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How To Form a WFOE in China, Part 2: The Eight Core Issues

Posted in Basics of China Business Law, China Business, Legal News

Yesterday, I wrote here about the questions our China lawyers ask our clients for whom we are forming a China WFOE. Today I step back a bit to focus on the issues that we deal with in determining whether a China WFOE makes sense for our clients at all. In future posts in this series I will focus on the nuts and bolts of what is involved in forming a Chinese company (including the minimum capital requirements) and in the final post, I will discuss the most common mistakes we see made when trying to form a Chinese company.

As China’s economy continues to slow, its tax crackdown on foreign companies operating improperly in China continues to accelerate. As difficult and expensive as it is to form a China entity (WFOE, Joint Venture or Rep Office), foreign companies doing business in China are increasingly realizing that not having an entity will in the long run cost them much much more.

China WFOE Formation requires care

Are you ready for sprouting a China WFOE?

Starting a business in China usually involves forming a Wholly Foreign Owned Entity or WFOE. Forming and getting a China WFOE up and running involves more than simply securing Chinese government approval for the new entity. It also usually implicates the following eight core issues as well.

1. Do you need a China entity at all? Forming and operating a China WFOE is expensive and time consuming. Therefore, no WFOE should be formed unless truly necessary from a legal or a business standpoint. For this reason, the first thing our China attorneys do when retained to form a China WFOE formation is to work with our client to determine whether a WFOE is truly necessary. For more on this, check out How To Manufacture In AND Sell In China Without A WFOE.

2.  Will your WFOE even be legal? There are still many industries in China in which a WFOE is not allowed, but a joint venture is. And sometimes, though incredibly rarely, a Representative Office (Rep Office) makes sense. See also this article I wrote for Forbes: Do This One Thing Before Doing Business In China.

3. Should a Hong Kong company own your China WFOE? Forming a Hong Kong company to own a China entity depends on the specific situation. The decision usually comes down to whether creating a Hong Kong company for our client will save it money or just create additional hassles. For more on whether it makes sense to use a Hong Kong parent company, check out How To Form A China WFOE: Hong Kong Parent Company Is Optional.

4. How should you describe your WFOE’s scope? If the scope of the WFOE is too narrow, it will not be able to do all that it wants to do in China. If the scope is too broad, WFOE formation will be denied. It truly is a Goldilocks situation. For more on this, check out How To Form a China WFOE. Scope Really Really Matters and How To Form a China WFOE. Scope Really Really Matters, Part II. It is critical that you get this right as Beijing does not hesitate in shutting down WFOEs after their formation for getting this wrong.

5. What is the appropriate amount of minimum capital? This too is a Goldilocks situation that usually has a lot more to do with our client’s present and future finances than it does with any Chinese government requirement. For more on this, check out How To Start A Business In China. The Minimum Capital Requirements For A WFOE, Part II — The Goldilocks Rule.

6. Is your lease suitable for a China WFOE/Does your location make sense? If the lease is not suitable, no China company can be formed. For more on this, check out China WFOE Lease Reviews. Choosing the right location for your China business implicates legal issues as well. With an office, this is usually relatively easy, but with something like a retail establishment, it can be a big issue. You typically do not want your official business location to be the same as your initial retail location because if you end up wanting to close down your initial retail location, you will then have to deal with the added hassle of needing to secure approvals from the Chinese bureaucracy to change your business location. There are also all sorts of issues that can arise from having a location in one place and your employees in another.

7. Are your employment documents in order? If you are going to have a Chinese entity with employees, it is critical that your employment documents be in order. This includes mandatory documents such as labor contracts and company rules and regulations, as well as optional documents such as confidentiality agreements, non-compete agreements, and educational reimbursement agreements. For more on China employment law check out China Employment Law: It’s Complicated And It’s Localized.

8. Is your IP protected in China? This typically begins with figuring out what can and should be done to protect trade secrets, trademarks, copyrights, and patents, and then drafting appropriate contracts and provisions with vendors, suppliers, counter-parties, and employees to protect that IP. This also usually involves figuring out what IP can and should register in China as a trademark, copyright, or patent. For more on China IP protection, check out How to Protect Your IP From China. Nine times out of ten, it makes sense to shore up your IP before you register your Chinese entity.

If you have your ducks in a row on these eight issues, you should be well on your way to starting a business in China.

How to Form a WFOE in China

Posted in Basics of China Business Law, Legal News

This being Thanksgiving weekend and all, I thought I would reprise (and update) some of our “more important” posts, including the one below on how to form a WFOE in China. The below post is “important” because so companies looking to form WFOEs in China refer to it when they first communicate with our China lawyers regarding their China plans and because so often companies come to us after having stalled midway in their China WFOE formation efforts.

Forming a China WFOE. It's complicated.

Forming a China WFOE. It’s complicated.

The below is a typical initial email we send to clients that retain us for China WFOE formation. More than anything, this email highlights why forming a WFOE and why it tends to be so complicated and time consuming, and how different it is from forming a company in the United States.

Thank you for engaging us to assist with the formation of your China WFOE. I have set forth below the preliminary information and documents we will need. Depending on the exact nature of your planned China operations and local government requirements (which change frequently and can even vary depending on the nature of the business), we almost certainly will need additional information at a later date, but this should be a good start.

2.Some of our clients elect to form a Hong Kong company as an intermediary company, so that the sole shareholder of the WFOE is the HK company, and the sole shareholder of the HK company is the US company. At one time forming a HK company made it significantly easier to move through the initial stages of the WFOE formation process, but these days it’s pretty much a wash. Forming a HK company is relatively cheap and but it will create yet another corporate entity and it will require ongoing maintenance, which will include annual reports, taxes, renewals, and so forth. Forming a HK company also requires opening a Hong Kong bank account, which usually requires a director of the HK company go to Hong Kong in person.

The main reason to form a Hong Kong company is for tax reasons, particularly if you anticipate your China WFOE will become a profit center and remit substantial sums back to its parent company. We will need to work together to determine whether your tax situation warrants our forming a Hong Kong company to own your China WFOE.

3. Have you determined a location for the WFOE? If you have already have a proposed office address, please provide it, along with the landlord’s name and contact information. If you haven’t yet determined the exact address, then provide the city and district (e.g., Huzhou, Wuxing District).

4. If you have a lease or proposed lease for the office space, please provide us with that. Note that the lease should be valid for at least one year beyond the eventual approval date for the WFOE. As the WFOE may not be approved until several months hence, it is best for the initial term of the lease to be at least a year and a half, with 2 years being even better. The lease should also be in a proper format, and typically will need to be registered with the local real estate authority. We will work with you on this. An appropriate lease is required for WFOE approval.

