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China Hiring. Background Checks Required.

Posted in China Business

Just read a post on the China Leadership Blog, entitled, Why China Hiring Background Checks: We now have 15 reasons. The post was on the writer’s hiring agency had narrowed down job candidates to 15 and none of the 15 passed the background check:

We were placing a GM for a Western family owned factory. They are small and troubled.  We found 15 thoroughly qualified candidates for the position. We had candidates tell us they worked at a company 5 years when they only worked 1. We had candidates tell us they were super valuable,  and the company does not want to let them go. We were able to find out that they were fired a year before  while still in probation.

As the last of the group of 15 refused to come clean and give us an accurate resume, we shook our heads in dismay. We are excellent at interviews and interview 90 minutes as our goal is to know. Despite that, we were unable to uncover these issues before the background check.

We had one guy tell us he was the overall manager for a big project, and he could describe in great detail all he had done. Our China hiring background check uncovered that he was a common worker under a manager who led that project.

I suspect many are surprised by the above, but I can tell you that if I told this to the China lawyers at my firm, not a single one of them would be surprised. In fact, their reaction would be along the lines, of “so.” We see this sort of thing ALL the time, with employees of our clients and with the Chinese companies with which they do business. Just the other day, an American company called to see about getting out of a long-term exclusive product distribution agreement it had signed with a Chinese company that claimed experience with selling a particular product, but had actually been in an entirely different business.

Bottom Line: Trust but verify. Conduct your due diligence.

Selling Into China. Because There Is Lots Of Money To Be Made.

Posted in Basics of China Business Law, China Business, Legal News
For years now, we have been screaming writing about how it is eminently possible to sell product and services to China without having a legal entity in China and with no personnel in China. And we get heat just about every time we do.

The heat comes from China consultants who fear the demise (0r at least a decline) in their business if foreign companies cease creating full-scale and expensive presences in China. These consultants insist that it is either legal impossible or just not feasible from a business perspective to sell into China from overseas.

Our response to these naysayers is always the same: we have plenty of clients minting money from China without a Chinese entity or a single company person on the ground in China. We then qualify it by saying that the appropriateness of such a strategy really does depend on the individual company’s product or service and various other legal and factual situations. In other words, selling into China from outside China can range from being a great solution to a terrible idea.

I thought of all this today after reading a fascinating New York Times Dealbook article by David Gellis, entitled, Alibaba Is Bringing Luxury, Fast, to China’s Middle Class. To grossly summarize the article, foreign companies are making money selling high end luxury goods (even food) into China through TMall.

Yes they are.

From the legal side, we as China lawyers deal with the following issues (among others):

  • China compliance issues. Is the Chinese entity facing any sort of sanctions? Is the Chinese entity one that is likely to cause our client corruption problems.
  • Product compliance issues. Is the product our client wants to sell into China legal in China? What sort of packaging/labeling is required? What about customs and duty issues?
  • The contracts between the foreign company and the Chinese company, be it a sales agreement, a distribution agreement, a consignment agreement, or whatever.
  • The intellectual property issues. Just because you do not have a company in China does not mean that you cannot and, more importantly, should not be doing everything you can to protect your IP in China, especially your trademarks.
  • Figuring out the best way for our client to get paid so as to minimize taxes.

For more on selling into China without being in China, check out the following:

China Law For Foreign Companies Doing Business In China. It’s Real.

Posted in Basics of China Business Law, Legal News

Pretty much since we started this blog, we have written posts that essentially set forth the following mantra:

  • China has laws.
  • China increasingly is enforcing those laws, against both domestic companies and foreign companies operating in China. Probably more against foreign companies operating in China than against domestic companies.
  • You are entitled to complain about the harsher enforcement of China’s laws against foreign companies as compared to as against domestic companies.
  • But you ignore China’s laws at your own peril.

