China Law Blog

FT.com wrote an interesting story the other day of a German advertising company whose employees had set up their own company within a company. The thrust of the article is that this sort of thing is peculiar to China and foreigners had better beware. I have received no fewer than three emails from people sending me the article suggesting I should write on it. Okay, I will, but only to say this sort of thing goes on all the time and it is certainly not peculiar to China. Not at all.

The article necessarily focuses on China and it quotes someone who wrongly paints this deception as a China-foreigner thing:

There is an attitude among many in the Chinese business community that foreigners are rich and stupid and therefore fair game; that deceiving them is somehow acceptable in a way it wouldn’t be if they were Chinese,” says one intellectual property lawyer who has worked in China for nearly two decades, and who asked not to be named to avoid repercussions for his business.

The article then blames the German company for putting a local Chinese in charge of the business:

Mr Hilligardt believed in putting local Chinese in charge of his business, not only because they spoke the language and understood the market but because they had connections and got things done.

“My management philosophy was one of mutual trust and harmony, a merging of European quality standards and discipline with Chinese drive and knowledge of the market,” he says, sitting in his plush Beijing office surrounded by contemporary Chinese art. “I realise now that the key to everything in China is not harmony but control.”

In daily business operations, Mr Hilligardt relied heavily on Li Yangyang, a young executive he recruited from the China Hairdressing and Beauty Association in 2003, at the tender age of 24, and groomed as his intended successor.

“I made him into who he is today; he was my partner from the start and he had my full trust,” Mr Hilligardt explains.

The problem was NOT putting a local Chinese in charge. The article then hints at the real problems, which problems I will explain more fully below:

In his private life, Mr Hilligardt, who does not speak Chinese, was completely reliant on his secretary since 2001, Teresa Tu, whom he hired after she served as his assistant on an earlier trip hunting for business opportunities in China.

According to Mr Hilligardt, Ms Tu managed many of his business dealings, his personal finances, his shopping, accommodation and transport and also handled a number of his personal investments.

A romance sprung up between Ms Tu and Mr Li after he joined Mr Hilligardt’s company, and in April 2006, they married.

Mr Hilligardt says now that he felt somewhat uneasy about the control over his life that the newlyweds enjoyed but he did nothing at the time because he trusted both implicitly.

* * * *

But some of BMC’s other employees were uncomfortable with Mr Hilligardt’s hands-off management style and the influence exerted in particular by Mr Li, who had recruited many of his former university classmates to work for the German company.

“Under Mr Hilligardt you could do anything in this company except challenge the positions of Teresa Tu and Li Yangyang,” says one BMC employee who asked not to be named. “Li controlled everything and when he attended meetings the only thing missing was a pinky ring and a cat in his arms.”

Present and former employees of BMC describe numerous situations in which Mr Li and his former university classmates would flatter Mr Hilligardt, praising his Chinese language ability in spite of the fact he could barely say anything and telling him that no other foreigner understood the country like he did.

According to two employees, Ms Tu and Mr Li also introduced Mr Hilligardt to Lillian, a former model in her early 40s who they say became his mistress. Mr Hilligardt declined to comment.

“He was a vain old man who trusted the wrong people,” says one BMC employee. “They built up a world around him in which he felt safe and he didn’t see the problems in the business because he didn’t want to see them.”

To make a long story short, the business went from doing well to doing poorly, all because Ms. Tu and Mr. Li were selling advertising on their own behalf, not that of the company.

In analyzing this, let me say that my firm has been involved in at least a half a dozen such matters on behalf of our clients, and only one of those was in China. My favorite one involved a very large food brokerage firm that discovered on the computer of one of its employees in the United States that on his company paid trips to buy product in Asia, he was buying at least as much product for his new company and selling that product from his own company to my client's customers.

This client caught this company within a company scheme pretty early because they monitored their business. And fortunately, this married crook left shockingly lewd pictures of himself on the computer with his Vietnamese girlfriend which made him want to resolve things as quickly as possible....

We are right now overseeing another United States case for a foreign company, involving a rogue employee who allegedly set up a new company bank account -- without company authorization -- in the very same bank where the overseas company maintained its accounts. This rogue employee would tell many of the buyers of the company's product to send the money to the rogue account. We are currently suing both the bank and the employee.

It can be unbelievably profitable to sell product, be it food, advertising or anything else, when you are not the one paying any of the underlying costs. Because of this, there will always be employees who seek to do this, and this is true everywhere in the world.

So what did the German company in the FT.com article do wrong? It was not wrong for it to go into China and it was not wrong for it to put a local Chinese in charge. Its mistake appears to have been putting way too much trust in a small core of employees, shutting out the lines of communication to the other employees, and failing to engage in even basic monitoring of the business. Setting up and running a business in China (or anywhere overseas for that matter) completely remotely is a classic path to problems.

It was also wrong for the German owner to allow his libido to get involved in his business. We have a client in a very much male dominated industry who sends only his female employees to China because, as he puts it, he "doesn't trust his male employees not to go on three day benders with females and do really stupid things."

Anyway, the moral of the FT.com story is really rather basic. If you mismanage your business in China (or anywhere else) you will probably end up with some pretty newsworthy problems.

UPDATE: In its post, "China Foreign Investment Advice: When In Doubt, Use Common Sense," China Hearsay also sees no big or deep lessons to be gleaned from this story and expresses this in far more colorful language than I:

Well, yeah. If you set up a company and don’t really manage it, there is a risk that people will screw you over. If your manager prefers to spend his time fucking around, as opposed to doing his job, something might go wrong.

Don’t need the FT to educate us on that, nor do we need expensive consultants to guide us around these pitfalls.

Lesson to foreign investors (anywhere): either manage your company competantly or consider another business model (e.g. a license with strong audit rights).

All true....