5. We will also need proof that the landlord owns the property you plan to lease and that it has the authority to enter into the lease. This is usually proved via a land rights certificate and documentary proof of existence from the landlord (i.e., a national ID for an individual, and a business license for a company).

6.We will also want to make sure that your proposed use is acceptable for the premises and that the premises are suitable for use by a foreign-owned entity. It used to be possible to check this with the local SAIC, but this information is no longer publicly available so we will need to make sure the lease includes provisions protecting your interests in this regard. We typically like to see the landlord guarantee its premises are suitable both for a WFOE and for your proposed use. We also will want lease provisions that require your landlord cooperate with our requests for documents, receipts, or certifications. All of this must be in Chinese, of course.

7. As part of the WFOE formation process, we will review the lease to make sure it is suitable for use by a WFOE, contains adequate protections for you during the formation process, and is properly executed. You should also have us conduct a substantive review of the entire lease and if you wish, we can also negotiate with the landlord on behalf of your company. If you want to know more about the linkage between a WFOE’s lease and its formation approval, I suggest you this: China WFOE Lease Reviews.

8. Please provide four proposed company names in Chinese, in order of preference. The shorter the better; if possible, use no more than four characters. For now, we only need the basic name (e.g, “Nike,” not “Nike, Inc.”) We will then work with the local authorities to determine what should be the full legal name, which will likely include the scope of business and the location. Note that the Chinese authorities are going to be concerned with your WFOE’s Chinese name. The WFOE’s English name will be unofficial and is, for the most part, up to you.

9. Please prepare a one-page summary of your WFOE’s activities that includes the following:

(i) A general description of the business your WFOE will conduct (i.e., the services and/or products it will provide). Once we get this, we will work with you to make this scope of business work for China, because this can actually be determinative of whether your WFOE is approved or not and it also will influence various other WFOE related matters for you going forward. For you wish to know more on China WFOE scope, I suggest you read How To Form a China WFOE. Scope Really Really Matters, Part II and the initial post in that series.

(ii) How the WFOE’s services and/or products will change over the 5-year period following formation;

(iii) How you will staff your WFOE (e.g., the number of employees upon formation, how that number will change over the next 5 years, and the citizenship of each employee);

(iv) Job descriptions for each employee and an explanation of how the employees will be managed;

(v) A general description of the customer base;

(vi) The cashflow model for the WFOE. From which entities will the WFOE’s income come from? How will this income be generated? Will the WFOE’s income stay in China or be paid to an entity in another country? To which entities will the WFOE’s expenses be paid? For what purpose will these expenses be paid? What are the estimated amounts of such inflows and outflows? In what currency will payments to/from the WFOE be made?

(vii) A detailed first-year cost projection for your WFOE.

(viii) A one-year and five-year pro forma income statement and balance sheet.

(ix) A statement of the amount of “total investment” and the amount of “registered capital,” if not contained in one of the above financial statements. Registered capital is money the parent company must contribute to the WFOE after formation. By contrast, total investment is the amount of registered capital plus the amount of (optional) debt financing the WFOE can take on. There is no requirement that the WFOE raise funds through debt financing; however, having a total investment amount higher than the amount of registered capital will give your WFOE flexibility with debt financing that, from a regulatory standpoint, it would not ordinarily have. Such debt financing is simply a loan from the parent company. Note that if a WFOE needs an influx of cash from its parent company, a loan is usually preferable to a payment, as the Chinese tax authorities treat the latter as income to the WFOE and will tax it accordingly. The relevant Chinese regulations state that for lower-capitalized WFOEs (i.e., those with total investments of less than US $3 million) the amount of registered capital must be at least 70% of the amount of the total investment.

10. Describe the WFOE’s management structure. Will it have (1) a board of directors or (2) a single director (called the managing director or executive director)? Once you decide that, we will need to know the identities of the following for your WFOE:

(i) Managing/Executive Director (or all the Directors, if you have a board): This person is in charge of overall management of the company, but not day-to-day management.

(ii) General Manager: This person is in charge of day-to-day management of the company—making bank deposits and withdrawals, paying taxes, arranging utilities, hiring and firing, and so forth. As a matter of law, the general manager and the managing director can be the same person and do not need to reside in China. As a practical matter, for any company actively operating in China, the general manager should be resident in China.

(iii) Supervisor: This person has nothing to do with the WFOE day-to-day operations. The supervisor merely represents the interests of the shareholders, and oversees the actions of the managing director (or board of directors, if you have a board). In a one-shareholder WFOE, the supervisor does almost nothing, but Chinese law still requires you appoint one.

(iv) Legal Representative: This person has overall responsibility for managing a China WFOe, and this person has the authority to act in the name of the company. The “legal representative” is a position unique to China companies; the closest analog in American corporate structure is the chairman of the board. By definition, the legal representative has authority to sign contracts on behalf of the company. The legal representative is not a standalone position; he or she virtually always is either the chairman of the board (for a three-person board) or the managing/executive director (for a one-person board).

11. Note that though the same person can simultaneously serve as the managing director, legal representative, and general manager, that person cannot be the supervisor. The supervisor must be a separate person.

12. Please provide color copies of the passports of the above people and a current resume of the WFOE’s legal representative.

The first step in WFOE formation is to apply for registration of the WFOE company name. But before we can do that, we must first finalize both your company’s scope of business and the exact location of the office, because the address of the office determines where we must submit the WFOE application. Additionally, the specific procedures for WFOE formation vary depending on the city and district in which your office will be located, and on the scope of business. In other words, the first step itself requires a considerable amount of preparation.

Copyright Takedowns in China, Part II: Searching, Linking or Storing?

Posted in China Business, China Film Industry

This is the second in a series of posts about China’s system for the takedown of copyright subject matter stored or posted online without the copyright owner’s approval. In our first post, Copyright Takedowns in China, we provided a general summary of the regulations that establish the takedown procedures. These regulations enable enforcement of the “right of communication through an information network” as it applies to sound recordings and audiovisual recordings. As we have seen, the regulations apply to “network service providers” (网络服务提供者)and “service recipients” (服务对象). They draw a distinction between providers of searching or linking services and those that provide storage space.

The distinction between searching and linking providers and storage space providers is not always clear. What is clear is that the liabilities of each are different.

China copyright takedown law varies depending on the source.

China copyright takedown law varies depending on the source.       (Photo by gaelx, http://bit.ly/1YoM0x1)

Souhu and Sina are examples of Chinese linking services. A search or link provider is not liable for compensation if it disconnects the link after receiving a takedown notice. The provider remains liable for contributory infringement if it knows, or had reasonable grounds to know, that the linking of the recording infringed the right of communication.