Uber China lawyer Stan Abrams just came out with an excellent post that pretty much sets forth the above for the updated China world, which involves a stepped up crack-down on foreign companies. Stan’s post, entitled, Foreign firms ‘must follow Chinese law’ – Who Knew? quotes a Chinese government official who himself was quoted in a China Daily article, Foreign firms ‘must follow Chinese law’:

The government’s recent intensive antitrust investigations were conducted following Chinese laws and never purposefully targeted any enterprises, Lu Wei, minister of the Office of the CPC Central Leading Group for Cyberspace Affairs, told a panel during the World Economic Forum in Tianjin.

“China’s governance of the Internet follows the ‘bottom line’ approach, and all foreign Internet enterprises in China must follow the ‘bottom line’ of abiding by Chinese laws. There are two points. The first point is safeguarding the interests of China, which is very clear. The second point is safeguarding the interests of Chinese consumers, which is also very clear. Foreign investors, if they follow the two points, will be OK and welcome,” Lu said.

Stan then analyzes the above quote. He starts out by noting that the part of the quote about “safeguarding the interests of China,” isn’t “empty fluff.” He then writes about why it is important it is for foreign companies to understand how their company’s goals align (or not) with Chinese government interests:

Although it’s not always stated up front, and not in every law that pertains to company behavior, most folks know that if corporate interests are in sync with government priorities, that’s a huge benefit.

Example: Company A sells a clean coal technology to power plants. China is trying to fight pollution. Result – Company A, all else being equal, will do pretty well in China, at least in the short term. In contrast, Company B sells luxury watches that most people can’t afford, but the watch has been a preferred way of gifting government officials. But China is fighting corruption. Result – the watch company’s sales are going to tank, at least in the short term.

Stan’s views very much correspond with our own, as expressed in the post, China’s 12th Five-Year Plan. Go With It, Not Against It:

[I]f you want to know where China is going over the next five years, read the plan, as China has and will continue to hew closely to it.  If your China business plan coincides with China’s Five-Year Plan, your likelihood of success will be considerably greater than if it does not…..To put it another way, “the trend is your friend.’

Stan then talks about how with all the recent investigations and fines being levied against foreign companies, foreign companies “feel like they are being singled out, while Beijing is saying: 1) most of our targets are domestic firms; and 2) but you broke the law” and then highlights why all of this really really matters to foreign companies doing business in China:

Bottom line here is that in the minds of regulators, these foreign firms have run afoul of local law and must face the consequences. As they are going to avoid commenting on specific cases, their only response is to say “Hey, follow the law and do what’s good for the country, and everything will be fine.” And if you don’t . . . well, bad things can happen.

So when a government official here says that foreign companies must safeguard the interests of China, you best pay attention. That is not the usual blah blah blah, but a very clear statement of reality.

He is absolutely right, of course. China is going after foreign companies and whether or not it is also going after domestic companies is of far less relevance to foreign companies, especially those that have experienced problems. And it is not just the foreign companies that are making the news. In the last few months alone, we have received phone calls or emails from foreign SMEs operating in China and reporting the following:

  • A very small company in a relatively small city had four of its five American employees — all of whom had been granted work visas by Beijing — denied their residency permits because the business was not making “enough money” to support so many expats. This was the local governments way of saying that we do not think you are reporting enough income and paying enough taxes and if you are not going to economically support us, we are not going to support you.
  • A mid-sized company in a mid-sized city told that if it did not pay at least double the amount of taxes next year, its use of foreign employees would be re-examined. The local taxing authorities believed that this company was not reporting all of its income and was penalizing them for this.
  • Two American companies operating as Rep Offices told to shut down their China operations and go home because they were exceeding the bounds of what Rep Offices are supposed to do in China. One American company operating as a Rep Office told that by next year it would need to be a WFOE or it too would be gone.
  • Multiple cases of companies being told that they need to stop buying so much of their raw material from outside China (i.e. Hong Kong) when that raw material is easily available within China. We find this particularly interesting because the Hong Kong companies from which the raw material is purchased are actually mainland Chinese companies that have illegally set up operations in Hong Kong so as to avoid paying mainland China taxes. We see this as part of China’s renewed effort to stop its own citizens and domestic companies from pushing money out of Mainland China. See Getting Money Out Of China. That’s Illegal.

