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China Legal Issues For Business. The Ten Minute Version.

Posted in Basics of China Business Law

I spoke yesterday at the 2010 U.S. China Business Conference in Atlanta. I was tasked with talking about the legal issues American businesses face in China and the legal issues Chinese businesses face in the United States. Here is my speech: 

I am going to be talking about the legal issues facing U.S. businesses that do business in China and the legal issues Chinese businesses face when they come over here.

Since U.S. businesses pretty much have to deal with all of the same legal issues in China that they have to deal with here in the United States — and then some — there is not nearly enough time for me to discuss specific Chinese laws. 

So instead, I am going to talk about the general approach U.S. companies should take regarding their Chinese legal matters. 

There are two keys to not getting burned by China’s legal system . The first is to not assume China’s legal system is anything like ours. The second is to not assume China’s legal system is different from ours. 

In other words, the real key is that you must not assume anything. 

I have seen countless instances where American companies have encountered problems in China because they just assumed that China’s legal system is like ours. 

A couple years ago, a pretty good-sized U.S. company called me to form their Wholly Foreign Owned Enterprise in China. They talked with great pride of the half million dollar study they had just finished which showed the huge demand there would be for the business service they would be starting in China. 

They were floored when I told them foreign companies cannot go into their proposed business in China without a Chinese joint venture partner. It had never even occurred to them that what was legal in the United States might be illegal in China.  

Joint ventures present a great example of where American companies get into trouble for assuming China’s laws are just like ours. In the United States, owning 51% of a company pretty much means you control the company, and so Americans frequently just assume that if they own 51% of their Chinese joint venture they will control the joint venture. 

The problem with this assumption is that it’s not based on Chinese law because in China, control of a joint venture in depends mostly on who has the right to appoint the Joint Venture’s Representative and Managing Directors. 

And let me tell you something, I am convinced there is a school somewhere in China that teaches EVERY SINGLE Chinese business to give their American joint venture partners 51% of the joint venture company and control of the joint venture’s Board of Directors, and then, in return, the Chinese company extracts from the American company the right to be able to appoint the Joint Venture’s Representative and Managing Directors. The American company goes along with this, not realizing that even though it owns a majority of the joint venture, it has just given up its ability to control it.  

Many years ago, I heard a story of an American who was renting an apartment in Shanghai. Now I am not even sure if this story is true or apocryphal, but it is such a good story to illustrate how Chinese judges and arbitrators view contracts it really doesn’t matter whether it happened or not.

It was a nice apartment, that this American was renting, and it had a really nice expensive office chair (high end apartments in China are virtually always rented out fully furnished). One day, the really nice office chair broke and became unusable and the American tenant kept asking his Chinese landlord to replace it. But that wasn’t happening. 

The lease on the apartment eventually came up for renewal and the American refused to renew it unless the landlord put in writing that he would replace the really nice office chair. The landlord agreed and after the new lease was signed, he came by and put in a $2 metal folding chair.

What would happen in the United States if this tenant were to sue the landlord over the landlord’s failure to replace the office chair with something pretty comparable? Anyone know?  

The tenant would win because the court would essentially write into the lease contract the provision that the replacement chair had to be a good office chair like the one it was replacing. What would happen if the tenant sued the landlord in a Chinese court? 

The Landlord would win because if you want something in your contract in China, you had better put it in there. 

Why is this chair story even relevant? It’s relevant because American companies time and time again fail to put enough into their contracts with Chinese companies. Instead, they just assume the courts or arbitrators will know what the parties intended and re-write their contracts accordingly. But it doesn’t work that way in China.

We had a company come to us after having received a large shipment of laptop bags that weren’t strong enough to hold a laptop. We called the Chinese company to ask about getting a refund and they told us that if our client had wanted a bag strong enough to hold a laptop, it should have paid 50 cents more per bag for one that could actually do that. This company should have specified in its contract that it wanted a bag that could hold x number of kilograms.  

But if I had to pick one arena where American companies most often mistakenly assume China’s laws are like the U.S’s, it would be in employment. There’s an old expression in the United States that employers can fire non-union employees for good reason, bad reason, or no reason at all. It’s the opposite in China where there should be the expression that you can’t fire or lay off your employees for just about any reason not expressly set forth in your employee manual.

American companies also get tripped up in China when they assume they have no requirement to pay managers overtime or that they can use independent contractors. Almost all employees in China (be they Chinese or foreign) are entitled to overtime pay and If someone in China (again, be they Chinese or foreign) is doing work for you and they are not your maid or just coming to your house for a day or two to fix your plumbing, they are your employee and don’t forget how hard it is going to be for you to fire them. 

On the flip side, American companies sometimes make the mistake of assuming everything about China’s legal system is different from ours and I will talk about this by way of an example.  

