China Law Blog

Co-blogger, Steve Dickinson, just wrote an article for China International Business Magazine entitled, "Debunking the Guanxi Myth." (if you are not reading this magazine, you should be) (h/t to Travis Hodgkins over at the Transnational Law Blog. Steve starts out talking about how so often after he has informed a client that a proposed transaction is illegal, the client tells Steve they do not care because "they are working with a powerful political or military figure who will ensure that the normal legal rules and documentation do not apply." Steve sees this as a mistake for the following reasons:

No foreigner can recreate a Chinese-style guanxi network. In China, guanxi refers to a vast network of connections arising from party, family and work connections that may go back several generations. No guanxi network relies on a single individual. The elimination of one member of the network is therefore not fatal. Foreigners almost always rely on only one or two individuals for their supposed connection. This kind of network is too fragile to be of enduring value. Foreign investors who think they have created a guanxi network in China are usually simply deluding themselves.

Connections with local government officials are short-term and can be abruptly terminated. Many foreign investors do not realize that government officials in China are regularly moved from office to office and from region to region. As a result, the connection with a local official is unlikely to be a long-term connection. It is quite common to negotiate a project for several years and then learn that the official in charge has been transferred to a new post. Where the project is not in compliance with the law, their replacements will often refuse to sign the documents that have already been negotiated.

The Chinese provider of guanxi may suddenly disappear. If the project depends on the protection of a single individual, what will happen if that person dies, is demoted, or prosecuted for corruption? This change in fortune can be a particular disaster where the foreign investor has already contributed funds, because the project can be cancelled with no refund on the investment.

A project based on guanxi gives too much power to the Chinese side of the deal. In many cases, the provider of guanxi will make use of the fact that the project is not in compliance with the law to ask for additional benefits. Since the foreign side has no legal recourse, the foreign side must accede to what is in effect a blackmail request or risk the collapse of the project. When the foreign investor comes to a lawyer for help, there is nothing that can be done, since the project itself is either illegal or poorly documented.

Steve recognizes the value of Guanxi, but not as a substitute for a soundly structured deal:

I do not mean to say that having good guanxi is of no value in China. It is of course beneficial in China, as in any country, to cultivate good government relations. Connections with the wealthy and powerful are also an advantage when working in a difficult investment environment.

However, these kinds of connections should never be seen as a replacement for carefully structured investment projects. All investments should be designed to comply with mandatory laws and regulations. The investment must be documented so that the foreign investor can defend its interests in the event of a dispute or changing conditions. Failure to follow this careful approach is the source of many self-inflicted foreign investment disasters that we see all too often in China.

Bottom Line: Be very skeptical of a China service provider who spends time talking about his or her China connections. Those who tout their connections/guanxi are almost always doing so because they have so little to say about their expertise and experience.