We are absolutely convinced that Chinese government officials have been instructed to crack down on rule breakers, but because our law firm does not represent any Chinese domestic companies in their China legal matters, we have no idea whether this widespread crackdown is being also happening to Chinese domestic companies as well. But again, for foreign companies more interested in being able to operate in China than in geopolitical issues, the impact on domestic companies is usually going to be of only peripheral (if any) importance.

The bottom line is what Stan says: “‘follow the law and do what’s good for the country [China], and everything will be fine.’ And if you don’t . . . well, bad things can happen.”

China Non-Competes. Oh, Oh, The Price You’ll Pay

Posted in Legal News

A Non-Compete Agreement is a contract where one party agrees not to compete with the other. These agreements reduce the likelihood of someone using information you provide them to compete against you. Non-compete agreements are fairly common between Western companies and their more important employees and it is common for those Western companies to want similar such agreements with their China-based employees.

In China non-compete (竞业限制) agreements between an employer and an employee are generally limited to senior management, senior technicians and other personnel who have a confidentiality obligation. China allows for non-compete agreements that prohibit high level employees from working for another company that competes with the employer.

China limits these non-compete provisions to two years or less after termination of the labor contract and it also requires that the employer pay economic compensation to the employee to maintain the non-compete requirement. There are a number of things to which an employer with a non-compete agreement should pay attention, but in this post I only focus on non-compete compensation. The most important thing employers must know about non-compete compensation in China is that the employer is required to pay this compensation after the employee leaves the company and a failure to do so means the employee ceases to be bound by his or her agreement not to compete.

Pursuant to the Judicial Interpretation IV of the Supreme People’s Court on Several Issues Concerning the Application of Law in Hearing Labor Dispute Cases (“Judicial Interpretation IV”), if there is an agreement between an employer and an employee regarding post-employment compensation for a non-compete provision, their agreement prevails. If the agreement is silent on the amount of post-employment compensation for the non-compete provision, the employer must pay the employee compensation at 30% of the employee’s average monthly salary in the 12 months before termination, or the local minimum wage, whichever is higher.

Before Judicial Interpretation IV, there was no statutory guidance (other than Labor Contract Law which does not say much) on the standard of non-compete compensation and locales dealt with this issue by coming up with their own rules. For example, Shanghai used to hold that if there was no agreement on the amount of post-employment compensation, the employer had to pay the employee 20% to 50% of the employee’s last monthly salary. In Jiangsu, the rule was different: the annual non-compete compensation had to be at least one third of the annual salary the employee received from the employer over the 12 months before leaving employment. Though Judicial Interpretation IV is supposed to supersede all the local rules, it is nonetheless advisable to check with the relevant authorities to figure out exactly what their standard is as we are still finding local differences.

A literal reading of Judicial Interpretation IV would mean that even if the amount of compensation agreed to in a non-compete agreement between an employer and an employee is less than the local minimum wage, it is nevertheless valid and enforceable, because the 30% rule applies only when the non-compete agreement does not specify the compensation. But ex-employees could also argue that any amount less than the minimum wage is unfair and against public policy and thus should not be enforced. Some municipalities faced with this argument, including Shanghai have upheld the “freedom to contract” and ruled against the poorly paid ex-employee.

The key is to draft your non-compete provisions (in Chinese, of course) in a clear and easy-to-understand manner so that your employee cannot claim confusion and so that the specified non-compete compensation will not trigger a default compensation rate. I will cover more on non-compete agreements in our future posts.

 

 

 

Does a “Prudent” Market Entry Strategy for Healthcare Services in China Exist?

Posted in China Business

The below is part II of guest posting by Ben Shobert and Damjan DeNoble, partners at Rubicon Strategy Group, LLC, a strategy advisory firm for healthcare companies going into China and Southeast Asia and the co-authors of HealthIntelAsia.com, a website dedicated to Asia and China healthcare business strategy. Ben also has a regular column on Forbes, where he writes about life science issues in Southeast Asia.

