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China Contracts: Calling A Table A Chair Is Not Clever.

Posted in Basics of China Business Law, China Business
Cartoon by Paul Noth from the Conde Naste Store. http://bit.ly/18cKloW

Cartoon by Paul Noth from the Conde Naste Store. http://bit.ly/18cKloW

I like this cartoon because it is funny. But I love this cartoon because it is so China relevant. This cartoon was sent to me by my friend Roberto De Vido, whose  own very funny and topical cartoons can be found here. Roberto told me that “he knew” I would like this and then we discussed some of the examples we have seen where foreign companies actually tried similar things in China.

The reason this post is titled the way it is is because I oftentimes analogize to tables and chairs when explaining to clients why what they are proposing will not work. I tell them that we can call a table a chair, but it will still be a table, and vice-versa. I then tell them that no government — including the one in China — is going to treat a table as a chair just because you call it that, and the same holds true for contracts.

Over the years, our China lawyers have seen the following, among other things:

1. Contracts with Chinese employees who are working in China that claim to be contracts for the employee to work in the United States. US companies (and yes, US lawyers) say that they do these contracts so as to avoid China’s onerous tax and labor laws. I say that they do these contracts because they have absolutely no clue regarding either international law or China’s labor laws. First off, no country in the world is going to allow you to employ one of its citizens in that country and have some foreign law apply to that employer-employee relationship, notwithstanding any lie in your contract. Second off, if you do not have a written contract with your China-based employees, you are opening yourself up for massive penalties. If I were a Chinese employee, I would argue that a contract like this does not qualify and I would expect the Chinese arbiters to concur with that.

My all time favorite on this was when an American company contacted me after learning that the Chinese government had come by wanting to see their employment contracts. When I told him that he was in big trouble because the government would see that all of his contracts claimed that the employees were working in the United States, he asked me how they wouild be able to prove that. I pointed out that all they would need to do is check the employee passports. I am not making this up!!

2.  We often see royalty agreements, service agreements and product sales agreements intentionally mislabeled in an attempt to reduce taxes, avoid the foreign company from being deemed to be doing business in China, or to make it easier for the Chinese company to be able to get money out of China. This sort of thing is never a good idea.

3. We also have seen a number of times where companies have gotten into trouble with China customs for claiming to be importing X when actually importing Y. Companies typically do this to secure a lower duty or because the Y product requires certifications or is not allowed in China at all. Let’s just say that China customs is not at all understanding in these situations.

4. Bribes. Without naming names, one prominent company has had huge bribery problems both in China and elsewhere and one of the things this company allegedly did was to provide its employees with $5,000 in monthly “travel reimbursements” which reimbursements were actually for the paying of bribes. Not smart.

Roberto told me of a story involving a friend of his who had been convinced by his Chinese partner to describe its business to the Chinese government officials one way, when it was actually something else, and to do so in order to get a business license, even though its real business was not open to foreigners. Roberto said that at a certain point, the government official interrupts his friend’s “umpteenth explanation of why the business license should be granted” and says something along the lines of “Mr. Xxxxxx, we understand your business very well. And for that very reason we don’t want to grant you a license.”

It should go without saying — but it doesn’t — that lying is a always a very bad way to try to deal with a government and that your putting a false label on something not only does not usually work, but it also usually will subject you to additional penalties, including criminal. It should also go without saying — but again it doesn’t — that just because your Chinese counter-party insists that “everyone does it” does not mean that you will get away with it and that Chinese government officials did not just fall off the turnip truck.

The cartoon above is funny, but what will happen to you if you seek to emulate it will not be. You agree, right?

China Distributor Relationships: Why Don’t They Get No Respect?

Posted in China Business, Legal News

Yesterday’s post China Distributor Agreements: A Relatively Easy Way To Sell Your Products Into China, was on how companies can sell their products into China via a China-based distributor. On Linkedin, in response to that post, Shanghai businessperson, Bill Cosgrove wrote the following:

Dan,

China Distribution AgreementsYou make a compelling case for distributors. Why do you think the distribution route isn’t getting respect? Fear of loss of control? Just early in the process of this channel?

I responded to that with this:

Bill, Great question! Such a great question, in fact, that I am going to answer it on our blog (www.chinalwblog.com), where I can give it the treatment it deserves, rather than here. Watch for it on Thursday (or maybe Friday).

My friend, and China supply chain expert, Michael Zakkour, then wrote the following:

Dan, there are a LOT of downsides to distribution and distribution only deals in China. Marketing, brand positioning, being locked into bad deals. I have a number of clients who were nearly ruined in China because of distribution only deals and we are restructuring their presence.

