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First Question For Doing Business In China: Is It Legal?

Posted in Basics of China Business Law, China Business

A couple weeks back, I co-moderated a Doing Business in China seminar at which two lawyers speakers went through the steps for forming a China WFOE. My two cent contribution was on the need to make sure that what you are planning on doing in China is legal, and to do that before anything else. I then proceeded to tell (maybe for the hundreth time) of a company that called me many years ago to retain my law firm to handle their China WFOE formation.

The company calling me was (and probably still is) a high powered New York City firm and they proceeded to tell me right out of the gate of how they had spent $500,000 researching the market in China and it was clear there was a huge need for their services and that they would be the first foreign company in China to provide such services .  As they were talking, I kept thinking of how there is indeed a huge need for foreigners to provide such services, but that the reason none had yet done so was because those services were on the prohibited list for foreigners.

A short digression here.  China has what it calls its Catalog for Guidance of Foreign Investment.  This catalog divides businesses into three categories: encouraged, restricted, and prohibited.  Generally, foreign companies are allowed to operate an encouraged business on their own, as a Wholly Foreign Owned Enterprise (WFOE).  Restricted businesses typically must be done via a Joint Venture (JV) and foreign companies cannot operate a prohibited business at all.

So instead of my offering to form this company’s WOFE, I instead asked if they had done any legal research regarding the legality of their proposed business in China. They told me they had not, and they then retained us to research it.  Very quickly we got back to them confirming my suspicion. They business they had spent the last year and $500,000 researching was prohibited to foreigners (I believe it is now on the restricted list).

Many love to tell of how “thirty years ago such and such company went into China in XYZ industry even though XYZ industry was clearly forbidden to foreign companies and now such and such company has X billions of dollars in sales in China.”  And though there are absolutely stories like that, they key to them is that they were thirty years ago and doing that today would almost certainly not end well.

I thought of all this today when I read an article entitled, “Report: Amazon Kindle store hit by regulatory trouble in China.”  According to the article, “Amazon’s new Chinese Kindle store is reportedly being investigated by Chinese authorities over charges that the store does not have a license to sell e-books in the country.”

China’s GAAP (General Administration of Press and Publication) agency requires that digital publishers operating in China must receive at least one of four licenses to publish, copy, distribute, or import ebooks, according to blog site MIC Gadget.

But Amazon allegedly did not obtain any of the required licenses. Instead, the company reportedly borrowed a license from one of its partners, which is against the law in China. Amazon did apply for a business license to run the store, MIC Gadget said, but that process is likely to take a long time to be approved.

The article goes on to talk about the “stiff competition” Amazon will be facing in China’s ebook market and also notes how “Amazon’s former China chief told Reuters this year that the company hopes to bring the Kindle to China within the next two years.”

So what is going on here?

Let me start out by making very clear that I have zero inside information and so whatever I say about what Amazon may be doing is pure speculation.  With that out of the way though, there are a number of plausible explanations, including the following:

  1. The article is completely wrong. Amazon has all of the required licenses.
  2. Amazon made a mistake and did not realize it needed all of the licenses mentioned in the article.  I think this is unlikely.
  3. Amazon made the decision to start selling its Kindle before obtaining all necessary licenses.

If either number one or number two above are true, there is little more for me to say.  But let’s assume for a moment that number three is true.  If true, there is some explanation for it. Amazon is a huge company. Amazon has a ton of money.  Amazon is not exactly unfamiliar with spending massive amounts of money to gain market share and then worry about profits later.  Is that what Amazon has done here?  Maybe.  If it is, is this in some way instructive for your business?  Unless you have something approaching Amazon-like money, it is NOT.

The bottom line here is that if you are a normal foreign company looking to do business in China, the best way for you to go about that is to first make sure that what you are proposing to do in China is legal in China and then do everything necessary to make your business legal in China.  It is that simple.

What do you think?

  • twofish

    I think this is absolutely wrong.

    There are times in which the Chinese government will tell you that they absolutely to not want you to do something. If you are interested in selling “I love the Dalai Lama” T-shirts then forget about it.

    However, in most business situations the government will send you mixed signals or no signals, because the government just does not know what it wants to do. If you wait for the Chinese government to tell you that something is absolutely OK to do, then you will wait forever.