Our last post introduced how regulations around foreign investment in China’s hospitals are changing, with the most recent announcement of seven WFOE pilots as evidence of these changes. Experienced China watchers easily recognize what is happening:  China has acknowledged that it has a problem which only foreign expertise and capital can fix.

Consequently, it is reforming its Foreign Direct Investment (FDI) Catalog, and associated sector-specific regulations, to accommodate more foreign involvement. This process is hardly unique to hospitals. Every other previously closed sector of the Chinese economy that is now open to FDI has gone through a similar process. Though it helps to be able to compare today’s opening of the hospital sector to efforts in other industries that have opened to foreigners, doing so is misguided in some important ways that impact go-to-market strategies for western hospital operators and investors.

First, while in form WFOEs are now possible for China’s hospital sector, it remains unclear whether as a foreigner you should really try to go it alone. If, as a western hospital provider, you want to take the WFOE path, you need to be very sure you can get the land you need, located in proximity to where your market exists, and that the requisite medical institution licenses you will need are obtainable without a Chinese partner.  One need look no further than German hospital operator Artemed, and their July 2014 announcement about their work in the seemingly progressive Shanghai Waigaoqiao Free Trade Zone, to see that even here a foreign operator found they needed a domestic Chinese partner.  Simply because a WFOE status within a particular sector has been given the green light by China’s central government doesn’t mean as a foreigner you still aren’t going to need a domestic Chinese JV partner.

Second, be very clear eyed about where profit resides in China’s healthcare economy.  In late 2013, we worked with CN Healthcare on a study of how much capital had been invested into China’s private hospital sector and why. The answer was telling: of the roughly $1.7 billion in capital that had been invested in China’s hospitals, almost all of it came from domestic Chinese players, and almost all was driven by pharmaceutical companies and distributors who viewed purchasing a Chinese hospital as a way to protect their profit margins in the wake of growing price pressures on pharmaceuticals sold via the hospital. For those reading this unfamiliar with China’s hospitals, keep in mind that historically one of the most important sources of revenue for Chinese hospitals has been the sale of pharmaceuticals. As China has developed more sophisticated reimbursement strategies such as those embodied in the Essential Drug List (EDL), hospitals have struggled to replace lost revenue from lower prices on pharmaceuticals with pricing models that emphasize services. This is hardly news; McKinsey China’s 2012 analysis of the Chinese healthcare consumer emphasized the challenges facing private healthcare operators given the resistance by Chinese consumers to pay for healthcare services. In other words, don’t assume the value of your services is going to be immediately clear to the Chinese consumer. In fact, the Chinese consumer is wary about private healthcare in general, and private hospitals in particular.

Third, be extremely cautious about the public-to-private option with Chinese hospitals.  Running in tandem with the gradual relaxation on foreign ownership of Chinese hospitals has been a set of policies from the Ministry of Health (MOH) that allows for formerly public hospitals to be privatized. In theory, foreigners now have at least three go-to-market options: greenfield (build an entirely new WFOE hospital from the ground up), public brownfield (buy and privatize a formerly public hospital), and private brownfield (buy a formerly Chinese privately run hospital and transfer ownership).  Let’s just say that if you are looking at a hospital in China that is for sale – whether public or private – it’s safe to assume there is a really good reason the hospital is for sale in the first place. You need to quickly get to the bottom of why the hospital is for sale, as well as the rights you have as a foreigner purchasing these assets (hint: hospital ownership and management laws are about as developed as company law was in China in 1985, which is to say, not very).