Youku, and Chinese video websites such as iqiyi.com and ku6.com, are storage space providers. But they also provide searching and linking services. For example, some videos are searchable on Youku but there is a link to letv.com where these videos are stored.

A service provider that provides storage space to a service recipient that stores infringing recordings is not liable for compensation if it:

  • makes no modification to the recordings
  • doesn’t know and has no reasonable grounds to know there is an infringement
  • gains no direct financial benefit from the recordings; and
  • removes the recordings on receiving notice from a rights owner according to the procedure outlined in the regulations.

One explanation for the distinction between the liability of storage space providers and the liability of search or link providers is that the copyright subject matter is not sitting on the servers of the search or link providers. Additionally, storage space providers have more control over the content they hold. In practice, the distinction can be mitigated because a Chinese court is entitled to take into account any rankings or recommendations made by the provider.

In our next post we’ll look at how the takedown procedures apply to Chinese cloud service providers.

China LOI and MOU: Don’t Let Them Happen to You

Posted in Basics of China Business Law, Legal News
Think different about China Letters of Intent and Memoranda of Understanding. Please.

Think different about China Letters of Intent (LOI) and Memoranda of Understanding (MOU). Please.

At least once a month a US company comes to one of our China lawyers after having spent considerable time in China negotiating a complex transaction. They then show us a Letter of Intent (LOI) or a Memorandum of Understanding (MOU) that sets out in great detail the terms of their proposed China deal. We then explain to them that it is a very bad idea in China to enter into this type of detailed LOI or MOU. The US company then usually says: “the document clearly states it is non-binding. What liability could possibly arise?”

These US companies are making a major mistake and are exposing themselves to substantial liability. Most U.S. (and many European companies) just assume that they are covered by the rule that prevails in England: no party is exposed to any liability during the negotiation period; liability arises only after the parties have executed a formal, written contract. Under this rule, if the written document clearly states that it is non-binding, no liability arises.

The rule in China is exactly the opposite. The Contract Law of the PRC has formally adopted the German law principle of liability for negligence in contracting (缔约过失责任). Contrary to the classic common law view of the United States and England, under this principle, parties to a contract owe one another a duty of good faith. In a case where negotiations have commenced but no contract is concluded, the party that caused the failure to contract can be liable to the other party for damages. The damages in this situation are not contract damages, but rather damages for compensation for loss resulting from the reasonable reliance of the damaged party on the conduct of the other.

This doctrine is embodied in Article 42 of the PRC Contract Law, which reads as follows:

Article 42 Pre-contract Liabilities

Where in the course of concluding a contract, a party engages in any of the following conduct, and thereby causes loss to the other party, that party shall be liable in the event of a claim for damages:

(i) negotiating in bad faith under the pretext of concluding a contract;

(ii) intentionally concealing a material fact or supplying false information relating to the conclusion of the contract;

(iii) any other conduct which violates the principle of good faith.

Items (i) and (ii) are directed at situations where a party negotiates in bad faith to prevent the other party from pursuing a business advantage. Though these two provisions are fairly specific, item (iii) is very broad and leaves Chinese judges with wide latitude to impose liability.

For this reason, any case of a failed contract negotiation in China can result in liability under this Article 42. For this reason, extreme care must be taken to make clear the terms of negotiation and the commitments being made by the negotiating parties. An abrupt termination of negotiations with no warning and no explanation is very dangerous under this principle. However, even more dangerous is the failure to conclude a deal when the terms have been memorialized in a detailed LOI or MOU.

The magnitude of potential damage is far greater than most companies imagine. In the case of a typical commercial LOI or MOU, compensation can be demanded for the following:

  • Direct damages: These include costs incurred in preparing for the business venture, including the costs of drafting (attorney’s fees), research and development, and travel. These also include costs for time spent negotiating and the costs spent in preparing and delivering product samples.
  • Indirect damages: These include costs arising from abandoning negotiations with a third party for a similar transaction, lost profits from the other needing to pursue the project independently, or from needing to pursue other funding or related business opportunities.

Consider how how a claim for this type of Article 42 liability could arise in the case of a complex business transaction in China. Assume that the U.S. and Chinese parties negotiated for six months and executed a detailed LOI that involved the US company purchasing product from the Chinese entity, the US company transferring technology to the Chinese entity and the US company making substantial capital equipment loans to the Chinese entity to produce the product. After the end of the six month preparation period set out in the LOI, the U.S. party terminates the LOI and enters into substantially the same deal with a Chinese competitor of the Chinese party to the LOI.

As it turns out, the U.S. company was investigating the same basic deal with multiple Chinese parties at the same time. It merely selected the best of the deals on the table. The U.S. company did not inform ANY of the Chinese companies that it was simultaneously negotiating with multiple parties. Chinese companies and Chinese courts generally view multiple negotiations without notice to all involved as a basic violation of the Chinese law requirement of good faith in contract negotiations.

Now assume the worst case. The Chinese company goes bankrupt and while looking for claims against creditors, the bankruptcy trustees find the executed, dated, sealed LOI in the company files. After investigating the facts, they bring a damages claim against the U.S. company for the following losses:

  • The Chinese company lost out on several lucrative contracts for sales of its products to the competitors of the U.S. company.
  • The Chinese company failed to act on a transfer of technology offer from a Russian company. Though not as good as the technology of the U.S. company, adoption of the Russian technology would have resulted in substantial cost savings for the Chinese company and would have opened access to several new markets in Russia and Europe.
  • The Chinese company failed to accept the offer of financing from a local bank in reliance on the commitment of the U.S. company to provide capital equipment financing.

Consider the magnitude of the financial damage that has resulted from the Chinese company’s reliance on the commitments of the U.S. company as stated in the LOI. In essence, the trustees would be seeking compensation for all of the costs resulting from the bankruptcy of the Chinese company. Would the trustees prevail in a claim of this magnitude? It is not certain. But, since it is clear that the U.S. company executed the written LOI and since it is clear that the U.S. company violated Chinese principles of good faith in contract negotiation, the risk is considerable that a Chinese court would require the U.S. company pay some compensation.

A common response to this by U.S. companies is to say, “I have no risk for two reasons. First, the LOI states clearly that it is not binding and that no liability will arise for either party. Second, because of our concern with the Chinese adoption of the good faith principle, we state in the LOI that interpretation of the LOI is subject to U.S. law.”

