Nearly every time I write on this topic, I get at least one email from someone accusing me of fear mongering. I used to dispute that accusation, now I heartily embrace it. I embrace it because the overwhelming majority of foreign companies doing business in China make no allowance even for the possibility of one of their people going to jail or being held hostage.

For previous posts on this subject, please check out the following:

Ignoring this possibility is a mistake.

I know this because my small law firm has been involved in at least a half a dozen incidents where someone held on “bizarre” charges. We have also been called countless additional times when people have been arrested for less bizarre things like fraud, theft, etc.

Two things have converged to make me want to write on this topic today. The first was that I am in the midst of taking Typhoid pills for upcoming foreign travel. I need to take four of them every other day, at proscribed times, and they need to be kept refrigerated. This has not been that easy because I have been travelling like a mad man of late and I don’t feel like carrying a refrigerator with me. So I keep thinking about stopping the regimen, but I haven’t and I am sure I won’t. It just makes sense for me to plan in advance to protect my health on my trip.

I have been going to the same travel medicine physician for years and every time I go, she engages in the same routine. She pulls out a map and we discuss every single place I will be going and we talk about what sorts of things I will be doing while there. She now knows I am a pretty low risk guy because my travel life basically consists of my staying in nice hotels and eating good food and engaging in business meetings and very very little else. Yet, every time I try to bag off on some shot or some horrible pill, she will tell me about how someone she knew got in a car accident requiring a blood transfusion…. Invariably, I end up taking every shot and pill on offer. Does she know too much and I too little?

I guess I am the lawyer to her being the doctor.

The other thing is the recent arrest of yet another Chinese-Australian on criminal charges. Now before I go any further in talking about this particular case, let me stress two things. One, I know absolutely nothing about this case other than what I have read about it on the internet. Two, I have no idea whether the person involved is guilty or not and I have no idea whether he was arrested based on legitimate evidence of guilt or if he is being railroaded for business reasons, as his people are claiming. I do know, however, that these sort of cases go on all the time (usually on a much lower level and with much less publicity) and they scare the hell out of me.

The cases my firm has handled typically involve a foreign company owing money or a foreign company getting into the cross-hairs of someone. Then, the police start holding someone from the foreign company. We typically handle these situations by negotiating the amount of the debt and/or the fine and advising our client to get the arrested person out of China post-haste and, in many cases, to think long and hard about the company remaining on in China as well.

The second thing causing me to write on this topic today is an article John Garnaut (someone who has consistently done a good job of covering China) article in Australia’s Business Day, entitled “China’s Straight Shooters.”  This article posits that the threat of criminal prosecution is always there for those doing business in China and things are only getting worse:

Law, politics and corruption are tangled so tightly together in China that it is impossible to invest faith in any given legal outcome. Criminal proceedings are commonly used as leverage in commercial disputes.

This is a growing problem for foreign businesses and especially their ethnic Chinese executives, such as Australian Matthew Ng, who has been arrested for ‘‘embezzlement’’ in Guangzhou in the context of a dispute with a locally powerful state-owned firm. If he is convicted, then that fact alone will not be enough to convince many observers that he is guilty.

The Chinese legal system can be a tool of unexpected tragedy to foreign business people, but it is an everyday migraine for home-grown entrepreneurs. There are so many laws and regulations in China it is almost impossible to avoid bending some of them.

These rules are designed to be sufficiently ambiguous to place huge administrative discretion in the hands of officials.

They can be bent at a price or avoided at some risk. And that’s where entrepreneurs are expected to discreetly bribe their way to opportunities and insurance in case things go wrong.

And you think I am a fear monger?  Yet, I find myself agreeing with Garnaut on how it is hugely difficult for even the most law abiding company to remain in full compliance and, worst of all, the penalties for non-compliance are all over the map.  Just this morning, a company asked me whether it should reveal to investors what it has already done in China when there is a chance that what it has already done in China should not have been done without first forming a Chinese WFOE. My response was essentially that the risk of China ever finding out is probably very low and the risk of China doing anything if it did find out is probably very low too, but that if China should find out it might do anything ranging from imposing some taxes and penalties to never letting that company and its people do anything in China again. It is just this sort of range of punishments that can be so effective at keeping everyone constantly on their toes and forever beholden to the powers that be.