Fourth, have a bias towards a healthcare delivery model that is extremely easy to articulate to the Chinese consumer. What do I mean by that? Too many westerners bring ideas about what they want to do in China based on how healthcare is consumed and paid for in the west. China’s healthcare needs are so overwhelming, and the potential market is so large, that it can be easy to assume whatever capacity you build out will be successful.  If we look at the revenue growth and profitability of three publicly held healthcare operators in China – iKang, Concord Medical, and Chindex – we can see very different revenue and profitability trajectories. Specifically, iKang and Concord are growing at very high growth rates (iKang’s 2011 revenue was 68.23 million USD, by last year they had achieved $202.3 million USD in revenue; Concord’s 2011 revenue was $372.05 million USD, by last year Concord had grown to $980.63 million USD).  Chindex’s revenue growth and profitability has been sufficiently uneven that, as we pointed out yesterday, they are being taken private later this month. There are a couple of ways to interpret this, but one important narrative is that iKang and Concord have a very specific set of treatments and interventions they market to the Chinese middle class consumer versus Chindex’s United Family Hospitals that are more general and perceived by the consumer to be less specialized in the care they offer.

The last component that should reinforce anyone looking to make an investment in China’s hospitals is an awareness that healthcare in China is a political hot potato. While today FDI policies in the hospital sector are perceived as “friendly” to foreign capital and expertise, we need look no further back than last summer at the GSK scandal to recognize that China’s government faces a fundamental challenge to its legitimacy as a consequence to decades of under-investment in the country’s healthcare system, and that it will use tactics of public trial and blame to distract Chinese families from problems that are entirely of the government’s own making. Yes, be positive about what China is doing in the hospital sector but also never lose sight that foreign involvement in this part of the country faces some of the most unique political pressures of any sector that has opened to foreign investment in the last decade.

China’s Hospital Sector Opening to Foreign Investment. Fools Rush In?

Posted in China Business
The below is a guest post by Ben Shobert and Damjan DeNoble, partners at Rubicon Strategy Group, LLC, a strategy advisory firm for healthcare companies going into China and Southeast Asia and the co-authors of HealthIntelAsia.com, a website dedicated to Asia and China healthcare business strategy. Ben also has a regular column on Forbes, where he writes about life science issues in Southeast Asia.

 

How much is a policy in China worth before it is implemented?

That is the question at the heart of the recent pilot pilot project announcement allowing for seven wholly foreign owned (WFOE) hospitals in three cities (Beijing, Tianjin and Shanghai) and four provinces (Jiangsu, Fujian, Guangdong and Hainan). On their face, these projects are going to create hospitals entirely owned by foreign investors.

Beyond the formal language of the pilot, however, what kind of system infrastructure is in place to support WFOE hospital structures?

China has a long history of instilling misplaced optimism regarding foreign investment into its health care sector, going all the way back to 1989, when the first liberalization of physician rights to practice outside of public hospital settings were tested, and the first calls for joint venture and cooperative joint venture hospital projects were sent out. To make a long story short, the optimism has for the most part been largely unfounded.

At the end of 2011 there were less than 100 foreign invested hospitals in China and, of these, these hospitals, less than 3% (2 hospitals total) are classified as general hospitals, compared to 61% of Chinese-owned hospitals being classified as the same. Moreover, more than half of the hospitals had investments of less than USD 2 million, while those with investments of more than USD 10 million accounted for only around 10% of the total. See China healthcare joint venture and WFOE policies and regulations where we wrote about how in 2012 widespread optimism about an opening up to foreign healthcare investment had been quashed.

China currently allows foreign investors from Macao, Hong Kong and Taiwan to wholly own a China hospital but the results of that partial opening up have been inconsequential. Until recently the only foreign hospital WFOE was Landseed International Hospital, a Shanghai 100 bed facility set up by Taiwan’s Landseed International Group, about which its superintendent admitted had managed to “roughly” break even and that due to high investment costs and low returns, Landseed is still the only Taiwanese company to set up a fully owned hospital in China since 2011.

You may at this point be asking, why is a developed legal structure to develop WFOE hospitals is important given that despite the virtual lack of governing principles in the past, foreign investors were still able to set up close to 100 hospitals that didn’t close down within a short time of their establishment? Furthermore, even though these hospitals are only covering costs or being mildly profitable in the short term, isn’t China always being sold as a long term play by sophisticated China commentators?