These arguments do not work. The good faith requirement of Article 42 is not a principle parties need to create by written contract; it is a statutory requirement that applies to all parties who negotiate contracts in China. It is an obligation that exists entirely separate from the agreement of the parties. More important, the requirement of good faith applies to the conduct of the parties, not to what they say in a written document. For this reason, a court will examine the underlying conduct of the parties to determine whether liability arises.

Thus, self serving statements of a party that no liability will arise will be ignored. Even worse, such statements could be seen as a part of the plan to deceive the Chinese party about the U.S. company’s bad faith intent to cause harm. Reference to U.S. law will also be ignored, because liability arises under compulsory statutory law, not the consensual agreement of the parties.

Stated bluntly: there is no way to escape from the application of the defect in contracting principle for any party who negotiates in China. This is particularly true when applied to a foreign company that has caused damaged to a Chinese entity. Since the basic principle is the opposite of what most U.S. companies think is the rule, extreme caution is therefore required. Our own advice is that foreign companies should almost never enter into an LOI or an MOU containing ANY detailed deal provisions.

Just about the only time an LOI or an MOU should be used is when the parties need to set out specific steps that will be taken to complete due diligence for a specific transaction. In this case, such a document should be treated not as an LOI or an MOU, but rather as a due diligence contract. The U.S. party should understand that it will be held liable if it does not perform strictly as required in the contract.

In all other settings, an LOI/MOU should not be used. The risk is high and there is no compensating benefit. A unilateral term sheet is the normal alternative and that is generally acceptable. However, the principle of good faith will still apply even in this case; once negotiations have begun in China, the rule of good faith applies. If no contract is ultimately concluded, then the risk of Article 42 damages is always there. For this reason, if no contract is concluded after negotiations have begun, the foreign side should carefully document the reasons and should provide those reasons in writing to the Chinese side.

Not only can signing an LOI or an MOU cause you all sorts of legal problems in China, it more commonly can result in business problems, which problems we discussed in a previous post, The China MOU (Memorandum of Understanding). Use Them At YOUR Peril, detailing a recent conversation Dan and I had just had with a reporter:

Dan then talked about how this difference in laws can so often lead to problems arising between Chinese and American companies:

The impact of this difference is that we frequently see the following: American company comes back from China and shows us their five page MOU and says that they now want to work on a contract. we tell them that what they have given us is probably a contract. They tell us that we are wrong. We 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.

Steve then summed up the problems:

Dan’s point is dead on. There is a major gap in legal systems here. It is not culture, it is the legal system itself. Both sides are behaving in a manner completely consistent with their own legal system. But in the end, both sides look to the other as though they are acting in bad faith, when in fact both sides are doing nothing more than trying to reach a deal as best they know how.

Dan then concurred with Steve:

Correct. And the thing is that neither side has malevolent intent. The Chinese side just puts a lot more stock in the MOU than the American side. The American side will sign the MOU thinking it is nothing and planning to come back and turn it over to their attorneys to draft the final agreement.

And then the problem starts when we tell the American company that the MOU it just signed is almost certainly a legally binding contract and that it is virtually certain that the Chinese side sees it as a contract and that the contract is terrible and that “it needs the following ten things.” The American company then goes back to the Chinese company with the ten things that need to be changed or added and the Chinese company then gets offended because it thought it had a deal and that only super minor things needed to be resolved and that those would be resolved over time. So now you have a situation where what could have been a good relationship starts off on the wrong foot or fails to start off at all.

Bottom Line: China LOI and MOU are different in China. Don’t let them happen to you.

China Contracts: Why Hong Kong Courts Are A Really Big Mistake….Really Big.

Posted in Basics of China Business Law, Legal News

We continue to see contracts rendered unenforceable because the American or European party seeks to avoid application of Chinese law and enforcement in Chinese courts. By their own actions the foreign party guarantees the contract it drafted will be of absolutely no value to them. This is what is called “to be hoisted with one’s own petard.” (Hamlet Act III, Scene 4,).

Making Hong Kong your jurisdiction in your contract with a PRC company is a really big mistake that cannot be erased

Making Hong Kong your jurisdiction in contracts with PRC companies is a really big mistake that cannot be erased.

Consider a contract between a U.S. technology company and its PRC licensee. The U.S company seeks to avoid Chinese law by providing for English as the contract language, U.S. law as the applicable law, and enforcement in a U.S. court. The Chinese side refuses and insists on the reverse: Chinese language, Chinese law and enforcement in a Chinese court. As a compromise, the U.S. side proposes the following: English language, Hong Kong law and enforcement in a Hong Kong court. The Chinese side agrees and the contract is signed.

Why did the Chinese side agree? It is because the Chinese side knows that under this “compromise” it has created the worst possible situation for the U.S. company. The contract is NOT enforceable against the Chinese company, so the Chinese company is off the hook for any liability. On the other hand, the contract IS enforceable against the U.S. company, giving the Chinese company substantial power in the event of a dispute. The U.S. company has placed itself in the worst possible position. The Chinese company is amused. I know this from my Chinese lawyer friends.

Of course, there is the chance that both parties will be disappointed because there is a risk that the Hong Kong court will refuse to hear the case because the matter has no connection to Hong Kong. It comes as a surprise to many in the U.S. that Hong Kong is an entirely separate jurisdiction from China. For this reason, a contract between a U.S. company and Chinese company governing conduct that will occur in China has no connection to Hong Kong. It is therefore entirely possible that that the Hong Kong court will refuse to further crowd its docket and refuse to hear the case.

For purposes of this post, however, we will make a leap of faith and assume that the Hong Kong court hears the case and renders a judgment. Consider what happens. If the plaintiff is the Chinese company, then the judgment against the U.S. defendant is easily enforceable in the U.S. against the assets of the U.S. company. Hong Kong is a common law country with laws and legal procedure based on the laws of England. U.S. courts regularly enforce such common law judgments and the odds are overwhelming that they would do so in this situation as well.

If the plaintiff is the U.S. company seeking to enforce in the PRC, the situation is quite different. On the surface, it appears enforcement of the judgment should not be an issue. In 2008, China and Hong Kong entered into a reciprocal enforcement agreement. Thus, in accordance with law, judgments from Hong Kong courts should be enforceable in China. However, the fact is that Chinese courts simply ignore this statute and they do not enforce Hong Kong judgments. I am aware of only one case were such enforcement was successful. In every other case of which I am aware, enforcement did not succeed. This is the same result as for arbitration. China is a signatory to the New York convention on the enforcement of arbitral awards, but Chinese courts regularly fail to enforce such awards.

Chinese courts avoid enforcement in two ways. The most common way is that they simply refuse to act. They do not openly reject the demand for enforcement. They accept the demand and then do absolutely nothing. This is the most common technique.

