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China Law As Guessing Game

Posted in Legal News

Stan Abrams over at China Hearsay did a great post, detailing the difficulties of uncertainty in dealing with Chinese law. The post is entitled, “The Law and New Tech in China,” but the issue it raises regarding the gaps in China’s commercial laws goes well beyond just new technologies.
Stan starts out with the following fact pattern:

Company A makes nano-widgets in the U.S. and sells them in the U.S., EU and parts of Asia. They now wish to sell in China and would like to know if China permits foreign companies to sell nano-widgets in the PRC.
Company A calls me up and asks me to check this out. First, we take a look at the relevant laws and regulations. No surprise, there is no law in China regulating nano-widgets because the technology is so new.
Second, one of my associates calls over to the Ministry of Mysterious Technology (MMT) to find out what their policy is on this. The official at MMT says that he is aware of nano-widgets, and although the Ministry has yet to take a formal position on the issue via publishing a regulation, their internal policy is that foreigners may not sell nano-widgets in China.
Further research shows that two foreign companies are selling these products, one in Tianjin and the other in Shenzhen. I ask the MMT about the likelihood of administrative enforcement, and the official says that MMT will not take any action and is aware of what these companies are doing.

Stan than asks, “What do you tell Company A?” He then posits the following:

1. There is no law that says you cannot sell nano-widgets in China. Go for it.
2. China has no licensing scheme at the present time for the sale of nano-widgets, therefore Company A cannot secure a license to sell these products.
3. It is illegal for Company A to sell these products because the MMT says that it is prohibited.
4. Company A should go ahead with sales in China because even though there is an internal policy against it, the lack of enforcement implies a tacit acceptance by MMT in the absence of regulation.
5. Company A should sell more traditional products.

Stan has absolutely nailed it. My firm gets these issues all the time as well, and not just in the area of new technologies. Media and financial services are also areas of Chinese law ripe with gaps. So how do we usually handle these things?
These situations make for the classic lawyer CYA letter setting out all of the applicable facts and then stating that the law is silent on the issue. The letter concludes by stating that because the law is silent, one cannot predict what will happen (or when) if the client goes forward with its plan.
We have had to write a whole score of these letters, but because this is China, most of the time, our clients have gone forward despite the risks and unresolved issues our letters set forth. This is particularly true of our clients that are not publicly tradeed. The publicly traded ones more often back down, simply because they do not want to have to put something in their disclosure statements along the lines of, “our China operations may or may not be legal and therefore, they may be closed down at any time.”
Our job as lawyers is to present the client with the facts on the ground and with the law. In the end, it is the client who must then incorporate those facts and law and make its own business decision on how to proceed. Indeed, we have a number of clients who have gone forward with businesses even after we have made very clear they are either illegal (an example might be an office building in a building that is required to be used as a hospital) or illegal for foreigners. That is their decision to make, not ours. Again, our job is simply to educate them to the risks.
It all comes down to that old business calculation of risk versus reward. Step right up.

  • Bill

    Chinese government is extremely skillful in allowing great among of discretion and interpretation in their legislation, intend to give the greatest flexibility to the law enforcement and judiciary to adapt the law to various situation – political, financial, personal, guanxi, etc. When you guess what would happen, you need to get information about law enforcement officials and judiciary about what is really in it for them, personally, family, organizationally, etc.
    Have fun.

  • http://www.whataboutclients.com/archives/2008/04/doing_business_1.html What About Clients?

    Doing business in China: Cutting paths on uncertain terrain.

    Dan Harris at China Law Blog discusses “China Law As Guessing Game”, inspired by the Stan Abrams post at China Hearsay called “The Law and New Tech in China”. Harris and Abrams are full-time China lawyers with busy practices….

  • http://www.hullmcguire.com Dan Hull

    Both posts are really useful and well-explained. And I like Bill’s comment. We’ve seen the syndrome at our shop (just not as frequently as you guys). Yank law constructs and Western logic alone are not enough to get you there. But you can still advise and act–because you must.