Foreign joint venture companies generally face similar difficulties. Even Chindex, probably the best known and most respected foreign investor in Chinese hospitals, recently cited the following reasons for deciding to sell the company:

  • The risk of relying on Company forecasts given the Company’s track record on failure to achieve projections.
  • The uncertainty of the legal, regulatory and business environments for healthcare service companies in China.
  • The risk of not being able to obtain financing for expansion plans.
  • The company’s prospects in the absence of being able to move forward with its expansion plans.

The uncertain “legal, regulatory and business environments” to which Chindex referred likely include the fact that foreign invested hospitals typically operate in a tangled, undefined network of competing central level government organs and ministries and local and provincial government bodies.

With all the difficulties foreign hospitals face in China, foreign investors have been and will continue to be reluctant to invest sufficient funds to make foreign hospitals competitive in China, notwithstanding the recent announcement regarding WFOE ownership of China hospitals.

In part II we will discuss prudent strategies for Western companies looking to make a healthcare play in China, including the benefits of entering China’s healthcare market now, as opposed to waiting “until things get better” later.

Identifying Your China Risk Factors

Posted in China Business, Legal News

China is in the midst of what appears to be a concerted government crackdown against foreign companies doing business in China. This has led many of our clients to ask themselves (and our China lawyers): “Are we at risk, and if so, how much risk?” Our quick answer is always “yes.  Hard to say.”

The risk usually depends on all sorts of factors, including the following:

1. How does the Chinese government categorize/view your China business’s industry?If your China business is in a restricted industry or one in which China’s citizenry has major concerns (food and medicine are classic examples), your risk is almost automatically high. If your China business is in an industry that requires you to joint venture with a Chinese partner, your risk is also almost automatically high. Ditto if your business is in an industry the Chinese government views as its own province, such as SAAS, cloud computing, the internet, publishing, and telecom. Andrew Hupert at ChinaSolved makes a similar pointwhen he notes how China’s “bureaucracy is much more tolerant of overseas companies that spend than of overseas companies that earn in China.”

2. Do the Chinese people consider your industry to be their government’s responsibility? Health care and education immediately spring to mind and we have had a number of our clients in those two areas have been subjected to intense government scrutiny for activities that probably would have been ignored in other industries. See GSK (not our client).

3. Does your China business rely on cleverly written contracts designed to get around China law? Chinese courts generally do not look kindly on companies that do this. As noted by our own Steve Dickinson in a recent article, “Chinese law contains a clause that deems all contracts concealing illegal intentions in a lawful form; to be invalid.” As your China business has only void contracts to rely on, the risk of this type of arrangement is high. If you are in China via a VIE (quasi alliteration intended) you have been warned.  See China VIEs. Avoid, Avoid, Avoid.

4. Do you know what your Chinese staff are doing? As much as we hate to say it, but virtually every instance we have seen of foreign companies getting into trouble in China involved a foreign company that gave too much leeway to its Chinese staff. This alone increases your risk as there is an inherent conflict in that your Chinese staff will want to do things the “China way” but you will be judged by the government against the “foreign standard.”  For more on this, check out the following:

5. Ultimately, what is the culture of your China business? Are you relying on “strategic” relationships to work around the letter or even the intent of China’s laws? Do you know well those with whom you are doing business? Are things happening at your company that make you uncomfortable? Do you feel like things are happening at your company behind your back? If you answered “yes” to one or more of these, you are probably at high risk.

If you are serious about mitigating risk with your China business in the current environment, get serious about compliance by doing what you can to improve your answers to the above questions.

UPDATE (by Dan Harris): My long-time friend Jeremy Gordon will on October 1 be coming out with a book, entitled, Risky Business in China: A Guide to Due Diligence.  I have talked enough with Jeremy about his upcoming book, seen enough portions of the book, and also worked enough with Jeremy enough to be able to guarantee this will be a great book and to urge everyone to buy a copy. Amazon describes it as follows:

Risk is a major reason that companies fail in, or fail to enter, China. This unique book demonstrates how correctly-applied due diligence can not only reduce business risk in China, but also provide excellent business intelligence to support negotiations and business relationships. Based upon the author’s twenty years of consulting experience in China, this practical book is packed with real-world case studies of failures and successes, providing a valuable and detailed ‘road map’ to avoiding the most high-profile pitfalls of business in China.