The other approach is to find technical reasons to reject the demand for enforcement. Usually the Chinese court will reject the Hong Kong judgment based on a claim that the foreign award was based on grounds that violate of Chinese public policy. Since Chinese civil law and Hong Kong common law come from an entirely different legal background and legal procedure, it is generally easy for a Chinese court to find a public policy issue. The following are the most common public policy grounds Chinese courts use to reject enforcement:

a. Often, the Chinese party does not appear in the foreign action. In this case, the U.S. side will obtain a default judgment. Like many Asian courts (and European and U.S. ones as well), Chinese courts are reluctant to enforce any form of default judgment. When the default judgment is from a foreign jurisdiction, the likelihood of enforcement is nearly zero. Knowing this, Chinese lawyers typically instruct their Chinese clients to simply not appear when sued in Hong Kong.

b. As noted above, a contract between a Chinese entity and a U.S. entity has no factual or legal connection with Hong Kong. Chinese law allows the parties to a contract to chose the applicable law, but when the parties chose a law with no connection to the underlying transaction, Chinese courts typically deem this to violate of public policy.

But like I said, the Chinese courts oftentimes do not even rule in this cases. They simply let them sit until they die out, using one or both of the above reasons to justify their doing nothing to enforce. Whether the Court issues a written ruling or simply does nothing, the effect is the same: no action taken and no enforcement of the judgment.

I cannot emphasize enough how harmful using Hong Kong in this sort of situation can be for the U.S. company. The U.S. company has placed itself in the worst of all positions. First, it must convince a skeptical Hong Kong court to hear a case with no connection to Hong Kong. Since Hong Kong has a loser pays system, the U.S. company usually must post a substantial monetary bond to cover the risk that it will not prevail on its claim. Then it must pay the very high attorneys’ fees and court costs demanded by the excellent Hong Kong legal system. Then it must wait as the Hong Kong court takes what can be a substantial period of time to render judgment when the facts and parties are all foreign to Hong Kong. Then, when it finally receives its judgment, the U.S. company learns the hard way that this judgment has no value since it is not enforceable in China. Or even worse, the Chinese party prevails on its counterclaim and the Chinese party is free to enforce its judgment in the United States. And to top it all off, the U.S. company loses its bond, which goes to pay the Chinese company’s legal fees.

A very sad result, all because the U.S. company would not face the simple truth of what is required for enforcement of a judgment in China. It is not a pleasant thought to consider enforcing a judgment in China against a Chinese company. But dreaming about an alternative that makes matters worse is not a solution. Facing the facts and designing a practical plan is the solution.

Your Company Can Be Sued In China And That Matters

Posted in Legal News

A while back I got an email from a veteran China consultant I have known for a long time. Very prominent and very good at what he does. His email was essentially bragging about how he had managed to pull one over on Chinese factory that had hired him. Here is his email, with anything that might identify anyone having been deleted or changed.

US courts will enforce China court judgments. Just ask Robinson Helicopters.

US courts will enforce China court judgments. Just ask Robinson Helicopters.

I am giving you this “hypothetical” because I am curious to get your opinion on this.

Imagine that I owe nearly $2 million to a China factory for business I did with them. Now imagine that I didn’t pay this factory because I learned that it was paying kickbacks to be able to inflate its prices. I am having to keep this debt on our books and it is preventing us from getting a needed loan. I reached out to the China factory today to try to buy off our alleged debt for pennies on the dollar and they told me that they have just sued me in China, which really surprised me.

Fortunately, we don’t even have a contract with them as we have always operated with purchase orders as a way to prevent just this sort of thing.

My immediate reaction to that was “go ahead – you’re welcome to do so but if you win a judgement against me you’ll never be able to collect that from us.” We don’t have a bank account in China, an office in China or any real presence at all there (other than buying some other goods from a couple other Chinese supplier and I’m okay if I’m told I can never travel there again (I’ve been to China more than 100 times in the past 16 years). Am I right that this China factory cannot collect a judgement against us? Is there a simple answer here?I met with my lawyer here [in a mid-sized US city] and he assured me that no US court would ever enforce that judgment and so the Chinese company can never collect against us. Consider this a posting on your blog. How would you respond to a hypothetical such as this?

Thank you Dan. I’m really curious to hear your opinion on this…and I appreciate your taking the time to read.

My response was as follows:

You are mistaken.

This company can sue your company in China and then win in China and then bring that judgment to a US Court and convert it to a US Judgment and then start seizing your company’s assets. My own law firm actually took a Chinese judgment to California and got it enforced and we have done the same thing with a Russian judgment. We also have on at least two occasions represented US companies sued under circumstances similar to what you describe and we settled both of those cases to avoid the substantial risk of the judgments being enforced in the US.

I do not understand why you think that your not having a contract will help you here but I think all that does is sow confusion and give the Chinese company free reign to sue you in either China or the US, which gives it another good argument for why a US Court should enforce the judgment. I mean, if the Chinese company can sue you in the US if it wants, why should a US court not enforce the judgment from another country? The other thing of which you need to be aware is that whatever settlement agreement you enter with this guy had better be in both Chinese and in English and written so as to truly end things in BOTH countries. This agreements are not simple and they require certain tried and true buzzwords to work. We often hear from US companies that think that they have settled with a Chinese company only to learn that their settlement agreement was defective and in fact they have not. I cannot tell you how many times US and European companies call us after having just been sued by a person (usually in an employment case) or entity with whom they thought that they had settled. Our China lawyers then review the “settlement” agreement and give the bad news that it either is not valid or may not be valid.

Good thing this is just a hypothetical.

The above email exchange was a long time ago, but I pull it out now because the American Bar Association Journal just came out with an article, Chinese companies doing business in the US build barriers to legal remedies, propagating the same mistake. I came across this ABA Journal because it quotes me on how Chinese courts will not enforce judgments from US courts, but it then quotes another lawyer saying that “never in history has a US Court enforced a Chinese judgment”:

A Chinese court can enforce a foreign judgment, according to Davis. “But never in history has a Chinese court enforced a [U.S.] judgment against a Chinese firm.”

Conversely, he says, “no U.S. court will recognize a Chinese judgment against a U.S. firm.”

