The following is an amalgamation of a number (maybe 5 or 6) of conversations I have had over the years with people wanting to register a WFOE (Wholly Foreign Owned Entity) in China fast:

Potential Client: Can you help me register a WFOE in China.

Me: Yes. Not a problem. Do you have a lease yet? Do you know that a legitimate lease is required for the approval of a WFOE?

Potential Client: I know that but we are in a real hurry here.

Me:  Okay. But do you have a lease.

Potential Client: We have a lease but I don’t think it technically will qualify.

Me: What do you mean?

Potential Client: The land is zoned agricultural but my Chinese partner has secured all the okays to allow us to use it for our factory.

Me: Not a good idea. Trust me on that.

Potential Client: The factory has been there for two years without a problem and my Chinese partner assures me that the local government is fine with it.

Me: Don’t do it. Right now, the local government is okay with it. But what if the current mayor is pushed out next week on corruption grounds. Do you really want to be in a situation where you have spent a large amount of money on a space that gets shut down?

Potential Client: I am in a hurry and this is the only space that works.

Me: Are you sure? You are in a hurry, but is it really going to be worth the few months if you get shut down?

Potential Client: I am not going to get shut down. My Chinese partner is incredibly connected.

Me: Incredibly connected to the current local administration, MAYBE, but as I said, that administration could be out the door next week. Beijing checks on these things too and if they see that your facility is illegal, Beijing could see to its shut-down. I just don’t think it a good idea to go into a WFOE illegally and my firm cannot be a part of that.

Potential Client: That’s ridiculous. This is how business is done in China. Are you really saying you won’t take us.

Me: Yes. We won’t take you because we do not want our reputation damaged when you get shut down and we won’t take you because we do not want to be blamed when you get shut down.

Potential Client: Well I am sure I will have no trouble finding someone to help me on this. Good-by.

I know that at least one of these companies did end up getting shut down (within about a year) because someone at the company who had sided with me on the company not going forward emailed me to tell me of this.

I thought of the above today after reading “Cracking Down On Illegal Land Use: The BYD Case” over at the consistently excellent China Bystander blog. The post is on BYD, “the fast-growing compact automaker in which American investor Warren Buffett has a 10% stake.” Seems BYD has seven factories on land zoned for agriculture and China’s Ministry of Land and Resources is going to be ruling by September 30 on what to do about that:

China Bystander nails it in describing these situations:

It is not unknown for local officials to turn a blind eye to such zoning violations in the drive for economic growth. Companies want to bring new production capacity on stream without waiting for all the red tape to be dealt with, while officials themselves are judged on their promotion of local economic growth and local governments have become hooked on land sales for their revenue.

The ministry has said that 7,800 hectares of land had been used illegally in the first half of this year, a 14% increase over the same period last year. That reversed the trend of the figures of the past three years. They had shown the issue was shrinking, but that may just have reflected lax enforcement and reporting. The country’s farmland has continued to be eaten up by industrialization and urbanization. It has shrunk by 6% over the past decade to 122 million hectares, barely above the minimum arable land the ministry reckons China needs to be self-sufficient in food. The summer’s floods and the drought earlier in the year in some parts of the country have reduced that margin further.

China has been cracking down hard on facilities operating outside China’s zoning laws:

The ministry has hit five companies so far this year for illegal land use, following a tougher inspection regime launched in February that found examples of illegal land use in more than half the 13 cities examined in an initial spot check and officials cooking the books in four. In those cases buildings were ordered to be demolished, land taken back, executives imprisoned and official reprimanded.

China Bystander ends its post by noting that none of the companies previously sanctioned were as high profile as BYD and then wonders” how tough the ministry will be this time” and what sort of signal will it want its ruling to send?

Bottom Line:  If China is going after Chinese companies for putting manufacturing facilities on agricultural land, what in the world makes you as a foreign company think you will be able to get away with doing the same thing? And it is not just agricultural land. I am aware of a big China city office building that was shut down because it was zoned for a hospital.

What are you seeing out there?

  • First, thanks for the kind words about CB. Second, I’ve heard but not been able to confirm that in one case a golf course got ploughed up and returned to farmland. Any of your readers know anything of that?

  • I guess China is just beginning to try to resolve its corruption issues. Just when we were getting used to it.

  • Ag Man

    Exactly. China is becoming much more focused on enforcing its laws, particularly its land laws and particularly its laws as they apply to foreigners. The only right way to form a company in China these days is strictly by the book. I had a friend whose small factory was shut down under circumstances not all that different from what you have described. Beijing did an audit and that was that.

