China's Business Laws. Ignore Them At Your Peril.

Very interesting and very thoughtful post up over at Think China, entitled, "Are rules meant to be broken?" The theme of the post is that one needs to learn to "tiptoe through the gray areas of China law." I disagree.

Think China has this to say:

There are many rules and regulations in China that are ignored systematically. One of the hardest things for an outsider to master is the art of tiptoeing through the gray area. If you use the western interpretation of the law, you will find PRC laws paralyzing - if you are going to be a boyscout about it, you will not be able to get anything done.

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The Chinese legal system is more similar to parenting. Just because other kids have an iphone doesn't mean you can have it too. When I said no more TV ever, I really meant no more TV until I change my mind. When I said you're grounded for life, you can of course go to school... and after school activities, and if you behave well, I won't say a word when you tell me you're heading out for a movie. Let's both just forget the rule is there.

To operate in China effectively requires one to push the envelope and to challenge authority. But remember, not all laws are meant to be broken. And just because your neighbor breaks the law doesn't mean you can do so too. And herein lies the art of doing business in China.

Well....no.

The Chinese government is remarkably practical. We have time and time again been able to properly register foreign companies that have been doing business in China for years, without any questions or problems. We once registered a company with 55 China employees that manufactured $300 million worth of product. The client had to pay some back taxes, but bringing them into the grid was really not much more difficult than registering a start up company from scratch.

But this misses the point.

As I am always telling people, if we had come in a week later for this company and they had been caught by the government in the meantime, things would have been very very different. We have dealt with those situations and they have never gone smoothly or easily and they should be avoided at all costs. We have represented companies that have been caught and were tossed out of the country and we have represented companies that have been allowed to stay. But in all instances, the companies would have been far better off had they registered their businesses before they were caught. And the other thing you need to know is that the odds of getting caught have increased tremendously in China over the last few years. If you have any China based business it is very difficult to stay under the radar for long.

And it is not just in company registration that skirting the law no longer makes sense. This is true too of the labor laws. Based both on what I am seeing at my firm and on what I am hearing, if you do not abide by China's labor laws, you very likely will get sued and if you get sued and do not settle, you are pretty much certain to lose. I so far am not aware of a single foreign company that has prevailed on a labor law dispute in the last year. I am not saying no such foreign company actually has, but I am saying that I have been asking around about this for some time and nobody has told me otherwise.

But what about the grey areas in China's laws? China's laws are simply not that grey. They were grey five years ago, but their business laws are now, for the most part, pretty clear, particularly as they apply to issues important to foreigners. I wrote on this about a year ago in the context of company formations, in a post entitled, "China Company Formation Law Is Clear -- WFOEs Are Easy." I see the idea of a lack of clarity in China's laws on forming companies stemming from those who have not actually read them or from those who benefit from propagating this idea :

We recently took on three new WFOE formation matters for U.S. lawyers. Two of these matters are for lawyers working on behalf of their clients and one is for a lawyer who owns the (non-law related) business. All three of these lawyers told me they had spoken with company formation firms and had grown frustrated with the information they were being given. They relayed that these firms were not giving clear answers to many of their questions, but were instead responding by saying China's WFOE laws were "vague" and/or "ever changing."

What these company formation firms are saying is just not true.

Chinese law on WFOE formations is actually quite clear and I suspect these company formation firms were claiming otherwise only because the laws are vague to them. Near as I can tell, these company formation firms typically consist of a foreign voice or two (oftentimes in Hong Kong) who takes in the work and then farms it out to a Chinese lawyer in a low cost city to do the work. The people on the phone or at the other end of the e-mail at these firms have never read China's laws on WFOE formation and so, not unexpectedly, those laws are vague to them.

As for "ever changing," on January 1, 2006, there was a sea change in China company formation laws for foreign companies, but they have remained static since then.

By far the biggest source of confusion/frustration for these lawyers seeking information on forming a China WFOE is the minimum registered capital requirement.

The law on minimum registered capital is clear, but the amount of capital that will be required does vary, depending mostly on the nature of the business of the company to be formed and on the city in which it is going to be registered.

I really do not see much more gray in China's business laws than in those in the US.

Enforcement is another matter. Though China's business laws are relatively clear, the enforcement of those laws against Chinese companies is, to put it kindly, quite spotty. BUT, and this is the key here, when it comes to foreign companies, it is not spotty at all. Foreign companies are expected to abide by the laws in China and those who do not almost invariably face serious issues. Yes, you can try to push against China's laws, but unless you have big time guanxi (and I am betting you do not) or are just really lucky, my experience tells me that it just ain't worth it.