Wrong, wrong, wrong. First off, it is my understanding (based on one conversation I had with an international family lawyer years ago and the fact that I know this to generally be the case regarding other countries) that US courts generally enforce Chinese family law and custody decisions. Second, there is the case of Hubei Gezhouba Sanlian Indus. Co. v. Robinson Helicopter Co., which Ted Folkman wrote about in US Courts For Chinese Litigants. The Year In Review:


Everyone knows that US judgments are not readily enforceable in China, but the converse is not true, as Hubei Gezhouba Sanlian Indus. Co. v. Robinson Helicopter Co., 425 Fed. Appx. 580 (9th Cir. 2011) shows. Hubei first sued Robinson in Los Angeles, but Robinson, perhaps planning a “boomerang litigation” and thinking that a US court would never enforce a Chinese judgment, successfully sought dismissal on forum non conveniens grounds. But the Chinese court entered a default judgment against Robinson. Robinson appealed, arguing, among other things, that the judgment should not be recognized because China does not recognize US judgments.

The court gave that argument short shrift. Reciprocity or lack of reciprocity simply is not one of the grounds on which a court may refuse recognition or enforcement under the Uniform Foreign Money Judgment Recognition Act or similar statutes. It’s noteworthy that neither Robinson nor the court took the view that there were any systematic problems with the Chinese judiciary that precluded recognition of a Chinese judgment. There is a growing recognition in the US of the increasing maturity of the Chinese judiciary. And it’s interesting that neither Robinson nor the US court raised the issues of lack of finality that have caused courts in the Hong Kong SAR to question whether mainland Chinese judgments are entitled to recognition and enforcement.

There is indeed no treaty nor any reciprocal arrangements between the U.S. and China that mandates U.S. courts enforce China judgements. However, Thirty-Two US States have adopted the Uniform Foreign Money Judgments Recognition Act and that act, with specific exceptions, generally requires signatory state courts to enforce judgments that are final, conclusive and enforceable under the law of the jurisdiction in which it was rendered. There is no “China exception.”

Third, there is a case in which my law firm got a US court to enforce a Chinese judgment. I talked about that case in the same post in which Ted talked about Robinson Helicopter:

CHINA LAW BLOG NOTES: My law firm recently took a Chinese judgment and secured its enforcement in the United States, with pretty much no hassle. I have to remain somewhat mum on this because we intend to use that judgment to seize the assets of a Chinese company, but I have always been of the (minority?) view that it really just isn’t that tough to get Chinese judgments enforced in the United States, even though the opposite is pretty much impossible. I have been involved in about a dozen cases involving the enforcement of foreign judgments in the United States — on both sides of the issue — and of those cases, the foreign judgment was enforced every single time. In maybe five of those occasions, the foreign judgment came from Russia. If the US courts will enforce Russian judgments, I just don’t see why they won’t enforce Chinese judgments as well.

In the case obliquely referred to above, we took a Chinese judgment obtained by an American company and we converted it to a Washington State Court judgment, without the Washington State Court raising any issues regarding its ability to do the same. As I recall, the court did make us jump through a number of hoops in terms of translating and explaining the Chinese court decision, but it never raised any issues regarding the propriety of a US Court enforcing a Chinese court judgment. We subsequently took the Washington State Court judgment and converted it to a California Court judgment. The California court never batted an eye. I should note though that this judgment was against a Chinese company, but I do not see that as necessarily making a legal difference.

The very first day my law firm first set up its website I got a call from a company in Mississippi that had been sued by a Chinese company for allegedly having provided that company with millions of dollars in factory equipment that did not work. This MS company had been sued in a Chinese Court by the Chinese company to whom the MS company had provided the allegedly defective equipment and the MS company’s MS lawyer had told it that it need not defend the case in China because “the Chinese courts do not have jurisdiction over you and nobody would ever enforce any of its rulings.” The MS company asked me if this was true and our conversation then went something like the following [I was so shocked by the call based solely on our website that I actually have a pretty good recollection of our conversation]:

Me: Have you ever sold your equipment to a company in another US state and then been sued in that state for the product you supplied?

MS Company: Yes. Multiple times.

Me: And in those cases did you ever argue that the company suing you in its home state needed to be suing you in Mississippi instead.

MS Company: At the beginning we did, but eventually after losing every time we stopped making that argument.

Me: Right. And we should at this point just assume that China will be the same way. In other words, why shouldn’t a Chinese court have jurisdiction over your company when your people went to China to market your equipment and when you regularly sell and even service your equipment there. [He had told me these facts, and he also mentioned that his company even had a brochure in Mandarin]

Me: Okay, so now we know that you have to at least consider that you can be sued in China. And has the Chinese company complained to you about your equipment in the past?

MS Company:  Yes, pretty much from day one and I have to admit that much of their problem stems from our own people having installed it incorrectly.

Me: So are you saying that the Chinese company’s claims against you have some merit.

MS Company: I don’t remember at all what he said at this point, but I do remember the essence of it was that the installation had been bad and some of the Chinese company’s complaints about the product were valid, some might be valid and some were not valid. But to summarize, the Chinese company had brought a legitimate case.

I then confirmed with the MS Company that it had been given plenty of notice about the pending China case against it as it had JUST begun. I then asked him if his company wanted to continue doing business in China and he emphatically said yes. At which point I noted that even though I thought his company would be at serious risk (based on the facts above) of a US court enforcing any China court judgment against his company, his wanting to continue doing business in China meant that a Chinese court judgment could be enforced against his company’s operations there and that would be a really bad thing.

Bottom Line: US companies should not bet on US courts not enforcing Chinese court judgments. When U.S. lawyers or US companies call one of our China lawyers to try to get our firm to help them enforce a US judgment in China, we tell them that is impossible and we then start talking to them about other options. But for enforcing foreign judgments — including Chinese court judgments — in US courts, our lines our always open.

Quick Question Friday, China Law Answers, Part VII

Posted in Basics of China Business Law

Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all these questions and then comprehensively answer them, that would soon become all that we do and we would soon be out of business. And that would be a bad thing for us and for this blog. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here.

China employment laws generally apply to foreign employees too.

China employment laws generally apply to foreign employees too.

A common question we get (from both companies doing business in China and from expats employed in China) is whether foreign employees in China are covered by China’s employment laws.

The short answer is “generally yes.” For more on this, check out China Employment Contracts: If Yours Are Not Current, You Have A Problem and Employer Social Insurance In China. I See Foreign People.


How to Execute a Chinese Contract So It Will Work

Posted in Basics of China Business Law, Legal News

A China-centric written contract is an effective tool for doing businesses in or with China. A first step in creating this effective tool is to carefully follow the rules for execution. Chinese courts are bureaucratic and formalistic. Make use of that tendency so that you can prevail. Don’t blunt the edge of your instrument with sloppy execution procedures. A casual approach to execution is neither appropriate nor effective for China. A failure to follow China contract law formalities can lead to a Chinese court not enforcing your contract.