First off, let me be perfectly clear here. I am not saying, nor would I ever say that a distribution arrangement works for every situation. I would not even go so far as to say that it works for most situations. All I am saying is that we have seen it work many times when undertaken in the right situation and too many companies fail even to consider it. On the flip side, as Michael would no doubt attest, too many American companies go into distribution relationships without sufficiently considering them and without erecting sufficient protections.

Michael’s answer does go a long way in explaining why China distribution deals are not more common, but there is more to it than what Michael is saying. Michael is absolutely right in saying that there are a lot of downsides to China distribution deals and he only lists a few of them. I am not going to underplay the risks of a China distribution arrangement. Not at all. What I will say instead though is that there will always be risks with any business avenue taken on China and that for many companies, a distribution model is the least risky of all.

For what sort of companies does a China distribution arrangement make sense? Most clearly, the company that either cannot afford or is unwilling to pay what it would take to go into China on its own. The risks Micheal lays out above will all be there for these companies, but a good distributor coupled with a good distribution contract can go a long way towards reducing (not eliminating) those risks. And it is not as though those same risks would not also be present were the American company to go into China alone. Yes, your China distributor can ruin you by bad marketing and bad brand positioning, but I also have seen American companies ruin themselves with those same things. As for Michael’s concern about getting locked into bad distribution deals, I personally have seen countless American companies for whom that has been true, but if I might brag just a bit here, none of them have been clients of my firm.

Without a doubt, the worst deals that my firm’s China lawyers see are exclusive distribution deals with a Chinese distributor that fails to contain a termination provision that allows the American company to end the relationship if the Chinese side is not making sufficient sales or in any way tarnishing the American company’s brand or reputation.

I actually think the most interesting question is a subset of Bill’s question as to why distribution deals get so little respect from American companies going into China and my theories on that follow.

First, I think that too often American companies’ eyes exceed the size of their stomach. In other words, they too often believe that they are capable of selling their products themselves within China when in fact they are not. If you are not capable of selling your products yourself in China, you should be considering other alternatives, of which a distribution deal is just one.

Second, I think that many American companies do not realize that there are good distributors in China. There are bad ones too and it largely depends on the industry. By way of examples, we have worked with many companies in the pharmaceutical, software, and publishing industries that have achieved great results with Chinese distributors, including in many instances where these companies would almost certainly have failed in China without their distributors.

When it comes to business and when it comes to China, there is rarely a one size fits all solution. Using China distributors as a way to sell your product into China should not be ignored.

What are your thoughts?

China Distributor Agreements: A Relatively Easy Way To Sell Your Products Into China

Posted in Basics of China Business Law, China Business

China Distribution Agreement

For most American SMEs, getting their products into China and then marketing, selling and delivering them is a difficult and massive task. Using an experienced Chinese distributor or distributors is oftentimes the best way for these companies to accomplish these things.

Distribution contracts with Chinese companies are both similar to and quite different from US distribution agreements. U.S. law makes it difficult and expensive to terminate distributors, but because China makes no special allowances for distributors we draft China distribution agreements to provide for applying Chinese law in a Chinese court. We also do not bother with provisions that try to work around distributor protections.

One big issue in China with nearly all distributor agreements is intellectual property protection. To “further” protect the IP of our American clients, we usually put into our distributor agreements what we call a “no registration” provision. In this provision, the distributor agrees that our client exclusively owns all trademarks or other IP that might be at risk, that the distributor gains no rights to those trademarks, and that the distributor will not register any IP in any way related to our client’s IP. We use the words “further protect” because the first line of protection for your in China should always be to register your trademarks in China right away.

China’s Anti-Monopoly Law prohibits retail price maintenance — which includes requiring a distributor sell goods at a minimum resale price to third parties. Therefore your China distribution agreements should not require your Chinese distributor sell your goods at a certain price.

One final important difference between Chinese and American distribution agreements is the signature line. Your Chinese distribution contract should provide a place for your Chinese distributor to affix its company seal because without that, a Chinese court might find your distribution contract invalid.

A distribution relationship with an experienced Chinese distributor and a China-specific distribution agreement may be just the solution for getting your product into China.

What do you think?

China Business Deals: What China Business Deal?

Posted in China Business, Recommended Reading

Great article in The Hollywood Reporter. The article is by Michael Wolff and it is entitled, Hollywood’s Disappearing Chinese Money. But it is about a lot more than just Hollywood-China deals. It is really about all China deals. China Negotiation Tactics

This article does as good a job as I have ever seen in describing how eager American companies are to “do deals” with Chinese companies and how that eagerness to a large extent blinds them to the fact that the deal they think is going to happen will not.