Is criminal prosecution always lurking in China? Have things only gotten worse? I answer a weak “no” to both those questions, but I do hope my even asking them has scared at least a few of you. Oh, and for those who think you have nothing to worry about because you never do anything wrong, let me tell you that I have seen enough legal car accidents to know that you are wrong to think that way.

What do you think?

  • Chris

    Dan
    All very astute comments. There is no doubt that despite every effort to hit 100% compliance, all enterprises will have gaps. China’s regulatory environment is tough, extraordinarily tough. Compliance demands in taxation, human resources and labour, on-costs, environmental, business scope, business activity, legals, contracts etc are extraordinarily high if 100% compliance to be achieved.
    While many foreign enterprises go a long way towards this (and domestic enterprises simply seek to meet current core demands for tax, labour and whatever is being impacted by current govt. campaigns), there is always the threat that, based on a single issue, that it will all fall apart.
    In the GZL / Matthew Ng case in Guangdong, it appears that one of the reasons for the arrest appears to be illegal foreign investment in an area of restricted investment. Should that turn out to be the case then much private equity investment in China, half the listings on the NYSE and NASDAQ and hundreds of other investments in China may result in arrests and criminal prosecutions. With restrictions on investments in internet, e-commerce, education, insurance and much else many foreign enterprises through clever legal structures have taken significant stakes in businesses in these restricted areas.
    For other foreign enterprises operating within permitted areas of investment there will always be other compliance issues.
    You are correct in noting that penalties can be difficult to determine in advance, ranging from requests by authorities to ‘clean up your act’, to minor fines to significant legal penalties including arrest and detention of senior personnel. You are also correct in noting that for domestic enterprises this is an ‘everyday migraine’ and that they are forced to manage these issues more locally and with more legal flexibility.
    Given the ‘campaign’ orientation of Chinese authorities, many of the issues are relatively easy to spot in advance as they are pre-announced or the subject of significant govt announcements and enterprises generally have time to prepare. Currently, enterprise tax evasion or illegal minimisation presents significant risk of arrest for senior staff of both domestic and foreign enterprises.
    Overall, Chinese enterprises and managers do ‘live in fear’ of unwanted govt attention and spend significant time cultivating relationships with relevant authorities to ensure they are positioned for lighter treatment should issues arise. Most foreign enterprises focus on compliance rather than relationships with authorities.
    If you are comfortable with a certain level of ambiguity in business and manage risk through compliance efforts all should be OK. However as Dan points out, it could all go horribly wrong…

  • Mr. Blarge

    We all know that a good web copywriter-in-print grabs readers by the eyeballs and does not them go until they are persuaded to grab their wallets and beg you to rush them your product. And that’s what this site is providing.

  • Small Town Hater

    You may be fear mongering, but you should be and you need to be. Far too many of the “China consultants” out there like to act like everything is good in China. They want us to think that so they can make more money. Articles like this help to counter that. Everything you say here is true and I know it because two of us from my company were held by the police for a week in a third tier city because we didn’t pay a supplier there that had provided us with bad product. The supplier claimed we owed it $60,000 and we had to pay $30,000 to get released. Since this incident, we have focused on reducing the number of our suppliers and we focus a lot more now on the city in which our suppliers are located.

  • Andeli

    The issue here is the change in rules for outbound tourism. Matthew Ng and Et-China entered an area of the tourist industry that was and is restricted, and where only semi-private or state owned Chinese companies are allowed to operate. The reason for arresting Matthew Ng now and not before is that the national government because of pressure from it’s WTO commitments is opening up the out bound sector.
    This means that the window of opportunity for the state owned companies on getting something out of the Et-China deal is closing. If they where to wait for 3-4 more years, then Et-China would properly be surrounded by many WOFEs engaged in outbound tourism, which would make criminal charges harder to stick. This is a classical example of a state owned company trying to go back and change a deal it made eailer. The problem is that the counts and the police are going along with it.
    This case is different then the Rio Tinto case and is in my view a classic business case of “everything is illegal in China, but we don’t uphold the law unless there some reason for the system to do so”. Having said this I don’t think Beijing will like this story, and I am not sure there is the same backing as with the Rio Tinto case. Anyway this proves one point above all. Don’t ever don’t business with state owned companies they will destroy you in the end.