Get your Chinese company counter-party to properly seal your contract.

Get your Chinese company counter-party to properly seal your contract.

The basic rules for execution by the Chinese side are as follows:

1. The date of execution must be specified for each entity that signs. Do not rely on a single date at the top. Each party should enter a date indicating when that party signed.

2. The legal name of the signing entity and the legal, registered address of that entity must be stated, in the Chinese language, in the document. Many Chinese companies will only provide their common name or English-language name, or provide a business address rather than the registered address. Failing to request the proper information is a major mistake.

3. The individual who signs on behalf of the Chinese entity must have the authority to sign that contract on behalf of the Chinese entity. If the individual is the legal representative of the Chinese entity, his or her authority is clear. In other cases, however, that person’s authority must be demonstrated by the title given to the individual by the Chinese entity. If that title is sufficient to show authority, then the Chinese entity is bound to the contract, regardless of the individual’s actual status with the company. Care is getting this right is required. A person with the title “foreign acquisitions manager” clearly has authority to purchase from foreign buyers. But what if the title is “accounting department manager” or “research and development department manager”? It is not certain that these persons have any authority at all with respect to executing contracts.

4. The contract should be stamped with the official, registered company seal. Chinese entities often have seals in addition to the standard company seal. For example, many companies have seals specifically designated for executing contracts. Such seals are acceptable, provided they are registered and provided that they are individually numbered if the Chinese company has more than one, which is common. Chinese entities may have other seals such as technical verification seals, tax department seals and banking/financial seals. These additional seals should never be used for sealing contracts. Only the official company seal and registered contract seals should be used on a China contract. Every legitimate Chinese company has documentation of the registration of their official company seal or their registered contract seal(s). Just ask for a copy. If they do not provide that, it means they are planning to use an unofficial seal, with predictable results in the event of a dispute.

The area that causes the most confusion is the requirement of a seal. An unsealed contract is not invalid on its face but it can cause you all sorts of trouble. Chinese law on the issue of seals and contracts provides as follows:

  • Article 10 of China’s Contract Law provides that contracts may be oral or written.
  • Article 32 of the Contract Law provides that contracts must be executed by the company legal representative OR by a person with authority  to execute the contract. It also provides that execution may be by signature OR by seal.
  • Article 50 of the Contract Law provides that if a person with apparent authority executes a contract beyond that person’s actual authority, the contract is still valid with respect to a third party who had no knowledge of the scope of actual authority.

Thus, by the terms of the Contract Law, a contract that is not sealed is still a valid contract if it was executed by a person with apparent authority. So why is it so important to get your China contracts sealed? The purpose of a written contract with your Chinese counter-party is to provide you with an effective tool that you can use in a Chinese court to obtain swift and certain relief against a Chinese entity that has breached the terms of your contract.

The first thing Chinese courts usually do in any contract action is determine the authenticity of the contract. Where a contract is sealed with the official, registered company seal, the contract is prima facie valid. Chinese courts nearly always rule against a Chinese entity that argues that the seal is false or that the seal has been lost or similar if a registered company seal was used to seal the contract. This is the situation that you want to be in when you are a plaintiff in a Chinese court: the authenticity of your contract is clear and certain. Any contract that lacks any of the four elements I set out above is subject to challenge. Though you may prevail over that challenge, this will lead to considerable delay that can extend over many years. You also might not prevail and the uncertainty alone can be enough to give the Chinese company enough comfort to fight you hard and to force you into a less than favorable settlement.

But why is a seal “required” when China’s Contract Law clearly provides that a signature is sufficient. Again, this is matter of proving authenticity. It is the custom in China to have ALL contracts sealed. Every company in China, no matter what size and no matter what form of ownership is issued a registered company seal upon its formation. Government regulation requires state owned enterprises to seal all contacts. This practice is followed by all legitimate private companies.

For this reason, a document that has not been sealed is immediately suspect. Chinese courts have lots of experience in determining the authenticity of seals. They have virtually no experience in determining the authenticity of signatures. For this reason, it is virtually certain that if a Chinese defendant questions the validity of a contract that is signed but not sealed, the court will deem the contract invalid. I have never read or heard about a case in China where the validity of a non-sealed contract was upheld by a Chinese court in the face of a challenge from a defendant. Now just imagine how the Chinese courts will treat your “email contract,” your PO/Invoice contract or your oral contract.

What happens if the seal is not in fact the official, registered company seal? Litigation in this area has been common in China over the past fifteen years. The usual facts involve a Chinese or a foreign entity that enters into a contract with a Chinese company for the provision of goods or services. The entity provides the goods or services to the Chinese company, but the Chinese company then  that has received the benefit refuses to pay because the written contract was not properly sealed. The following are standard seal defects:

  • The wrong type of seal was used: perhaps a technical seal instead of a contact seal.
  • The Chinese company has many unofficial seals and one of these unofficial seals was used rather than an official seal.
  • The party who signed the contract for the Chinese company is an agent of the Chinese company, but not an employee, but the seal is an official seal.
  • The primary contract is improperly sealed but its supporting receipts are properly sealed.

In all of these cases, the courts have held that for the defendant to prevail the defendant must prove that the plaintiff falsified the seal and sealed the document with such a false seal in to defraud the defendant. This burden has been impossible to meet in cases where the goods and services have already been delivered.

Even though plaintiffs have prevailed under these circumstances, this is not a reason to depart from the basic rule. Even though the plaintiff eventually prevailed under these circumstances, the defects in contract execution turned a routine, six month collection case into an expensive, multi-year ordeal. Note also that in all of these cases, the goods/services had already been provided. Finally, in all cases the contract or other documents were sealed in some way. I have not found any China court cases* where a bare signature was sufficient.

Chinese courts are hyper-technical when working with written documents. If there is any surface flaw, a party will object to the authenticity of the document and then force the party offering the document to prove its authenticity. Chinese lawyers will seek out all of these minor surface flaws and then object to authenticity even where that objection is clearly ridiculous. The courts in China then reward them for this behavior because this is a good way for them to clear the docket of commercial cases, which allows them to concentrate on their real job of doing criminal work. But if you follow the above rules the Chinese courts will almost certainly find your contract to be authentic and because of this, you will have leverage against your Chinese counter-party should something go wrong between the two of you. Most importantly, you will in most instances forestall an authenticity argument entirely. If you don’t follow the above rules, you will likely create create uncertainty and added costs.


