of the supplier-purchaser relationship, I do see that as a factor.  But whatever is causing it, I am convinced it is happening because I am more and more hearing from foreign companies that rightly describe their relationship with their Chinese manufacturer as a partnership.  Foreign companies are becoming more experienced at dealing with Chinese factories and Chinese factories are becoming more experienced at dealing with foreign companies.

And with these real partnerships comes a desire from both the Chinese manufacturer and the foreign product buyer to “take the business to a higher level.”  This desire typically manifests itself with the two companies wanting to sell their “mutual” product in China (and sometimes elsewhere in Asia) together or to develop new and better products together. Neither of these things are particularly legally complicated but both of these things call for new contracts.

If you are going to have your Chinese manufacturer selling your product in China, you should, at minimum, enter into a distribution and/or licensing contract with your Chinese manufacturer. Your manufacturing agreement is not going to cover even close to the various important matters that are involved with using another party to market and sell your product.

For what is involved in a distribution contract with a Chinese company, check out the following:

If someone else is going to be using your trade name or logo in China or elsewhere, either through a distribution or a licensing arrangement, you are almost certainly going to want to register that trade name/logo as a trademark to make sure you and nobody else have ownership of those trademark rights. Here’s some information on that: China: Do Just One Thing. Trademarks.

If you are going to work extensively with a Chinese manufacturer to develop a new product, you need a specific product development agreement. These agreements cover the cost and procedure for development and ownership of the developed product. Many companies fail to enter into this kind of agreement and then discover that the Chinese side owns “their” product and/or molds at the end of the process.

What are you seeing out there?

China Importation 101, Part IV. AQSIQ.

By Dan Harris on Posted in China Business, Legal News

As China steps up its enforcement of its customs laws, it is becoming increasingly important for foreign companies doing business in China to understand those laws and how they are enforced. This is the final part of a four part series of posts by Shawn Mahoney designed to help you avoid China customs problems.  Go here for Part I, China Importation 101, which dealt mostly with the core concepts related to importing product into China.  Go here for China Importation 101. Part II, which mostly discussed China’s Harmonized Tariff Schedule and the similarities between China customs laws and US and EU customs laws. And go here for China Importation 101, Part III, which mostly deals with how to deal with China’s General Administration of Customs (GACC).  This post examines the most effective ways to communicate and interact with AQSIQ (The General Administration of Quality Supervision, Inspection and Quarantine).  Here is part IV of Shawn’s series:

Though just about everyone is aware of China Customs (GACC), many foreign companies doing business in or with China know little or nothing about the General Administration of Quality Supervision, Inspection and Quarantine (AQSIQ). This lack of knowledge is dangerous, as AQSIQ has more power than GACC in many aspects of importation approval. In today’s post I will introduce AQSIQ as an institution, with some brief advise on how best to interact with them.

AQSIQ is most widely recognized for its oversight of food/beverage products and scrap materials, yet it controls, directly or indirectly, thousands of products including:

  • Chemicals
  • Cosmetics
  • Any item which requires a CCC Mark
  • Items that require compulsory inspection
  • Specialized machinery like Refrigerators

All told, AQSIQ has 19 internal departments and 15 separate “affiliates” and it manages the administration of the Certification and Accreditation Administration of China (CNCA) and the Standardization Administration of China (SAC). AQSIQ has 35 Entry-Exit Inspection and Quarantine Bureaus (usually known as CIQ’s), nearly 300 branches, more than 200 local offices, nearly 3500 laboratories and tens of thousands of employees in China to assist with its mandate. To quote AQSIQ’s own website:

AQSIQ participates in the planning and checking of national ports opening up to the outside world. According to the relevant law, AQSIQ formulates the List of Entry-exit Commodities subject to Inspection and Quarantine of Entry-exit Inspection and Quarantine Agencies. AQSIQ administers the inspection and quarantine clearance for the entry-exit goods related to environment, health, animal and plant health, and human safety, and for transportation means and personnel. At ports, an inspection and quarantine clearance management model is applied to entry-exit goods, that is, “Inspection application first, and customs declaration second”.