  • http://twofish.wordpress.com/ Twofish

    Something important is to define the role of a lawyer. It is not the job of the lawyer to run a business. It’s usually a bad idea for a lawyer to give business related advice, since they are an expert in the law and not the business.
    The job of the lawyer is to give as best as he can, information on the current state of the law, and the possible legal ramifications of courses of action., and then leave it to management to decide what to do. For example, it can be perfectly rational for a business to do something knowing full well that the government might or even probably would shut them down in the future.
    So you tell company A what you found out in the first block, and then let company A make their decision about what to do about it, and if you don’t know what is going to happen, then you don’t know. It’s also important for lawyers to state the legal situation in detail because there is sometimes a very important implication that the manager is aware of, but the lawyer isn’t, because the manager didn’t think it was important until the lawyer mentioned it.
    BTW, even if something was 100% legal under a Chinese regulation, one should mention that regulations change, that poses legal risk.
    Also, if I were a manager, my next questions would be:
    Can you do a legal analysis of the feasibility of partnering with a Chinese partner? Are there any special regulations that would allow an HK or Taiwan company to do this distribution? What are the legal risks of having a Chinese partner do distribution? What are the legal risks of importing parts of the widget and have a local Chinese company do final assembly. Suppose we do start producing X in China and the MMT decides to shut us down. What happens? Does production just stop or does MMT have legal authority to seize product or plant? Would we be barred from ever doing business in China again? Can we write a contract that has us distributing product X, but immediately transfer ownership to a Chinese partner if there is a legal issue? Would we lose profits that we have already made if distribution stops? Can we immediately transfer profits outside of China? Would we be legally responsible for the social welfare of our employees if the government shuts us down?
    Suppose the MMT shuts us down, are contract provisions that we have to provide product X enforcable? Can you put into our distribution agreements that we don’t have to supply product X if we get such down? Can we recover product and resale them in Vietnam?
    Can we open a representative office in China to prepare for selling product X? Is there anyway we can get our competitors who are selling product X in legal trouble so that they don’t have a competitive advantage over us? How long do you think it will be before we can open a distribution network? Can we advertise for product X? Can we have Chinese buyers take delivery of product X in the US? Suppose we establish a representative office, and have our salesman go to potential clients, and they request product X to be imported directly from the US, is this considered a sale? What if we fly our customer over to the US, they take possession within the US, and then take it with them back to China? Is this prohibited? What if we meet them in HK? What if we don’t have salesmen, but advertise in Chinese trade journals? What if we don’t advertise in Chinese trade journals, but US trade journals that we know our clients read? What if we approach Chinese clients at trade shows in the United States? In Hong Kong?
    I’d like to take to our competitors about what they are doing selling product X, what are the legal restrictions for me to do so? Can I have our competitor distribute our version of product X so that they take the legal risk? Are there anti-trust issues (both in US and in China) that I have to be aware of? Would it be better if I don’t call the competitor but rather you call their corporate counsel to start the conversation?
    Once you answer those questions, I’ll go back to the board, and I’ll come up with another set of questions…. :-) :-) :-)

  • Anders k

    One should also ask, what would a Chinese company do in a situation like this?
    Well they would not have called the MMT up and asked them.
    They would find someone to protect them in case of a disargeement, maybe in the local legal system where their firm is based or try to get close to people in the MMT or people related to them by offering a research deal with a university or something else that would make the MMT look good.
    This is of cause not something a foreigner just does, but what I learned in China is that if a lot of people stand to lose money, especially if it the ones that understand the system, then laws can change overnight.
    So maybe risk assessment in China is more about making the right people dependent on you in the right way, then about crushing numbers on what it will cost you if the hammer falls, or having an army of foreign and Chinese lawers assessing risk for you.
    This all takes time and money, but it would still be the best insurance you can get, and it beats trying to guess what’s going to happen next

  • http://teachingchinalaw.blogspot.org BrianJ

    Sounds like ex post facto laws to me!

  • maomwl

    This is exactly how I felt after about a month in the China Tax group. Good to know once and for all I’m not mistaken! No one said anything to me, it was all a lot of guessing and very confusing. Then I deciphered the “code” around the office and found out we all just “wing it”. We do the best we can, but there’s only so much we can do.

  • WilliamP

    I read this post last week and while researching for my personal assignment I came across this little paragraph that reminded me about the nano-widget case:
    ‘Much of the regulatory framework for business has been developed on an incremental basis in response to grass-roots initiatives. To meet the demands of investors, local governments regularly have forged ahead in carrying out commercial law reforms without central approval. Among countless examples, local governments approved the establishment of wholly foreign-owned enterprises and holding companies, and allowed investors to mortgage their assets, years before the central government passed laws sanctioning such activities. Similarly, by the time the Lawyers Law was passed in 1996, authorizing the establishment of partnership law firms, local justice bureaus had already approved hundreds of such firms.’
    1.Peerenboom, Randall. China’s Long March Toward Rule of Law.
    West Nyack, NY, USA: Cambridge University Press, 2002. p 154.
    As stated in the original post and everyone’s comments; risk assessment is vital.

  • http://www.chinalawblog.com/2008/05/foreign_companies_in_china_can.html China Law Blog

    Foreign Companies In China Can’t Get No Love

    Rich Brubaker over at All Roads Lead to China has a post up on how the Chinese government makes its laws with its own populace in mind, not out of consideration for foreign companies. The post is entitled, “Regulations in China: Are You Prepared? Are Y…

  • http://www.ag-anwaltspraxis.ch Anwalt für Arbeitsrecht

    Great article !
    I am going to give it a shot, thanks.