Whenever a company calls one of our China lawyers to draft a contract for a deal, we always suggest that before they incur attorneys’ fees, they make certain that they really do have a deal. About 50 percent of the time they come back to us a few days later to tell us that it turns out they are still negotiating. Whether it be because of cultural differences of miscommunication, we have found that there is too often a disconnect between the American side and the Chinese side when it comes to getting a deal done.

For more on this sort of deal disconnect, check out

Beijing Touts “Cyber-Sovereignty” In Internet Governance: Global Technology Firms Could Mine Silver Lining

Posted in China Business, Legal News

A Guest Post By Scott Livingston*

It has been a difficult few weeks for global technology companies operating in China.

Chinese officials strengthened the Internet firewall by blocking the use of virtual private networks (VPNs), reasserted demands that web users register their real names, and issued a new regulation requiring enhanced scrutiny of imported IT products in the financial industry. In response, a consortium of 17 trade groups wrote U.S. trade officials urging them to resist China’s new cybersecurity policies.China Internet Law

But while U.S. tech firms are right to be concerned about their present treatment in China, they should understand that China’s maneuverings are rooted in its new embrace of “cyber-sovereignty,” a principle that holds that national governments should have the right to supervise, regulate, and censor all electronic content transmitted within their borders. China’s push to practice this principle at home and abroad brings with it the promise of substantial new opportunities for global tech firms operating in China, even as it challenges long-held Western assumptions about a free and democratic Internet.

Cyber-Sovereignty and Global Internet Governance

Cyber-sovereignty (“wangluo zhuquan” or “internet sovereignty,” as it is sometimes translated) emerged as a foundational policy following an administrative realignment that occurred in the wake of Edward Snowden’s revelations that the U.S. had been snooping into Chinese cybernetworks for years, often through third-party technology.

In response to these revelations, China reacted to the new threat by centralizing Internet policy in two high-level organs: a Communist Party “Central Leading Group for Cyberspace Affairs” chaired by President Xi Jinping and tasked with drafting “national strategies, development plans, and major policies”; and a State Internet Information Office (SIIO), led by Lu Wei, and apparently tasked with promulgating these policies to lower-ranking ministries. (In addition to his position as Director of SIIO, Lu is also the Director of the General Office of the Central Leading Group for Cyberspace Affairs, and thus clearly has the ear of President Xi.)

The concept of cyber-sovereignty began to appear in China’s political discourse shortly following this administrative reshuffling. Since last summer, it has become a near-ubiquitous component of Chinese comments delivered to overseas audiences on the subject of Internet management.

To date, the most high-profile political benediction for this principle has come from President Xi in official comments made at two international forums. At a speech to Brazil’s National Congress in July 2014, Xi asserted that “Internet technologies must not be used to violate cyber-sovereignty.” In November, at the inaugural China-hosted World Internet Congress, Xi wrote a welcoming letter to attendees stressing that China was willing to work with other countries to build an Internet founded on “respect for cyber- sovereignty and the upholding of cyber-security.”

These remarks have since been synthesized by Chinese media, with the online arm of China Radio International noting that President Xi’s conception of cyber-sovereignty “has two levels of significance: an internal component where each government has the right to develop, regulate, and manage its domestic Internet in line with its national independent autonomy; and an external component involving the right to defend its Internet from foreign intrusion and attack.”

The importance of cyber-sovereignty as a guiding principle for China’s leaders was further demonstrated by an incident at the close of the aforementioned World Internet Congress. There, conference attendees, including representatives of the world’s leading technology companies, received a last-minute nine-point “draft declaration” placed under their hotel room doors at midnight, with comments due back by 8 a.m. The communiqué included a commitment to respect “the Internet sovereignty of all countries.” After conference attendees refused to accept China’s last-minute gambit, the issue was quietly tabled. However, word of this refusal must not have reached the editors of China Daily, whose headline proclaimed “Key Internet Leaders Agree on Cyber Sovereignty, Security” in a story posted online the next day. The article’s claims that conference attendees had agreed at the closing ceremony “to respect Internet sovereignty” was sharply disputed by The Wall Street Journal, whose own account of the proceedings reported “[cyber-sovereignty] was left unmentioned in the final speeches.”

Of course, given that China is the country with the world’s largest Internet population (649 million Chinese were online at last official count in February), we should not be surprised it insists on a seat at the table of global Internet governance. Indeed, the world should welcome China’s desire to engage. But China’s conception of cyber-sovereignty is nothing less than a sharp realignment of the traditional conception of the Internet promoted in the developed world, from an open platform regulated by a diverse array of stakeholders, to one fragmented by national boundaries and regulated piecemeal by national governments. Under the Chinese conception of “cyber-sovereignty” all forms of national censorship are equivalent. Whether a German ban on hate speech or a Chinese ban on any content “disrupting social stability,” each prohibition stems from specific national and cultural conditions—as determined by their governments—and therefore is equally valid.