According to the Law of the People’s Republic of China on Import and Export Commodity Inspection and its implementation regulations, AQSIQ carries out inspection and supervision on import and export commodity and its packaging and transportation means. AQSIQ conducts legal inspection, supervision and administration over commodities included in the List of Entry-exit Commodities subject to the Inspection and Quarantine of Entry-exit Inspection and Quarantine Administrations, and conducts sampling test over the non-listed commodities.

As evident from its own description, AQSIQ is responsible for inspecting and supervising the import and export of ANY product specifically listed under its authority and for sample testing non-listed commodities. I am always saying “Inspection application first and customs declaration second” to clearly signify how AQSIQ has greater relevant authority than GACC for all products in which it has been given statutory oversight. Yet virtually every month a company already exporting products to China will contact me with no knowledge about AQSIQ and no idea why AQSIQ has authority over their products.

Much like GACC, AQSIQ has become a much more efficiently run and managed institution over the last decade, especially in the last five years. However, it has not developed a professional relationship infrastructure like the Customs MCME system. This only heightens the importance of discovering in advance if AQSIQ has oversight over your product(s) exported to China. If it does have that authority, it is vital to learn as much as possible about the specific law and regulations pertaining to your product before you begin exporting it to China. Once you have acquired this knowledge, it is important to reach out and create a relationship with AQSIQ in the Chinese ports and cities in which your products will be imported and used. Depending on the circumstances, your WOFE office or your customer would work on creating this relationship.

Although there is no MCME system in place for directly working with AQSIQ, several laws have recently been enacted requiring registration by all exporters and importers in certain product categories, with the most notable being all food and beverage imports starting in 2012. This required registration allows foreign companies a foot in the door to create a working relationship with AQSIQ.

I will leave you with an example of the value in knowing the regulatory details regarding your product and in having a relationship with the appropriate branch of AQSIQ. A few years ago, I was working with dozens of customers in a specific part of the food industry. One customer in particular had an ongoing problem exporting one of its more valuable food products to China. Over the course of five years, AQSIQ had rejected every sample and order shipped by our client. Even though both the importer and exporters tests showed they were in compliance, AQSIQ continually claimed the product was outside the allowed limits for nitrate and nitrite.

We offered to assist our client in finding a workable solution to this ongoing problem. We quickly identified the AQSIQ standard allowing only three testing methods for nitrates and nitrites, two of which were never used in the US. Our next step was to approach a customer outside of the largest ports with a good working relationship with their local CIQ. Via this relationship, we approached the local CIQ and after several days we were able to agree among the three parties to:

  • Use the exact same testing method (the one we use in the US),
  • Use the same quantities of solution
  • Use the same fluid to create the solution
  • Share all test results

In the end, all tests came back nearly identical and all showed that the product was well within China’s standards for both nitrate and nitrite levels. Because of this, our customer was able to ship its product to China on a consistent basis for the first time in six years. This result would not have been achievable without the intercession of someone with an ongoing relationship with AQSIQ and a thorough understanding of the rules and regulations pertaining to that specific product.

China MOUs. I Really Do Care. Deeply.

By Dan Harris on Posted in China Business, Legal News

My last blog post was a CBC (Canadian Broadcasting Interview) regarding my reaction to press releases/media stories regarding North American companies entering into an MOU (Memoranda of Understanding) with a Chinese company. The point I made in the interview is that stories about such MOUs are just not worth much because the MOU itself could very well be non-binding. My whole point was that I just don’t view these announcements as a big deal because so often no binding agreement ever follows:

AK: And do companies and organizations in North America generally view them in the same way as their counterparts in China

DH: Probably yes, and the way they’re generally viewed is that they can range from being fairly important to being completely meaningless. So you don’t see them all that often between two North American companies, but they’re fairly common with Chinese companies and Chinese governmental bodies, because those companies and governmental entities like to show them off in China to show that they’re doing something outside of China. But whether they’re really doing something or not is always open to question. And quite frankly it’s really the same on this side, in that, when I see someone saying that they have a Memorandum of Understanding with a company in China, my first thought is “Yeah, so what. Why don’t you just wait to announce that you actually have a real deal?”

AK: So how do you tell the difference between an MOU that doesn’t hold much weight and an actual announcement of weight or actual deal that indicates a real relationship?

DH: When I see an announcement of an MOU, I really have no choice but to assume that it has no weight, unless and until something comes down the road later that shows that it did have some weight. And that something down the road later would be an enforceable contract. In my experience, MOUs lead to enforceable contracts probably less than 10% of the time. So when I read about MOUs, I just completely ignore them.