I believe it.

Shanghai Free Trade Zone. Still A Yawn.

Posted in China Business, Legal News

Gabriel Wildau of the Financial Times, recently wrote an article nicely summed up by its title: Shanghai free-trade zone struggles to live up to its hype.  She starts her piece by saying that “the disappointment is palpable, with scant progress on loosening capital controls or liberalizing interest rates.”

Even those who have gone into the zone seem unable to extol its benefits and discuss it in terms of “hype” not benefits:

Even US ecommerce group Amazon, which last month announced plans to open a logistics warehouse in the zone, was vague about the benefits of operating in the zone beyond geographical proximity to consumers.

Few people expected immediate breakthroughs on financial reform. However, the near total lack of substantive changes has led to cynicism among bankers.

“It’s been mostly hype so far,” said a loan banker in Shanghai who works with small and medium-sized companies in the zone. “Nothing has really changed.”

*   *   *   *

Investors deserve some blame for buying into the hype. Chinese policy makers have maintained a resolutely cautious approach over the past two decades to any financial reforms that could potentially destabilize the economy.

This very much corresponds with what we wrote about the Shanghai FTZ in The Shanghai Free Trade Zone. Yawn. In that post, we had this to say about the Zone:

I was talking with a China lawyer based in Beijing the other day and at one point he mentioned that he had recently been to a talk on Shanghai’s Free Trade Zone. When I asked what he had learned from that talk, he said something like the following:

Three people talked about the FTZ. One person from a big accounting firm, one from a big law firm, and one from the FTZ itself. They all essentially talked about how great it was and about how great it would be but really, neither I nor anyone else there with whom I talked could figure out one concrete reason why to bother with it.

I thought of that today after receiving a link to a [previous] Financial Times article that pretty much says the same thing. The article is entitled, Benefits of Shanghai free-trade zone still shrouded in mystery, and it pretty much says exactly what my lawyer-friend said. That a bunch of people with an interest in seeing the Shanghai FTZ become something important are out there proclaiming its importance, but when pressed on why it is important, they have no answer.

I am also reminded of a friend of mine who is in-house counsel at a very large tech company in China who is always getting calls from people at his company complaining that their company isn’t doing more with the Shanghai FTZ, especially in comparison to other foreign companies. My friend says he responds by asking what more they should be doing and what exactly other companies are doing that is leaving his own company in the dust. He says that these questions produce either stammering or silence and he has yet to receive a real answer.

Shanghai’s FTZ, what is it good for? Absolutely nothing?

China Product Development Contracts: The Questions We Ask

Posted in Basics of China Business Law, Legal News

We often write on how foreign companies outsourcing their product manufacturing to China need an NNN Agreement (in Chinese), an OEM Agreement (in Chinese), and their trademarks registered in China. For most companies seeking to manufacture product in China, those three are enough.

But for those foreign companies that do not have a finished product ready for manufacturing, a fourth item is oftentimes needed: a product development agreement. If you are going to work extensively with a Chinese manufacturer to develop a new product, you probably are going to need a product development agreement. These agreements cover the cost and procedure for developing a product. Many companies fail to enter into this kind of agreement only to discover later that the Chinese side owns “their” product IP or the molds or the tooling at the end of the process.

And what better way to give you a better idea of the sort of thing that should go into a China product development agreement than to list out the initial set of questions our China lawyers typically ask our clients to gather the information needed for drafting such an agreement. Those questions are as follows:

1.    Scope of Work

  • What products will this development agreement cover?
  • Will there be a formal timeline with specific milestones? If so, please describe the timeline and the milestones in as much detail as possible, including prototypes, the evaluation process and any required certifications.