  • Twofish

    Just one bit of Chinese law. It’s currently requires the permission of the central government to legally convert land from agricultural to non-agricultural use.
    It’s part of the “corruption business cycle.” What happens is that when you are on the upside of the business cycle, there is a huge amount of money flowing around, credit is easy to get, and it’s easy for local officials to lend themselves money, and a lot of that money goes for things that are bit shady. It’s hard for the central government to intervene because the local governments are basically printing their own money, and everyone is either benefiting directly or indirectly from all the money that is flowing around.
    The problem is that at some point the business cycle turns, the money runs out, and all of the IOU’s that people created early come due. At that point the center will come in and start with the bailouts. The thing about bailouts is that the center will do bailouts, but they’ll ask for their pound of flesh in return, which involving finding scapegoats with nice corruption trials. Also, people with friends suddenly find themselves without friends once the money runs out.
    The other landmine is that you start your business, and then two years later, you suddenly find your “friends” taking over your factory. What are you going to do? The factory is illegal, and it’s not as if you can complain to higher ups. Going to either the Chinese or the Western press is not going to get you much sympathy.
    Something that you have to be aware of is that there may be a lot of farmers that are seriously annoyed that their land was taken to build your factory. Those farmers aren’t going anywhere, and right now they may be writing all sorts of petitions about how nasty the local officials were to them. Now, when you are in the upside of the business cycle, then enough people are making enough money so that those farmers are pretty much ignored. However, once the money stops, then both you and the local officials are expendable, and having the center crack down on illegal land seizures ends up making the farmers happy at your expense.

  • PC Smith

    I agree. There is no reason beyond hubris for a foreigner to think it can get away with this sort of thing and they mostly are not.

  • outcast

    Anyone remember when we used to be able to get away with anything? 😛

  • Chris

    Agree that land use getting very, very tough, particularly on the conversion of agricultural land to other uses. I don’t think this is at all directed at foreigners or WOFEs. Each and every town and village in the country now undertaking a land use audit, to identify abuse and misuse. Building permits in villages in much of the country have not been issued for years, with quotas for locals to build housing being diverted by local govts. to commercial projects. Hence there are huge numbers of farm houses with no permits illegally built on agricultural land. Nonetheless, I doubt Govt will forcibly pull all of them down and will look for avenues to legalise most over time. For commercial developments illegally built on agricultural land (the overwhelming number of which will be Chinese domestic enterprises) there will be little mercy and few avenues for legalisation.
    China acutely aware that domestic ‘food security’ absolutely critical. Bans on exports of rice by SE Asian countries a few years ago and this year by Russia for wheat has made Chinese policy makers aware than in the case of global shortages it will be every country for themselves. China has a lot of mouths to feed and every mu of land will count.

  • Twofish

    The other thing is that you have to be careful about terminology. The caller was talking about the land being “zoned agricultural” which suggests he thinks that Chinese land law is like the US, when it is very, very different.
    To simplify things, all Chinese land is owned by the state, but there are two types of land. Land that is directly owned by the state, and land that is “collectively owned.” What the government does with directly owned state law is to sell land use rights to build factories. The second class of land is land that is “collectively owned.” Technically, “collectively owned” land is owned by the farmers in a village, and the village committee are merely administrators of that land. What does happen often is that the village committee figures that it can make money selling land for something more lucrative than farming.
    The problem is that when they do that, they are in essence selling land that they have no right to sell. When a village committee wants to use farmland for non-agriculture uses, they have to convert the collectively owned land into state-owned land, and that involves getting the approval of people much higher up who have different incentives. In particular, when the land is sold, the money goes to the village committee where it can be used for both licit and illicit purposes. By contrast, the officials at a higher level, don’t get any benefits when land is sold, and if they have to deal with angry farmers, their chances for promotion are a lot lower.
    The reason calling this “zoning” is extremely misleading, is that in the US zoning is handled by local officials and doesn’t involve ownership issues. The person probably assumes that it’s a trivial matter to “rezone” the land. In fact, to build a factory legally on the land, you have to transfer ownership from the collective to the state, and the people that have to approve that, don’t have any particular incentive to do that.
    Having the village committee approve building a factory on collective farmland is less an issue of “zoning” more akin on me giving you permission to start a factory in an apartment I’m renting from someone else. I might be able get away with it for a while, but my landlord is going to get annoyed if they find out.

  • momo

    lol. chimerica is bonded by three things.
    1. greed
    2. money
    3. greed and money
    greedy Chinese convinces money-grubbing American investor that strong connections circumvent anything, even the law, on the mainland.
    American, raised on the myth of a market with 1.3 billion, casts caution to the winds and ends up…calling his lawyers.
    Dahlings, even Overseas Chinese tread carefully in their dealings with their native-born cousins in business.
    Loving China is one thing; dealing with some of the nefarious (deliberate or not) aspects is another.
    Why give yourself heartburn. Just listen to what your lawyer tells you.

  • Hah! Classic naive foreigner understanding of China.
    Money = Guanxi. The provision of money or giving money does not equate to guanxi. A foreigner can never and will never have real guanxi.
    The ONLY way to do business in China is to dot all i’s and cross all T’s and do everything by the book. Think of it as 6 Sigma for being messed with. Remove all and any opportunity for others to mess with you. Quite simple really. Why are new business people here STILL getting shafted left, right and centre?
    Hmm – I know – read here for some “Cultural Understanding” courses:
    http://www.utilitycomputing.com.cn/china/cultural-understanding-course-payment

  • serti

    I too have heard of the illegal golf course getting plowed under to return it to farmland, but I cannot prove that it really happened. Would also like to hear if anyone out there can prove it one way or the other.