    The fact that the Chinese government is made of a hundred different entities that all want different things makes it more difficult. Sometimes you end up with different entities fighting each other. For example, censorship is a notorious area for “turf wars.” and it turns out that the GAAP and the MIIT (and for that matter the Ministry of Culture and the MSP and the CPD and the SCIO) have been fighting like cats and dogs over this. If one agencies says no, and another says yes, you might be able to get something done. If you wait for everyone to say yes, you’ll never get anything done. In the case of online stuff, what the MIIT thinks is more important than what the GAAP thinks, since the MIIT can actually shut you down, whereas the GAAP can’t put turn off the network links.

    Personally, I think if GAAP says no, and MIIT says yes, and the CPD and SCIO are neutral, you win. The Ministry of Culture wants to ban everything, but no one cares about what they think.

    There is legal risk involved with *anything* you do in China, as with all risk it’s something to be managed and not avoided. One thing about the Chinese government is that sometimes they will give you “hints” about what they want. One reason people feel comfortable at “bending” licensing restrictions is that if you end up bending the rules, but you get the government want they want, they’ll forgive you for it, since to some extent the government wants you to bend the rules if “good things happen.” A lot of it involves trying to convince the government that “good things” from their point of view will happen, if you let things go ahead.

    The problem with “staying legal” is that often (and this especially happens with new technology) it’s not clear what legal is. For example, there is likely to be no regulation explicitly allowing for the sharing of licenses, but there is also likely to be no regulation explicitly *prohibiting* the sharing of licenses, and then you end up with a fun situation in which five different agencies issue five different regulations. If you wait until everyone says yes, then you lose.

    Also, big companies have large amounts of money. Small companies can sometimes fly under the radar. Sometimes having big amounts of money is a handicap. If you are spending $50 billion at something, then it’s a disaster if people shut it down. If you have $5000 at risk, then it may be a wise strategy to just go ahead and “do it” and if you get shut down, you just lose your $5000.

  • twofish

    I also think that it’s possible, perhaps even likely that the article has Chinese law wrong. Whenever someone states that something is against a Chinese regulation, I think it’s not unreasonable to have a link to that regulation, because often they just get it wrong.

    It’s also worth noting that the article seems to missing one specific piece of legal information which is the WTO case regarding audio-visual products.

    http://www.paulweiss.com/files/upload/PW_HK_8Jul11.pdf

    The full report is here

    http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds363_e.htm

    But to summarize. WTO ruled that the Chinese government had unlimited authorized to censor books and other media under the public morals/public order exceptions to trade rules *however* the Chinese government could not treat foreign and domestic companies differently. In other words, the Chinese government can ban books, but it can’t make it more difficult for a foreign company to distribute books than a domestic company if that foreign company is willing to abide by the censorship restrictions of the Chinese government.

    The Chinese government has stated that it will change it’s regulations to comply with the ruling. One thing that they did was to immediately remove AV from the prohibited list in the import/export guidelines. I haven’t kept track of what’s happened since then, but the fact that the article isn’t aware of the WTO ruling makes me dubious that they know what they are talking about, which isn’t surprising since the article was likely written by a journalist and not a lawyer.

    One thing that makes Chinese law tricky is that you not only have to analyze what the law is now but what the law is likely to be next year, three years, five years or ten years from now. In 2008, it was absolutely prohibited for a foreign distributor to distribute books in China, but the WTO case started in 2007, and if you made some guesses about what the WTO was likely to do and how China was likely to respond, you could have figured out that this restriction was not tenable, and gotten a jump on other people. Once the ruling came out in 2009, the Chinese government stated pretty quickly that it was going to comply, which meant that for planning purposes, you could assume that the current regulations were going to be changed, and you could make some pretty good guesses about what the new regulations would look like.

  • Drjeep

    What I suspect, being remotely aware of the Amazon project, is that they acquired a chinese company that had some licence (dont know exactly what kind of level) and they assumed that this could be used for Amazon brand. Apparently licences are not easily transferred from one company to another, and that could be Amazons mistake. We’ll see

  • Zolbayar Byambasaikan

    I have plan to open small clothes shop in shanghai. Should I have company ? If I need company , Chinese company or my country company ? If I should have Chinese company , how can I open Chinese company ?