AK: So you don’t feel like there’s much weight to a press release or an announcement or a photo opportunity around an MOU?

DH: I feel like there’s no weight. In fact, my first reaction is, why are you announcing something that may or may not happen down the road? If something’s really going to happen down the road — if something’s really imminent down the road — then why not just wait until you’ve gotten down the road? Why are you taking the risk of acting as though some big thing has happened, and then two or three months later what are you going to do when it really doesn’t come to fruition? Are you going to issue another press release saying, “oh we were just kidding three months ago,” or are you going to do what most companies do, which is just say nothing?

In the same interview, however, I also made clear (or so I thought) that MOUs can and sometimes are binding on the parties that sign them:

AK: In your blog you do warn that MOUs with Chinese organizations can sometimes actually be more than they appear.

DH: That’s exactly right. That’s sort of the flip side of all of this, and that is that MOUs, in North America but even more so in China, sometimes are not really MOUs—they’re contracts. And the American company doesn’t realize that. We’ve had companies come to us and say “hey, could you help us with this MOU and then we’re going to have to figure out what to do to by way of a contract.” And then we look at the MOU and we tell them that under Chinese law this [what they thought was an MOU] is a contract. And a lot of times in those instances, that’s how the Chinese company views the MOU, and the American company didn’t even realize it. So they’ve gone over [to China] and signed something without the authority of the higher-ups in their own company, and that something they signed is a two-or three-year contract that they nobody ever really approved. So that’s the flip side of all of this. Just calling something an MOU doesn’t mean it’s an MOU as is commonly defined by North American business people.

Then at the end of the post, I referred back to one of our previous posts, The China MOU (Memorandum of Understanding). Use Them At YOUR Peril,on how MOUs can and sometimes are binding and that American companies far too often believe that simply calling something an “MOU” is enough to prevent them from being bound by the MOU they sign.

But for some reason, a number of readers missed this aspect of the post and I ended up getting hit with a flurry of emails pointing out how I was wrong to be so flippant about MOUs with China.  To the extent my interview was not clear, I accept the criticism and I want to clarify.  The point of my interview was to note how outsiders to an MOU have no idea regarding the meaning of the MOU as such documents can range from “hey let’s cooperate” all the way to a binding deal.  Generally though, if a company is going to announce an MOU, it means that they likely do not have a binding deal (or at least do not realize that they have a binding deal).  Put simply, if the company has a binding deal or thinks it has a binding deal, why bother announcing an MOU?

The post was not intended to minimize the importance of the MOU that you may go off and sign.  Far from it as these documents can be critical to anyone doing business in China.

One commenter talked of how they are important to Chinese companies and they are.  And as I keep saying, they also can be binding.  Where we often have a problem with them as lawyers is when a client comes to us with an MOU that says A and then wants us to draft a contract “based on it” that says B.  We then tell the client that going from A to B might offend the Chinese side and the client usually says something like, “but it is just an MOU.”  Yes, it is just an MOU, but binding or not, Chinese companies generally take these pretty seriously.  In fact, I cannot tell you how many times we stress to our clients the need to give us (as lawyers) a chance to review their MOUs before they circulate them because binding or not, MOUs do have meaning.  And just to be as clear as I can be: what you call an MOU may very well be what a Chinese Court or your Chinese counterpart calls a binding contract:

The impact of this difference is that we frequently see the following: American company comes back from China and shows me their five page MOU and says that they now want to work on a contract .  I tell them that what they have given me is probably a contract.  They tell me that I’m wrong.  I tell them to tell their Chinese counterpart that they now want a contract and see what happens.  Virtually every time, the Chinese company tells the American company that there is no need for a contract and then the American insists that there is and then the Chinese party thinks the American is being a jerk.  The parties have already gotten off on the wrong foot.

China MOUs can matter. China MOUs can be important.  China MOUs can be binding.  Believe it.

What more can I say?

What do you think?

China MOU. Like I Really Care.