* If you are now thinking that the way to avoid all of the above problems is to draft a contract calling for disputes to be resolved in a U.S. or some other foreign court, DON’T. China does not enforce U.S. court judgments so even if you prevail against your Chinese counter-party in a U.S. court, unless that Chinese company has assets in the United States, you probably will never collect a penny from that Chinese company. The same is true with respect to most other countries as well. Arbitration outside China has its own special risks as well.

China Guanxi: You Want Complicated?

Posted in China Business
Study Guanxi. become more enlightened.

Study Guanxi. become more enlightened.

Back in the day when I was working at a Chicago mega law firm, a good friend of mine there was a Sicilian who grew up in New York. While in high school this friend worked at a New York deli, where he learned to subsume his Italian accent in favor of the accent and intonations required for that particular line of work. Is the corn beef lean, my friend would be asked. Lean, he would reply, you want lean? I got lean. If you don’t find this funny, I guess you had to have been there.

I can’t help thinking along similar lines whenever someone talks or writes about guanxi. Complicated? You want complicated. I got complicated. guanxi is one of those things that is borderline impossible to fully comprehend if you did not grow up in China, or at least grow up in a Chinese family. Yes, those of us who are not from China can grasp portions of the meaning of guanxi by studying it and seeing it “in action,” but the non-Chinese who truly understand are few and far between (far less than the number who claim full understanding) and I most certainly do not include myself in that rarefied company.

But that does not mean we neophytes cannot benefit from learning as much as we can about guanxi, and towards that end I recommend you read this just out post: Is Guanxi China’s Cultural System of Grass Roots Business and Justice? And in reading this post, I also recommend that you read that to which it links, including the videos. If you do all that, you will not achieve total guanxi comprehension but you will be closer to that sort of enlightenment.

For more on guanxi and, in particular, how it relates to doing business in China and with China, check out China Guanxi: You Don’t Have It.


China Product Sourcing Writ Large

Posted in Basics of China Business Law, China Business, Recommended Reading
Tell Mark Rothko that color shades don't matter.

Mark Rothko knew that color shades matter.

Yesterday’s post, China’s New NGO Law and Calculating China Business Risks, talked of how really good micro posts on what at first appear to be small topics can when done well serve as a great platform for understanding how to do business in China overall. Today’s post has the same theme.

The micro post is by Jacob Yount, who helps foreign companies source their promotional products from China. That alone is micro but the post is more micro still in that it talks about how to avoid color confusion. That’s right, the post, appropriately entitled Color Confusion in China Manufacturing is about how to make sure that your China manufacturer gets your color right? Now before you stop reading believing that this post has nothing to do with you, let me tell you that it most certainly does.

One of my standby speeches is on How to Succeed in Sourcing Product from China and one of my favorite stories in that speech involves — you guessed it — color confusion. The story goes something like this:

Many many years ago, a U.S. company out of North Carolina called me wanting my firm’s China lawyers to pursue litigation against a Chinese company that had provided the U.S. company with “bad” shirts. What was bad about the shirts was the color. This U.S. company had sent a sample shirt to a Chinese manufacturer and the Chinese manufacturer in turn had made its own sample shirt (or maybe it had just bought a sample shirt elsewhere, something that is not terribly uncommon) and sent that to the U.S. company. The U.S. company liked the sample shirt and then ordered another million dollars or so more of them.

Well when the shirts arrived the U.S. company had a major problem. You see we are talking North Carolina here and as every college basketball fan knows, the University of North Carolina has its own specific shade of blue, with its own name. It’s called Carolina blue and my just mentioning it here immediately conjures up images of Indiana University’s Dan Dakich holding Michael Jordan to 13 points. But that color obviously holds a different but equally visceral meaning for the people who would buy a blue University of North Carolina jersey. And let me tell you, those people are not going to buy a North Carolina jersey that is not the exact color of Carolina blue.

And that was the problem with the million dollars of shirts this U.S. company had bought and paid for. They were blue all right, but they were not Carolina blue. That meant that instead of this U.S. company being able to sell them for maybe $30, he would maybe be able to get $3 a shirt. The U.S. company had obviously suffered major damages.

But my firm turned down the case because we did not want it on a contingency fee basis and we also did not want to charge our hourly rates on a case we did not think could be won? Why would it be so difficult to win? Because generally if you are in front of a Chinese court and something is not specifically in your OEM contract (in Chinese) with your Chinese manufacturer, it essentially does not exist. What you want if you are going to be suing a Chinese manufacturer in a Chinese court is a written contract, in Chinese, sealed/chopped by your Chinese manufacturer (see China Contract Signing Formalities: You are not in Kansas anymore) that describes in excruciating detail exactly what the product you are having manufactured should be. In other words, you need a China contract that works. This poor guy in North Carolina had only some emails written in English saying that he wanted his shirts to be like “the samples.” What samples?

Note that this North Carolina company could have sued its Chinese manufacturer in a U.S. court and won. However, because China does not enforce U.S. judgments, and because this Chinese shirt manufacturer did not have any assets in the United States, the U.S. judgment would have been worth less than the paper on which it was printed. Yes, the NC company was stuck, out nearly a million dollars over a few shades of blue.

I tell the above story to emphasize how China and its laws are so different from the United States and Europe and how Western companies so often lose big money by just assuming that they can do things with Chinese companies just as they do things with American or European companies. I use this micro story to writ large on how to operate when doing business with China.

Jacob Yount writes about sourcing promotional products from China to instruct on how to source promotional products from China, but he so knows his stuff and explains it so clearly that what he writes often goes well beyond that, and his color post is a great example of that. Yount starts his post describing what both he and the China attorneys at my firm so often hear and then recognizing that his post likely will apply well beyond promotional products:

“But I gave the factory the Pantone number!”

In the trials and tribulations of China manufacturing when a buyer finds out the color of their sample, or, even worse their production is “off”, this is a common exclamation.

Perhaps not completely wrong, but not completely right.

The result is a color that is deemed different from the official Pantone. Why is this?

Is it the typical that “factories don’t care”. Or, “they didn’t pay attention”.

Or is there more to it?As always, most of my posts are geared towards the Promotional Product Industry, but undoubtedly this will ring true across the board where color matching is critical.

Going in to my 15th year of working and manufacturing from China, here are some of the basic points and lessons I’ve learned on color mixing and matching.

Yount then explains in painstaking (but necessary) detail how you can minimize your risk of getting the wrong color product from your China supplier. To summarize, Yount emphasizes the need to use multiple strategies to make sure that your Chinese factory knows exactly what you want and the importance to you that you get it.

To which I would only add that once you have done all that Yount mandates, you appropriately memorialize it in a China-centric contract. Do all that and you will greatly minimize the likelihood of your seeing some variation of red the next time you have your product manufactured in China.