While there are certainly merits to this idea, China has yet to argue convincingly how such a multilateral approach improves upon the current multi-stakeholder model. Unsurprisingly, it also hasn’t addressed the risk such a scheme poses for citizens of non-democratic governments. Nevertheless, China’s emphasis on the principle of cyber-sovereignty appears to have become a central part of its international engagement—one we will likely see more of in the coming years. Ultimately, this will pose a challenge to the democratic Internet as a platform for many of the values Westerners long have viewed as universal.

What Cyber-Sovereignty Means for Global Technology

While China’s cyber-sovereignty push poses challenges for global Internet governance, it also may conceal something of a silver lining for global technology firms wishing to operate in China. The consolidation of Internet rulemaking in bodies such as the Central Leading Group for Cyberspace Affairs and the SIIO, represents a fundamental change from China’s previous patchwork online governance, suggesting that Internet regulations soon will be developed in a more coordinated manner. Further, the positioning of these organs near the apex of China’s leadership hierarchy means China’s top leaders will be able to pursue fundamental reform of national Internet regulations in line with those principles that they view as most essential to China’s future development.

Recent activity indicates that top officials are comfortable with furthering market openings provided they meet the two conditions of cyber-sovereignty. First, imported investment or products must not pose a threat to China’s cybersecurity (hence the recent regulation requiring security checks on IT products delivered to Chinese banks); and, second, global technology companies must adhere strictly to Chinese laws and regulations. They may not, for instance, employ VPNs that weaken the the firewall.

Several recent legislative developments suggest that Chinese leaders are in the process of opening the domestic market:

Chinese officials already loosened certain Internet restrictions in the newly-established Shanghai Free Trade Zone, which now allows wholly foreign-owned enterprises to operate nationwide e-commerce businesses from within the zone. To date, Amazon has been the most high-profile foreign technology firm to set up operations there. As the Shanghai Free Trade Zone is intended as a testing ground for national reforms, its relatively relaxed treatment of foreign investment in general, and ecommerce in particular, suggests further national liberalization.

In November 2014, China’s National Development and Reform Commission solicited public opinion on a draft revision of China’s Catalogue of Industries for Foreign Investment, the list that says where overseas money will be welcomed and where it will be rebuffed. Replicating the aforementioned reforms of the Shanghai Free Trade Zone, the draft would, if promulgated in its present form, remove the present 50% cap on foreign ownership of e-commerce businesses nationwide. The drafted revisions to the Catalogue also place venture capital on its “encouraged industries” list.

In late January 2015, the Ministry of Commerce issued a draft Foreign Investment Law that would likely stop future use of the Variable Interest Entity (VIE) structure under which many overseas and domestic investors long have skirted China’s traditional restrictions on non-Chinese ownership of online businesses (VIEs presently in existence would be grandfathered in). Such a move seems at first to be a further crackdown on foreign market entry, but, seen in the context of China’s cyber-sovereignty push, it could also signal that China is preparing to liberalize its licensing of joint-venture Internet companies—companies operating online businesses that require a local partner—by ensuring that no loopholes exist for overseas technology firms to work around existing equity and control requirements.

In addition to these regulatory developments, comments from China’s officials and state media indicate that they already may view overseas investment into China’s Internet market as inevitable. In an op-ed published in the Huffington Post, entitled “Cyber Sovereignty Must Rule Global Internet” China’s cyberspace czar Lu Wei alluded to the core conception of cyber-sovereignty in comments suggesting that overseas firms would be permitted to do business in China provided they obeyed Chinese law:

U.S. companies operating in China show that those who respect the Chinese law can seize the opportunity of China’s Internet innovation and create immense value, while those who chose opposition will be isolated by themselves and finally abandoned by the Chinese market.

This theme was picked up in a recent op-ed in the government-run newspaper Global Times: “… we can be sure that US Internet giants such as Google will not stay away from the Chinese market forever. We think the Firewall is a stopgap arrangement, whose function will diminish as Chinese cyberspace becomes more developed.”

These comments, directed at an international audience, support China’s fundamental principle of cyber-sovereignty and hint at a wider opening to foreign tech firms once China has perfected its legal framework for Internet business ownership. The ability of companies such as Amazon, LinkedIn, and Evernote to do business in China provides further support for the idea that global technology firms can serve Chinese consumers provided they operate in strict compliance with Chinese laws and regulations. Officials in Beijing certainly are not blind to the benefits such companies can bring China’s citizens.