By Dan Harris on Posted in China Business, Legal News

I was interviewed the other day by CBC Radio out of Canada for a story on the “Perils of Signing an MOU.”  The topic was the meaning of a Memorandum of Understanding (MOU) between American and Chinese companies.  Andrew Kurjata conducted the interview and he reaffirmed for me what I have already observed first-hand: Canadian radio and television newscasters generally go into their interviews better prepared than their US counterparts. Here is that interview:

 

AK: From ghost towns to universities, everyone wants to cash in on the booming Chinese economy. Yesterday, both the deserted Gold Rush town, now a tourist attraction, Barkerville, and the University of Northern British Columbia signed separate Memorandums of Understanding with delegates from Wuyi University in China. MOUs, as Memorandum of Understandings are called, are frequently used as photo opportunities for officials, but what do they actually mean? To find out we have reached Dan Harris.  He’s a lawyer specializing in doing business with China and the author of China LawBlog.com.  We have reached him in Seattle.

 

AK: Good morning.

DH: Good morning.

 

AK: First of all, what is a Memorandum of Understanding?

DH: Well, it really varies. It can be anything from a one-page document saying, “hey, let’s get together and maybe agree on something in the future” or it could be a 150-page document between two massive companies detailing what they want to do once all the regulatory hurdles and various other issues are resolved. Those usually involve at least one publicly traded company.

 

AK: And do companies and organizations in North America generally view them in the same way as their counterparts in China

DH: Probably yes, and the way they’re generally viewed is that they can range from being fairly important to being completely meaningless. So you don’t see them all that often between two North American companies, but they’re fairly common with Chinese companies and Chinese governmental bodies, because those companies and governmental entities like to show them off in China to show that they’re doing something outside of China. But whether they’re really doing something or not is always open to question. And quite frankly it’s really the same on this side, in that, when I see someone saying that they have a Memorandum of Understanding with a company in China, my first thought is “Yeah, so what. Why don’t you just wait to announce that you actually have a real deal?”

 

AK: So how do you tell the difference between an MOU that doesn’t hold much weight and an actual announcement of weight or actual deal that indicates a real relationship?

DH: When I see an announcement of an MOU, I really have no choice but to assume that it has no weight, unless and until something comes down the road later that shows that it did have some weight. And that something down the road later would be an enforceable contract. In my experience, MOUs lead to enforceable contracts probably less than 10% of the time. So when I read about MOUs, I just completely ignore them.

 

AK: So you don’t feel like there’s much weight to a press release or an announcement or a photo opportunity around an MOU?

DH: I feel like there’s no weight. In fact, my first reaction is, why are you announcing something that may or may not happen down the road? If something’s really going to happen down the road — if something’s really imminent down the road — then why not just wait until you’ve gotten down the road? Why are you taking the risk of acting as though some big thing has happened, and then two or three months later what are you going to do when it really doesn’t come to fruition? Are you going to issue another press release saying, “oh we were just kidding three months ago,” or are you going to do what most companies do, which is just say nothing?

 

AK: Frequently officials in North America, here in British Columbia, across Canada, stress that, in doing business in China, it’s a very long term process and you have go back and forth and take lots of little steps in order to get towards that big deal. Is that a correct assessment?

DH: Often times yes it is, but so what? That doesn’t mean you need to run off and announce that you’ve got an MOU. Now you can go off and announce that you’ve got an MOU, but what you’re really saying in most cases is that we are somewhere along the line of a long process of negotiating with a Chinese company, and that negotiation process may or may not ever result in anything real. And companies don’t usually announce that. I think the reason we see this sort of announcement happen with Chinese companies more often than we do with, let’s say, other North American companies, is that it makes North American companies feel better to be able to tell the world that, “hey, we’re trying to do something in China.” China is definitely the flavor of the week. Everyone is wants to get a ride on the train, even those who don’t really have a seat on the train want to advertise that they’re trying to get into the train car.

 

AK: In your blog you do warn that MOUs with Chinese organizations can sometimes actually be more than they appear.

DH: That’s exactly right. That’s sort of the flip side of all of this, and that is that MOUs, in North America but even more so in China, sometimes are not really MOUs—they’re contracts. And the American company doesn’t realize that. We’ve had companies come to us and say “hey, could you help us with this MOU and then we’re going to have to figure out what to do to by way of a contract.” And then we look at the MOU and we tell them that under Chinese law this [what they thought was an MOU] is a contract. And a lot of times in those instances, that’s how the Chinese company views the MOU, and the American company didn’t even realize it. So they’ve gone over [to China] and signed something without the authority of the higher-ups in their own company, and that something they signed is a two-or three-year contract that they nobody ever really approved. So that’s the flip side of all of this. Just calling something an MOU doesn’t mean it’s an MOU as is commonly defined by North American business people.

