Floating Houses, Conflicting Laws, And Really Nice Governmental Officials. China Law Practice Writ Large.

I love this post. It speaks to me. Stan Abrams of China Hearsay wrote a post on Chinese law, entitled, "Shenzhen’s ‘Floating House’ - My New Example of Administrative Uncertainty in China." The post is about the floating house pictured below, which house cost USD$15 million:

Stan sees this house and what has been happening with it as a perfect illustration of China's legal system. I so agree.

The house in Stan's post cost nearly USD$15 million to build and it is right now at risk of being demolished by the government because it was built without the proper building permit. The house's owner, however, claims it to have been built legally because it had the approval from Guangdong's oceanic administration

The law professor in Stan sees this house as nicely illustrating the following:

1. Federalism - one of the most important topics in China law. Note that the floating house guy apparently went to one agency for approval and may be shut down by another part of the government. This is common and sometimes difficult to avoid.

2. No applicable law - the developer says that the law didn’t cover what he wanted to do, so he obtained what he could from the government and moved ahead with the project.

I see this a lot with new technology. It’s painful from a lawyer’s perspective, when you essentially have to tell a client “Sorry, the law doesn’t really cover this, and of course the government will not formally comment on the matter at this time.” Clients have a tendency to get pissed off at their lawyers when they can’t give them a straight answer on a regulatory matter. Ultimately it comes down to how much risk the client wishes to assume.

Of course, if something bad happens later on, it’s the lawyer who gets blamed for it anyway. (Budding lawyers out there: make sure your risk analysis is in writing and your client acknowledges your conclusions - in writing!)

3. National treatment - Foreign investors are not the only ones who have trouble with legal uncertainty and government approvals. The situation here involved a domestic property developer who (I assume) had enough juice to get a preliminary approval document from some part of the government. The document was worthless (of course), but the fact that he got it in the first place says something. A foreign company probably wouldn’t have gotten even that far.

Stan then admits he does not have "some perfect advice for foreign investors hoping to avoid these situations" and he rightly calls for "skepticism if any lawyer or consultant claims to know all the answers either."

Having said that, however, Stan sets forth what I see as the perfect (translated as best advice possible under the circumstances) advice for foreigners that might find themselves in similar situations -- and trust me, you probably will. Stan's advice is to perform thorough due diligence before "jumping in on deal that involves this sort of uncertainty" and to always "investigate the shit out of" your government approvals, particularly if issued by local authorities.

All true and I have three stories of my own to add.

1. Many many years ago, a company came to us for legal help with a big business it was planning to build (I am being intentionally vague here. Sorry). Early on in our due diligence, we realized that the land on which the hotel was to be built could not in a million years be used for that purpose. Our client though told us that a VERY powerful governmental entity wanted the business built there and wanted our client to build and run it. So we as lawyers told them, in writing of course, of how their business was both illegal and risked being shut down as soon as it opened. Despite this, our client chose to move ahead with the project, having calculated that if it could stay open for a certain amount of time it would make enough money to justify the risk.

2. Many years ago (note how this is one fewer many than the previous one), a client came to us for assistance in getting foreign investors for a large scale renovation project it was going to be doing on a building it had bought and was converting into upscale offices. Early on in our due diligence, we discovered that the building was zoned for hospital use only and that investors would need to be alerted to that. Our client insisted we had to be wrong because the "local authorities" had sold him the building (for quite a lot of money, actually) and had made all kinds of promises to him. He was wrong.

3. Not all that long ago, a domestic US attorney contacted me with some tax questions regarding China joint ventures. I could not answer his questions off the top of my head, but I immediately recognized that the joint venture was nowhere close to complying with China's laws regarding the monetary contributions required by the foreign joint venture entity. The foreign entity would be contributing only intellectual property (IP) of an insufficient value. I told this attorney that the deal was illegal and the way it would likely play out would be with the Chinese joint venture partner ending up with the US company's intellectual property and the US company ending up with nothing. The domestic lawyer insisted I had to be wrong because the local officials were going to "help shepherd this deal through" and "there is no way they would engage in illegal activity." He then added that he "had met them and they are definitely not that kind of people." I sent a CYA email and said to count me out.

Bottom Line: If you are a foreigner in China, you cannot expect to work the system. Instead, you should assume the system will work you. Your defense to that is to follow the law to the letter and if the laws are in conflict, then know what your risks are and be prepared to weigh them against the rewards.

Got it?