To be sure, any further openings to foreign technology firms will not immediately end the challenges global firms face in China. Following the Snowden revelations, we can expect China to continue to exercise increased scrutiny over products from the world’s largest technology companies, in particularly those providers of backbone network hardware. Foreign companies must also cope with the persisting vagueness of China’s still-developing rule of law and the substantial discretion afforded administrative authorities to interpret that law in an ad hoc manner. But with China’s own technology capability growing at a phenomenal rate, we can take comfort that China has a shared interest in ensuring open communication and trade in the sector, and it seems likely that smaller technology firms in the U.S. and elsewhere may be willing to follow China’s cyber-sovereignty principles and design content and services that adhere to Chinese law, potentially heralding a new era of foreign investment in China’s Internet. Silver linings in dark clouds often disappear, but global technology firms able to wait out the stormy formation of China’s new Internet policy may, in the end, see some rain.

*Scott Livingston is an American attorney specializing in Chinese trade and investment law, with a particular focus on technology. Scott was formerly an associate in Covington & Burling’s Beijing office, and now resides in California.

NOTE: This article was co-published with the good folks over at China File, which if it is not on your regular China reading list, should be.

China Arbitration: Second Thoughts on Clarity

Posted in Legal News

Steve Dickinson’s Monday post summarizes a spate of recent Shanghai Number 2 Intermediate People’s Court decisions and makes clear that in Shanghai, if a contract calls for arbitration by the CIETAC Shanghai subcommission, the one and only proper arbitral body is the Shanghai International Arbitration Center (SHIAC).China arbitration

I agree with Steve’s conclusion that the matter is now settled for Shanghai. It is similarly settled for Shenzhen. On January 6, 2015, the Shenzhen Intermediate People’s Court issued a decision upholding the primacy of the Shenzhen Court of International Arbitration (SCIA) for contracts that call for arbitration by the CIETAC Shenzhen subcommission.

But let’s just step back a moment and consider: did anyone seriously think that Shanghai and Shenzhen would not rule in favor of their own respective arbitration centers? Others are far keener followers of the Supreme People’s Court, but I would be chary of proclaiming that these decisions obviously signify the court’s invisible hand and the matter is therefore settled for the entire country. On some level, the decisions are nothing but local protectionism. For more on how local protectionism can impact an arbitral body’s decision to keep a case filed before it, check out Forum Selection Clauses: Do NOT Try These At Home

A few international law firms (see here and here) have issued well-written commentaries on these decisions, but do not even raise the specter of home-town favoritism, instead assuming that the decisions must have the imprimatur of China’s Supreme Court because otherwise they could not have been issued. But because the Supreme Court has not actually acted, the commentaries are couched with phrases like “it would appear that” and “it has yet to be seen.”

 

One thing is clear: these decisions all but sound the death knell for CIETAC’s newly reconstituted Shanghai and Shenzhen subcommissions. Given that CIETAC announced the reorganization of these subcommissions mere days before, the Shanghai and Shenzhen decisions must have come as a shock. Will CIETAC and its allies in Beijing really go away so quietly? If not, this story may get messy again.

 

The takeaway from all of this, as Steve stresses, is that if you are doing business in China and plan to resolve your disputes via arbitration, be very careful when designating the arbitral body

China Arbitration: An End To Uncertainty

Posted in Legal News

Clarity Comes to CIETAC at Last

As we reported in earlier posts, international arbitration in China entered a period of uncertainty in 2012. See Will The Real CIETAC Arbitration Please Stand Up. For many years, Beijing based CIETAC controlled international arbitration in China. To expand its scope, Beijing CIETAC established sub-commissions in both Shanghai and Shenzhen.

Tiring of the oppression of their Beijing masters, the Shanghai and Shenzhen Sub-Commissions of CIETAC in 2012 broke away from control by Beijing CIETAC. Then to cement their new-found independence, each sub-commission adopted a new name. The Shanghai sub-commission changed its name to the Shanghai International Arbitration Center (SHIAC). This newly named arbitration center adopted new rules and engaged a new panel of arbitrators. However, the formal legal entity was never changed.

The question then immediately arose: For a contract that specified arbitration at the Shanghai CIETAC subcommision, did the newly renamed SHIAC have jurisdiction or not? Beijing struck the first blow by issuing a notice on August 1, 2012 stating that the former sub-commissions had no jurisdiction and that all contracts referring to the CIETAC Shanghai-subcommission should be referred to Beijing CIETAC for resolution.