 

AK: Dan Harris, thank you for your time this morning.

DH: Thank you very much.

 

For more on MOUs with Chinese companies, and on the mistaken belief that such documents are never binding, check out  The China MOU (Memorandum of Understanding). Use Them At YOUR Peril.

 

Trademark Registration for Companies That WON’T Be Doing Business In China. Do You Want Some Fries With That?

By Dan Harris on Posted in China Business, Legal News

A few weeks ago, the China Law internet and listserve (yes, we lawyer-nerds still have a China Law listserve) was abuzz with an article on In-N-Out-Burger’s China trademark troubles. Surprisingly, the article was written by a just graduated law student.  I contacted that recent law school grad to request that he do a shortened version for our blog and he graciously agreed. The law grad is Bradley Sova and his vitals are as follows:

Bradley Sova graduated magna cum laude from Truman State University with a degree in Political Science and Chinese Studies. After completing additional language study at Tsinghua University, he earned his law degree from the William S. Richardson School of Law. In law school, Bradley completed extensive coursework on Chinese and international law, served on the board of the Asian-Pacific Law & Policy Journal, completed a semester at Tsinghua University School of Law, and worked for multiple Chinese law firms and international organizations. Bradley is currently preparing for the California bar exam and he hopes to work in China-related commercial law or international arbitration. His full paper on the issues discussed below can be found here and I urge you-all to read it.

Here’s Bradley’s blog post:

In late 2011, burger advertisements from an unnamed source sprang up in Shanghai promoting Double-Double, Animal Style, and Protein Style burgers, all of which are well-known staples of the West coast fast food legend, In-N-Out Burger. The ads, however, were not from In-N-Out, but were posted by a new company called CaliBurger, which had registered these names as trademarks in China and in several other Asian and Eastern European countries. CaliBurger’s restaurant design and business model also closely imitated the American chain.

Although In-N-Out was able to use CaliBurger’s corporate registration in California as a toehold to bring a Lanham Act claim in the United States, this toehold does not appear have given In-N-Out too much leverage. The two parties ultimately reached a confidential settlement, with CaliBurger slightly altering its burger names and décor and In-N-Out presumably paying CaliBurger a decent settlement to retrieve the trademarks out from under its Chinese doppelgänger. CaliBurger continues to operate in Shanghai and Guangzhou and recently signed franchise agreements for locations in Hong Kong and the Philippines. For its part, In-N-Out has been more vigilant in Asia, conducting multiple promotional activities throughout the region since its dust up with CaliBurger.

Trademark squatting is common in China, and American fast food brands have been fertile ground for Chinese copycats, as those who have seen places like Starbox Coffee or Pizza Huh can confirm. As such, it is easy to write this dispute off as yet another squatting squabble where an American company was forced to buy its American trademark names back in China. There are, however, several elements that should cause American brand owners to consider registering trademarks in China, even if they never plan to go there.

Like many companies facing Chinese copiers, In-N-Out had no presence in China nor any immediate plans to enter the Chinese market. Indeed, despite the pleas of many homesick Californians, In-N-Out has never ventured to the East Coast. Yet, In-N-Out ruthlessly pursued CaliBurger and was ultimately willing to pay to secure the Chinese burger trademarks. Its reasons for doing so reveal why Chinese trademark registration in China is important, even for businesses that may never end up doing business in China.

In-N-Out has limited its growth to protect its supply chains, customer loyalty, and, most importantly, its brand reputation. This is why In-N-Out has never left the American west despite over forty years of success and a cult-like following. CaliBurger, on the other hand, had no such quibbles about rapid expansion. Although expectations have since cooled, CaliBurger’s initial plans called for hundreds of locations in China and franchises in almost a dozen other countries. More than the trademarks themselves, the threat to its brand and paradigm that roused In-N-Out to confront CaliBurger. Like any zealous brand owner, In-N-Out could not allow confusion in China and elsewhere to tarnish its meticulously built identity.