  • Twofish

    Chris: Should that turn out to be the case then much private equity investment in China, half the listings on the NYSE and NASDAQ and hundreds of other investments in China may result in arrests and criminal prosecutions.
    I have to ask. What part of “investment in this area is restricted or forbidden” was not understood?
    Chris: With restrictions on investments in internet, e-commerce, education, insurance and much else many foreign enterprises through clever legal structures have taken significant stakes in businesses in these restricted areas.
    And those clever legal structures were always extremely shaky. I mean it’s not as if the Chinese government is surprising people with these sorts of crackdowns. You try to do something that is clearly illegal and go around the rules by doing something complicated which *might* not be completely illegal, and then people are surprised when it all ends in tears.

  • Wiley F.

    This stuff goes on ALL the time. We just don’t hear about it much because the company’s to whom this has happened don’t want to talk about it and the China hands who make money from getting people to go to China don’t want to talk about it.
    So, thanks for talking about it.

  • Twofish

    Andeli: his is a classical example of a state owned company trying to go back and change a deal it made eailer. The problem is that the counts and the police are going along with it. (…) Having said this I don’t think Beijing will like this story, and I am not sure there is the same backing as with the Rio Tinto case. Anyway this proves one point above all.
    The important thing here is that if you are extremely compliant and follow the law as best you can, then you have much less pretext for someone to play hard ball if they want. If the Chinese government was randomly picking up businessmen that had clean hands, then you can count on some backing from either the public media or foreign governments. If your hands aren’t clean, then if you get hit by criminal charges, then you really have no defense. If the Chinese government tosses you in jail for corruption or embezzlement, and the facts were that you actually *did* bribe an official or move money to get around regulations, then what can you say?
    Andeli: Anyway this proves one point above all. Don’t ever don’t business with state owned companies they will destroy you in the end.
    I work for a company that does do a lot of business with Chinese state owned corporations. The important principle is to keep your hands clean, and follow the regulations to the letter. Yes, it’s massively expensive, and yes there are things that you just can’t do within the boundaries of the law, and yes the regulations are unfair and put you at a sharp disadvantage.
    But if you can’t do something with clean hands, then you just can’t do it. The reason that you just can’t do it is that if your hands are not clean, the moment you start making money then the people that you are partners with, they *will* stab you in the back.
    You are swimming with sharks, you have to know that if they *can* make money off you by putting you in jail, then will. which means that you have to have tons of documentation and compliance officers to make sure that *when* they decide to stab you in the back, they have no recourse.

  • Chris

    @Twofish. “I work for a company that does do a lot of business with Chinese state owned corporations. ”
    I’m in the fortunate position of being in a business with very, very few govt or SOE clients. It makes life far more pleasant, compliance questions get simplified to those affecting our internal operations and it removes threats of partners with capacity to bully or threaten.
    For those that have govt depts or SOEs as clients, yes life would be a lot more paranoid.

  • Andeli

    Twofish: If the Chinese government was randomly picking up businessmen that had clean hands, then you can count on some backing from either the public media or foreign governments.
    My point being that it is not possible to have clean hands in China. The Chinese economy is based on collectiv ownership so if any non governmental company enters an area where there is a SOE, then it has broken Chinese law. No matter how one secures oneself, then you are a criminal. I don’t know what business you are doing with SOE, but I guees it is financial services. That will become very illegal if you ever claim any form of ownership of any business operations based in China. Don’t forget there is public ownership of the means of production.
    第六条. 中华人民共和国的社会主义经济制度的基础是生产资料的社会主义公有制,即全民所有制和劳动群众集体所有制.
    Article 6. The basis of the socialist economic system of the People’s Republic of China is socialist public ownership of the means of production, namely, ownership by the whole people and collective ownership by the working people.
    This article 6 is the reason why the new slogan 国进民出 Government enters, people leaves is becoming so common. And no one will ever help you. No one.

  • santos

    This article is very good, I was working in china for 5 years i can only say that in 2005 things were much better than now, I am talking about living in china and working there, in 2011 things are worst, I had to quit China forever and leave it. I do not want to be too pessimistic but i have seen and experienced enough. Its almost impossible to live there long term now, Crossing borders is also not easy because beijing International airport is notorious we never know what is going to happen there