2.    Development Costs and Budgeting?

  • Which party will pay for development, design and engineering costs?
  • Which party will pay for tooling and molds?
  • Which party will pay for supplies and equipment?
  • How will costing and approval of such expense items be handled?
  • Will a formal development budget be drafted? If yes, how and on what schedule?

3.    Development Proposal

In what form will the development proposal be provided to the Chinese side? A general concept? Detailed drawings? A physical sample? Consider the following two extremes. In some cases, the foreign side simply has a very general idea of a product, perhaps just a sketch. In this case, the Chinese side will work with the foreign side to develop the product “from scratch.” At the other end of the scale, the foreign side has a fully developed working prototype and the issue is merely whether the Chinese manufacturer can make the product at a certain price and quantity?

4.    How will the target for the final product be determined? Will a target of price, quantity, timing of delivery be set in advance, or will this be worked out during the development process?

5.    IP Issues

  • Which party will own the IP created during the development process (including physical items such as prototypes and tooling)?
  • Will the Chinese side have any restrictions on its use of the IP created during the development process, manufacture of similar products?

6.    Relationship of the development agreement to the subsequent manufacturing agreement/OEM Agreement

  • If the Chinese side meets the targets/milestones, will you still need to enter into an OEM agreement with them for the manufacturing of the developed products?
  • If there will be an OEM agreement, will it be an exclusive one? For example, can you go to another Chinese manufacturer? Can you go to a manufacturer in another country? Can you manufacture the product yourself in the United States or elsewhere?
  • What happens if you decide not to manufacture the product at all?
  • What if you use another Chinese manufacturer?
  • What if you abandon the project entirely? For example, in a recent product development agreement we drafted, the parties agreed that if the Chinese side met all of the requirements of the agreement and yet the foreign side still decided not to go forward with actual production of the product, the foreign side would be required to pay a fee to the Chinese side.

China Compliance: The Mooncake Version

Posted in Basics of China Business Law, Legal News

The Mid-Autumn Festival is coming and mooncakes will soon be given to Chinese family, friends, and colleagues to demonstrate appreciation for these individuals’ generosity throughout the year. Most will exchange delicious mooncakes during the Mid-Autumn Festival with the purest of intentions. However, the holiday also provides an opportunity for individuals with less admirable intentions to corruptly curry favor with influential political and business contacts through extravagant and valuable gifts.

Keeping with tradition, individuals trying to corruptly influence others may gift mooncakes in expensive tins or containers in order to impress officials and win favor. Others may go the less culinary route and gift mooncakes made of precious metals or stones. Still others may break (?) with tradition all together and provide gifts of valuable goods or cash (sometimes inside the mooncake), in an attempt to win influence.

China is aware of and attempting to address the “mooncake corruption” issue. Focusing efforts on public servants, China’s Central Commission for Discipline Inspection and the Communist Party’s Central Committee warned government officials of using public funds to purchase luxurious mooncake gifts. It has even created a new website to report those who do.

Companies operating in China should never waste opportunities to enhance compliance initiatives. The Mid-Autumn Festival and the Chinese Government’s “Mooncake Anti-Corruption Measures” provide companies in China a unique opportunity to instruct their company officials and employees – as well as their Chinese vendors, customers, and agents – on the very real corruption risks that China is clearly and publicly addressing. The Mid-Autumn Festival’s gift-giving focus also provides an instructive backdrop for companies to assess their efforts to ensure they are appropriately complying with Chinese and other countries’ applicable laws and regulations that may impact their Chinese operations:

  • Does the company have a Compliance Officer, a Compliance Group, or an employee that generally reviews the company’s compliance with legal and regulatory requirements?
  • Does the company have corporate compliance and ethics policies that are distributed, discussed, and enforced with its employees and agents?  Are they written in the language or languages that its recipients truly understand?
  • Has the company implemented procedures that address such issues as reporting compliance concerns (e.g., gift giving)?

China’s Mid-Autumn Festival provides a good opportunity to address company compliance concerns. And a company meeting to discuss compliance issues provides a great opportunity to share mooncakes with your colleagues.