A U.S. company forms its Wholly Foreign Owned Enterprise (a WFOE) in China and builds a really nice factory there. Then, with a couple weeks to go before its factory is set to begin operations, it learns that China is not going to let them import the key chemical needed for their product. This company had spent nearly a year and nearly a million dollars getting the United States environmental protection agency to approve this particular chemical in its product and they just assumed that because this chemical had been deemed safe in the United States, it could use it in China without having to prove a thing to anyone there. It had never even occurred to this company that China has its own environmental regulations and its own Environmental Protection Agency and that China would require this chemical to go through China testing and would not just accept U.S. EPA testing standing alone. Does anyone think this US company would have thought it could import a chemical into the United States simply because the chemical was on an approved list in China?  

But the biggest mistake American companies make in assuming Chinese law is different from the law here in the United States is when they assume that China will not enforce its laws against them because they are bringing a couple thousand jobs to China or because China is not enforcing those same laws against Chinese domestic companies.  Both of these assumptions are wrong. For foreign companies, China is pretty much just like the United States in that NOT following the law is a very dangerous way to operate a business. 

What about the legal issues Chinese companies face when coming to the United States? Just take everything I have said about American companies in China and double it. 

Chinese companies tend to have even less experience than American companies when it comes to dealing with foreign laws and Chinese companies tend to be too inexperienced with operating internationally to realize that they cannot handle their legal issues in the United States the same way they handle those issues in China.

  • Steven

    Related to your notes, I also enjoyed the Key Success Factors shared by Mark Weidman, lunch keynote, CEO of Wheelabrator Tech, a Waste Management sub. It has a JV with Shanghai Chengtou. Anyone familiar with China should know how important the “Chengtou” is – it is basically in charge of developing and building up the city.
    1. Maintain excellent relationship with JV partner
    2.Recognize the challenge of a cultural transformation
    Understand and respect cultural differences and have patience
    Transform State-owned into a Sino-foreign JV culture
    Communicate transformation proactively to employees
    Don’t be quick to form judgments on the business until you have some experience
    3. Implement organizational changes at the top early in the process
    Make sure you put people in place that you trust completely
    Fill the leadership void
    Refine organization structure (e.g. governance, compliance etc.)
    Recruit and train staff to sustain rapid growth
    4. Apply western operational and construction management processes

    Select and standardize appropriate technology/ optimize assets

    Adhere to the highest environmental, health & safety standards

  • http://www.sinification.blogspot.com Tony

    Well done. When you talk about doing business in China, do you mean greater China including Hong Kong and Macau (both Special Administrative Regions), or only the mainland of China?

  • Twofish

    One thing that you do have to be careful is with the rules of when a contract will be enforced as rewritten and when the court will attempt to rewrite the contract. For example, Chinese courts are far, far more willing than US courts to change the terms of a contract when because of some unforeseen situation, one party just can’t meet the terms of the contract.
    Also there are reasons why things are what they are. One reason that Chinese judges have limited powers to change the terms of a contract is that the more discretion you give a judge, the more room for corruption there is. On the other hand, US judges are much less likely to change the terms of a contract for inability to pay because the US has a rather efficient and well tested bankruptcy system, whereas China does not.

  • Twofish

    The other difference between US and China is what it means to “own” 51% of a company. In the US, you can have different classes of shares, which means that if you own 51% of a company, you can end up with any fraction of the profits, from 0% to 100%. In China, if you own 51% of a company, you will get 51% of the profits, and that’s something that you can’t change with having different structures of shares.

  • Elemental

    I love the apartment story because it is just “so true,” whether it actually happened or not.

  • http://allwellbeing.com/ Douglas (Watkins)

    “Chinese companies tend to be too inexperienced with operating internationally to realize that they cannot handle their legal issues in the United States”
    What are you talking about…everything in the US is made in china… they must know what they are doing.

  • Twofish

    Harris: Well done. When you talk about doing business in China, do you mean greater China including Hong Kong and Macau (both Special Administrative Regions), or only the mainland of China?
    Hong Kong, Macau, (and for that matter Taiwan) have different legal systems and rules, which are both different from the US and from each other. There is also a lot of interaction and borrowing which makes things even more interesting.
    Hong Kong is one reason that Mainland Chinese businesses are less blind-sided when they do business in the US. People know that HK has a very different legal system than Mainland, and so they know it is possible to do things in very different wants. Americans are much more likely to think that the whole world looks like the United States, and are more apt to be surprised when things are very different.
    Also, the fact that things are different in China is not necessarily a consequence of anything Chinese. Chinese contract law is derived from German law. It’s rules on joint ventures are quite standard in the developing world. And as far as employment law goes, it’s the US that is extremely unusual. Where China is odd is that it sometimes combines two different types of laws in rather unique ways. Chinese securities and banking law involves copying large parts of US banking law, and making them work in a German civil law framework.
    The other thing is that all of the differences between China and the United States when it comes to commercial law have very little to do with the fact that China is a one-party authoritarian state and the US is a multi-party liberal democracy. If you look at Chinese human rights law, you can tell you are in a one-party state, but there isn’t anything obvious in Chinese commercial law that says that.
    One other surprising thing is that the Chinese legislative process when it comes to writing commercial laws tends to be much more similar than the US legislative process than most people in the US would think. Most Americans are surprised that China has a legislative process.