The situation was made further unclear by the CIETAC notice issued December 31, 2014 announcing that it had formed new sub-commissions in both Shanghai and Shenzhen. Under this notice, all contracts referring to the CIETAC Shanghai-subcommission should be heard in the newly formed, Beijing CIETAC controlled subcommissions. As a result of this decision, Shanghai now has two competing international arbitration centers: the SHIAC and the Beijing CIETAC-Shanghai-subcommission.

A recent set of decisions by the Shanghai Number 2 Intermediate Court have finally brought some semblance of order to this situation. In a decision announced on December 31, 2014, the court concluded that if a contract provides for arbitration before the CIETAC Shanghai-subcommission, SHIAC has exclusive jurisdiction in the matter and Beijing CIETAC has no jurisdiction. That is, the court held that the August, 2102 notice from Beijing CIETAC has no legal force and must be ignored. In a series of 12 decisions issued on January 8-9, 2015, the same court reached the same conclusion. This matter is thus settled for Shanghai.

The basis for the Shanghai Intermediate Court’s decision is very simple. The Court determined that the CIETAC Shanghai subcommission was formed in 1988. On April 17, 2013, that legal entity changed its name to Shanghai International Arbitration Center (SHIAC). Other than the change of name, the entity made no other change in its legal status. For this reason, an arbitration clause that refers to the CIETAC Shanghai subcommission is in fact referring to SHIAC. That is, at least during the period up to December 31, 2014, CIETAC Shanghai subcommission and SHIAC refer to exactly the same entity. SHIAC therefore has exclusive jurisdiction for arbitration where this designation has been used.

Though Chinese court decisions have no precedential value the logic of this series of Shanghai Court decisions is so powerful that our China lawyers are viewing this matter as having been settled. For the future though, care in drafting an arbitration clause in your China contract is required. There are now two competing international arbitration commissions operating in Shanghai: SHIAC and the CIETAC Shanghai subcommission. For newly formed contracts, you should take care to designate the exact arbitration entity that you wish to use. Like good lawyers everywhere, Chinese lawyers are masters at delay. It is therefore essential that your China contract be absolutely clear on threshold decisions like dispute resolution, governing language and governing law. For more on how to choose these, check out China Contracts That Work and Three Rules for Your China Contract.

Above all else though, foreign parties should carefully consider whether it even makes sense for them to use arbitration in China at all. In our experience, CIETAC arbitrators are excellent and the decisions are well crafted. See CIETAC Arbitration: Different But Fair. However, arbitration is usually slow and expensive and arbitration panels are limited in their power to coerce through attachment of assets, fines and injunctive relief. This recent period of arbitration uncertainty and chaos should cause all of us to think carefully on this issue. Which method is truly better: litigation in a Chinese court, international arbitration in China or arbitration in a neutral foreign country? Over the years I have been criticized (mostly by lawyers not based in China and not fluent in Chinese) for preferring litigation in China. But after this mess, I feel as though I have had the last laugh.

What are your thoughts?

 

China Highlights Compliance Initiatives. Should You?

Posted in Legal News

Momentum around President Xi Jinping’s anti-corruption campaign continues to grow. Last month, President Xi announced that China will expand anti-corruption efforts by evaluating its state-owned enterprises (“SOEs”) to ensure they are operating in compliance with China’s laws. President Xi’s announcement raises concerns not only for SOEs, whose transactions may face heightened scrutiny and periodic investigations, but also foreign companies conducting business with SOEs whose transactions will, consequently, be more closely reviewed.  

Through President Xi’s initiatives, China appears to be embracing the importance of corporate compliance that has generated considerable buzz in corporate and legal communities. Following the lead of companies in other countries, many businesses in China have recently decided to prioritize compliance efforts and have centralized responsibilities for such efforts in a corporate compliance officer position or with a compliance group. An internet search for “China corporate compliance” results in links to numerous materials offering various perspectives on the topic – including several compliance-related China Law Blog posts.

Many of you must admit that your eyes glaze over when you see an article on compliance efforts in China and that you are tempted to skip it. You shouldn’t.

Generally, “compliance” refers to a company’s efforts to understand the laws and regulations that apply to its operations and to operate in a manner that adheres with these laws. To date, China’s compliance efforts have principally focused on anti-corruption and anti-bribery issues. However, companies operating in China must also realize that China has been extending its compliance initiatives to embrace more uniform enforcement of its laws and regulations. We are seeing the greatest increase coming from companies penalized by the Chinese government for not operating under the entity structure appropriate for their operations and/or for not paying all of their taxes owed.