Companies without plans in China should also understand the threat that judicious use of Chinese law can pose, especially in the hands of a savvy entity such as CaliBurger. The perception that Chinese IP law cannot be used effectively is wrong and In-N-Out’s dispute with CaliBurger shows that the exact opposite is true: with proper knowledge, China’s IP system can be used very effectively — against foreign brand owners.

In-N-Out never registered its company or burger names in China or extended its protection into China. Although the company is well known in America, a Chinese court would not possibly find that the burger names of an American regional chain meet China’s high standards of being well-known to the relevant Chinese public and thus deserving of trademark protection without registration. Additionally, even though CaliBurger’s American origins might indicate bad faith registration, Chinese law makes proving such conduct very difficult. Finally, China’s first-to-register system gave CaliBurger strong rights once it received its China trademarks. CaliBurger no doubt knew all this. It did not seek to skirt China’s IP law. It actively used the law as a shield, and In-N-Out was left with little choice but to sue in America and ultimately buy out the trademarks.

These facts by themselves are not unique; Chinese trademark squatters exploit the system everyday. What makes CaliBurger unique and what should frighten American brand owners, is that CaliBurger was a sophisticated, American entity capable of raising millions of dollars in capital to carry out its plans to simultaneously execute trademark applications and challenges in several nations. Additionally, its founders had the legal knowledge necessary to fulfill its plans in China. All four of CaliBurger’s founders had law degrees from California law schools and two had IP legal experience. This sort of threat is a far cry from the small-scale squatter or shoddy pirating scheme many envision when considering Chinese IP theft.

Though CaliBurger and In-N-Out’s dispute is just one incident, such activities are ongoing and increasing in frequency and sophistication. With such a threat, even those companies with no plans for doing business in China should at least consider trademark registration there.

What do you think?

 

China VIEs. Avoid, Avoid, Avoid.

By Dan Harris on Posted in China Business

Back in 2011, we were writing like crazy about the risks of China VIEs.  And every time we did, someone with a financial stake in one would tell us that we were being too negative.  VIE stands for variable interest entity and those are entities that are used to allow a company in China to technically be a Chinese domestic company, but de facto controlled by a foreign-owned entity or entities.  VIE structures are usually used to allow foreign companies to get involved in various sectors of China’s economy that are forbidden to foreign companies.

In our last piece on VIEs, entitled, VIEs In China. The End Of A Flawed Strategy, we vehemently set forth the proposition that they are to be avoided:

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 be avoided at all costs.

We have been speaking out against VIEs for years and just about every time we do so, someone says that if they are illegal, why have so many large law firms, large accounting firms, and large companies gone along with them? The answer is simple. Money. Big money. Really big money. Now, some of these same law firms and accounting firms and companies are denying that anything has changed. And why is that? Again, money. Only this time they are taking positions not so much to make more money going forward, but to avoid losing through lawsuits the money they have already made.

And then we stopped.  Not because our position on VIEs had changed, but because we had said our piece (way more than once) and it was time to move on.

I am writing on VIEs today not just to say to everyone who doubted us that we told you so, but to emphasize that whatever the risks were with VIEs back in late 2011, they are even greater now.  They are even greater now because exactly what we said about China’s laws forbidding VIEs has been borne out by a recent China Supreme Court case with a very unfavorable ruling for those invested in a VIE.

The New York Times Deal Book did an article on that case today, entitled, In China Concern about a Chill in Foreign Investment, on the recent case. According to the Supreme Court, the contractual agreements between the foreign and the Chinese company “had clearly been intended to circumvent China’s restrictions on foreign investment, and amounted to ‘concealing illegal intentions with a lawful form.’”  Though some commentators in the story talk of how such deals are more “sophisticated” today, in the end, they too are “intended to circumvent China’s restrictions on foreign investment….with a lawful form.”

The article goes on to note that since 2010, “Shanghai’s arbitration board has invalidated two variable interest entities that had been used by foreign companies to control onshore businesses. In one case involving an online game company, the panel applied China’s contract law to reach the same conclusion as the supreme court in the Chinachem case — saying that the variable-interest entities were ‘concealing illegal intentions with a lawful form.’”  It then quotes Paul Gillis (who truly knows whereof he speaks when it comes to VIEs) to the effect that “China is attacking these VIE structures and the other ways that people have used legal form to get around the substance of what Chinese law says you can’t do.’

We were not surprised.  Were you?