Taking a wait-and-see attitude in deciding whether to undertake compliance initiatives no longer works for China; if you have not already done so, now is the time to evaluate your China business practices, identify and prioritize your legal and business risks, and determine the most effective means to address such risks. Compliance efforts will necessarily differ among companies operating in China depending on several factors: a company’s size; the nature of the company’s business; the financial, employee, and time resources that can be invested in the company’s compliance reviews and new processes; and the other countries in which the company operates or to which it sells or purchases goods and services.

Companies doing business in China are often constrained by financial and time resources, and such constraints impact senior management decisions to undertake compliance efforts. Compliance efforts in China should not be undertaken if company leaders are not fully committed to seeing the efforts through to completion. Evaluating and prioritizing legal and business risks in China require ongoing efforts to work with employees and a company’s agents to understand the scope of their responsibilities and what laws may apply to such individuals’ roles. Meetings with company representatives to understand compliance considerations often result in follow-up questions that may need to be confirmed by reviewing corporate documents or financial records.

Leaders of foreign companies doing business in or with China generally recognize that compliance initiatives will result in less legal risk for the company. However, they must also weigh the benefits of risk reduction against the financial and resource costs of such compliance initiatives. Evaluating such benefits becomes increasingly trickier as companies in China carefully consider how new Chinese programs, such as the new evaluation of China’s SOEs and various other government crackdowns and initiatives, will affect their business operations.

Compliance reviews can result in significant benefits for companies that undertake the efforts associated with such reviews.  Periodic compliance reviews can expose serious corporate wrongdoing and abuses. Compliance audits can, and often do, help companies identify violations of important legal requirements and provide opportunities to proactively remedy such violations and avoid regulatory fines and penalties. Compliance efforts also encourage better understanding and coordination between a company’s business departments that result in production and service efficiencies. Although not reflected on a company’s financial statements, compliance efforts generally reduce operating costs.

In addition to programs to address corruption and bribery concerns, one of the most fundamental compliance issues facing many foreign companies in China is effective document management. Because many companies do not have a document management system in place when they start their China commercial operations, initial employees usually assume responsibility for filing or saving company documents important or relevant to their positions. Implementing an effective document management system does not require a significant amount of effort but is not typically a priority when starting a company. However, not having such a system raises serious concerns about whether important documents can be found if needed and can result in committing unnecessary time and financial resources if documents must be re-filed with Chinese authorities.

The principal tools to address compliance risks are policies, procedures and training that should be customized to best fit a each company’s particular business operations and resources. Such tools should be carefully documented and preserved to ensure they can be referenced at a later time if necessary to demonstrate a company’s compliance or compliance efforts concerning Chinese regulations.

Foreign companies in China face a dynamic business culture that requires multi-tasking to address competing priorities. Time and energy constraints may leave little opportunity to focus energies on corporate compliance initiatives. Companies must decide whether to invest resources into compliance programs, policies, and training. Given the pace at which China’s regulations and enforcement mechanisms are changing, as demonstrated by recent anti-bribery prosecutions and the recently announced enhanced evaluation of SOEs, we think company-specific compliance evaluations and efforts are good investments.

China Non-Competes: Think Long And Hard About Dispute Resolution

Posted in Legal News

One of the things we always consider whenever we draft any contract, is where disputes that arise under the contract should be resolved. Arbitration in China or outside China? Litigation in China or outside China? In determining the best jurisdiction for our clients, our goal is usually to choose the fastest, easiest, cheapest and fairest jurisdiction, or some combination thereof, depending on the needs of our particular client and the particular contract. Sometimes though, we want the exact opposite — if, for instance, our goal is to make suing and winning as difficult as possible for the other side.  China Dispute Resolution Clause

The right jurisdiction for China employee non-compete agreements seldom lends itself to an “off the shelf” kind of answer. The reason being that Chinese law is unclear as to whether parties can take a dispute regarding an employee non-compete agreement straight to court without having to go through labor arbitration first. The answer to this question is a very important one and it usually depends on the locality of the employer.

Chinese law distinguishes labor law disputes from intellectual property (IP) disputes and some places treat disputes under non-compete agreements as labor law disputes while others treat them as IP disputes. The distinction matters because if they are treated as labor law disputes, the parties must first go through labor arbitration before they can file a lawsuit. To be clear here, labor arbitration means arbitration at the local labor dispute arbitration center, not China International Economic and Trade Arbitration Commission (CIETAC) or other arbitration institutions where commercial disputes are usually resolved.

In practice, different places in China have different understandings of how to categorize employer-employee non-compete disputes. For example, some courts in Zhejiang province and in Hangzhou are of the opinion that such dispute are labor law disputes and without a labor arbitration award, neither party can bring a suit in court. In Shanghai, generally speaking, employer-employee non-compete cases must first go through labor arbitration (note each district within Shanghai may have different requirement). However, some courts in Beijing believe that not every non-compete dispute must go through labor arbitration before litigation, and instead have ruled that claims for violating a non-compete agreement are “normal civil disputes” that can go straight to litigation.

What is important to note here is that under Chinese law, the statute of limitations for labor law disputes is one year while for IP disputes it is two years. This means if a non-compete dispute is treated as a labor law dispute, the statute of limitations will be “shortened” by half. Consider this scenario: the employer thinks the employee violated the non-compete agreement, but and waits just under a year to bring its case to the court. The court thinks that the dispute requires the parties first use labor arbitration and so it sends the parties there. However, by this time, more than a year has passed and the local labor arbitration center declines to hear the case because the one year statute of limitations for labor law disputes has already passed. This may sound extreme but it could happen under the current legal regime, especially if the employer does not have a clear dispute resolution clause or is slow to pursue its non-compete claims.

Bottom line: If you as an employer want to be best positioned to be able to enforce your China non-compete agreement against your employees, you need to have an dispute resolution provision appropriate for your particular locale and situation. You also should not delay pursuing your non-compete claims, should they arise.

 

Note: Yunwei Liang assisted with this post. Yunwei is an attorney licensed in both China and New York. Yunwei has a Master of Laws degree from USC School of Law and she formerly worked at a law firm in Shanghai, focusing on litigation, real estate law, employment litigation and international investments.

Will Chinese Broadcasters Pay Public Performance Royalties To Record Companies?

Posted in China Business, China Film Industry, Legal News

This is the second in a series of posts on music copyright in China. My first post China Music Copyrights is here.

China is often criticized by the US for its copyright laws but China and the US have more in common than you might have thought when it comes to copyright — they are both among a small number of nations that do not regard sound recording copyright as including a terrestrial broadcast performing right. To put that into perspective, most of the European Union has a terrestrial broadcast performing right. The few other countries that do not recognize this right include North Korea and Myanmar. The Future of Music Coalition has had a lot to say about this if you are interested.  

What it means in practical terms is that, in the US and China, when a recording of a song is played on radio the record company and the recording artist are not entitled to receive any performance royalties. This came about in the US because terrestrial broadcasters won the debate with other stakeholders. They convinced Congress with the argument that radio airtime provides free promotion to record companies and artists so there is no need to pay them royalties.

In China right now we are seeing a similar debate unfolding between the fledging recording industry and the powerful, state-funded broadcasters. Central to the debate have been changes proposed to China’s Copyright Law. The law has been in its current form since 2010.

In this post I’m taking a look at recording-related provisions of the  Fourth Draft of China’s new Copyright Law as promulgated by the National Copyright Administration of China, known as the “NCAC.” As mentioned in my previous post, this is a working draft that will be subject to further change as it passes through several more stages in a process that is relatively open.

Musical works (with or without lyrics) are included in the definition of “works” in the NCAC Fourth Draft. So are several other types of copyright subject matter including a new category of “audiovisual works” in place of cinematograph works. Sound recordings are not classified as “works” and are dealt with separately. It is unclear why audiovisual works should not also be treated separately, but that’s another story.

The NCAC Fourth Draft does not expressly list the rights comprising the copyright in a sound recording. We may infer that they are the rights conferred on the producer of the sound recording. Under Article 39 these include the rights to authorize others to reproduce, distribute and rent a sound recording. Also included is the right to make the sound recording available to the public, by “wireless” and by cable in “the information network,” in such a way that it may be accessed from a place and at a time of a person’s choosing. I am told by Guo Biao of IFPI China that these expressions refer to Internet use generally, including downloads and webcasting. In any case, the right of “making available” in this way is already enjoyed by the producer of a sound recording under the existing law.

What is most controversial is the proposal, under Article 40 of the NCAC Fourth Draft, that the producer of a sound recording should also enjoy a right of “reasonable remuneration” when the sound recording is “transmitted to the public in wireless or cable form” or “transmitted through technical devices”. Again, I’m told by Mr. Biao that this refers only to three categories of use: first, radio or TV broadcasting (wireless), second, cable transmission, and third, transmission through technical devices in public areas as background music. Article 40 does not involve any Internet use. China’s radio and television broadcasters are concerned that Article 40 of the NCAC Fourth Draft would mean that they would need to start paying royalties. So the NCAC Fourth Draft is being met with resistance.

Who do you think will win the debate?