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Dan Harris is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players, have looked to him for his perspective on international law issues.

Negotiating with Chinese CompaniesJust read a post over at Andrew Hupert’s ChinaSolved Bog, entitled, 5 Negotiating Lessons from Sec. of State Tillerson’s Beijing Trip. Hupert, who I count among the foremost experts at negotiating with Chinese companies, uses Tillerson’s recent Beijing trip as the springboard for explaining five tips on how foreign companies should negotiate with Chinese companies.

Before I get to the five tips however, I want to highlight what I see as one of the best, one of the most realistic, and — most importantly — one of the most accurate descriptions on what it is like to negotiate with a Chinese company:

We’ve seen it before. The Chinese side raises their glasses of Mao-tai and proposes a long relationship of mutual understanding and joint cooperation. The western side “gambei’s” and then makes their own polite toast about “long term cooperation, success, and prosperity”.

Now, at this point the westerners feel they are done with the preliminary small talk, and are ready to begin the opening phase of the REAL negotiation.

The Chinese side feels they are running the new partnership, co-own the intellectual property, and will make all substantive decisions about operations, hiring, and distribution.

If you for any reason do not believe the above accurately reflects how the typical Chinese company views its dealings with foreign companies you should memorize the above and then in one year of dealing with China ask yourself again whether it is accurate or not, because it just is.

Now on to a some of the Hupert five.

That treacherous opening Chinese toast. Hupert notes how Tillerson, “like many western execs before him, . . . doesn’t seem to understand what the Chinese believe he’s agreed to. This is true. Our China lawyers almost never document a China deal without there being at least one issue on which our Western client believes the China side has agreed to something to which it has not. There are many explanations for why this always seems to be the case, ranging from cultural and language differences to the China-side penchant for agreeing to something to get something in return for that agreement and then retrenching from the previously agreed upon item after it has already succeeded in getting concessions from the Western side.

Manage the agenda, and then focus on individual deal points. Western negotiating protocol is to focus on the key negotiating goals, but Chinese negotiators “always” have a larger agenda. Or as Hupert puts it, “too many western executives fighting internal deadlines and hoping to satisfy their HQ sacrifice big-picture strategy for short-term deliverables.”

Watch the timing mismatch. “Don’t make real concessions now for longer-term promises.”  Western companies too often believe that if they make xyz concession to their Chinese counterparty now, their Chinese counterparty will make the next concession the next time around. Wrong. Where we see this a lot is with Western service companies cutting their rates to Chinese customers to “get into China now”  and “build loyalty, all with the plan to raise their prices later. Problem is that the Chinese company for whom you just cut your prices will view your loss leader pricing as their ceiling, not as a floor and it will move on to another naive Western company for its next contract. Or as Hupert puts it

You’re in the same boat – but who is the captain and who is the crew? Hupert concludes his post by highlighting how different perspectives so often can lead to problems down the road. Hupert uses the example of how it is “relatively easy to get a Chinese negotiator to agree in principle to a cooperative partnership,” but how that “cooperative partnership is viewed by the two sides will be very different. “Both sides tend to walk away thinking that they will have the power and authority to protect their interests and further their positions. In practice, however, Chinese tend to feel that they will call the shots on issues pertaining to China.”

For more on how to negotiate with Chinese companies, check out the following:

China Design PatentsLast year, in the midst of media hullabloo regarding Apple having lost a design patent lawsuit in China, we wrote China’s Design Patent Scourge Has Snared Apple: Nobody Panic, calling for everyone to calm down because Apple would likely prevail in the end. Well Apple just did. Prevail that is. First though a large dollop of background, taken straight from last year’s post.

Big media today has been covering Apple’s BREA design patent dispute with “a small Chinese competitor” and I woke up this morning with my inbox filled with emails from financial analysts and reporters clamoring to talk with me about this news. I assume the other China lawyers at my firm are being similarly inundated. This is obviously huge news and for more on this story, check out the following:

But first, everyone calm down and let me explain.

I went on to make clear that I did not know anything but Apple’s specific case, but felt like I did, because our own China lawyers we had seen so many facially similar design patent matters.

I do not know anything at all specific about Apple’s case. Not a thing. My law firm does not represent Apple on its IP matters, nor do we represent the Chinese company with this patent claim. Additionally, I have not looked at a single pleading in this case, nor have I discussed this case with any of the China IP attorneys in my firm who may (or probably not) know more about this case than I. This post is based on what we have seen (especially lately) happening with China design patents, which is a whole lot.

In the last six months or so, we have gone from dealing with maybe one China design patent matter a year to at least one a month. We cannot pin down this massive acceleration in design patent matters on any one thing and so we simply think that word has gotten out among Chinese companies regarding the effectiveness of engaging foreign companies in design patent disputes.

I then explained China’s design patent laws:

China law defines a design as a shape, pattern, or combination thereof or the combination of a color with a shape and pattern, with an aesthetic appeal and for industrial application. If you think this definition is incredibly vague and potentially broad enough to drive a truck through, you would be right. On top of this, China’s patent office does not “review” design patents before granting them. Or, as I love to tell our clients over the telephone, “I could probably secure a China design patent on the blue socks I am wearing right now.” When I say that, I am being intentionally dramatic, but I honestly believe my chances of securing such a design patent are not that bad.

The other things you should know about Chinese design patents are that the patent grants its holder exclusive use of the aesthetic features of a product not its functioning portion. In other words, the patent is on how the product looks; its external appearance. Not kidding, but it is quite possible that the small Chinese company with the mobile phone design patent could use its design patent against any cell phone company with a product that looks like an iPhone.

I then discussed the design patent cases our China attorneys were handling:

These cases typically start with a phone call from a Western company telling us that some company (usually a company it already knows and usually either its manufacturer or a competitor) just contacted the Western company (or the Chinese company that makes the Western company’s product) and said that the Western company’s product is violating the Chinese company’s China design patent. The Chinese company then threatens to sue the Western company for patent infringement damages and to block any of the Western company’s “infringing” product from leaving China. Needless to say, the companies that call us on these matters are more than a little bit concerned.

Though I am not going to claim that these are pleasant situations or inexpensive for our clients, but I will claim that they are not as bad as they initially appear. I have heard that China issues around ten times more design patents than the United States patent office, which reinforces my contention that I could get a China design patent for my blue socks. There is no substantive examination of a design patent application in China. Instead, all you really need to do to get a China design patent is to complete your design patent application properly. So if I complete the design patent application on my blue socks, and attach a proper and appropriate drawing of them, along with a proper power of attorney and I make the right claims regarding my having designed my blue socks and regarding their being of a new design, I almost certainly will get my design patent.

I then explained why design patents are so weak as are most design patent cases filed by Chinese company plaintiffs:

BUT, my blue sock design patent will be as weak as a kitten. And it is for this reason why China design patent actions are not as scary as they first appear and why I am calling for nobody to panic on Apple’s behalf either.

In the cases we handle nobody has yet actually had customs block their product from leaving China. The reason is because China customs generally requires a party seeking such a block to post a substantial bond. That substantial bond then becomes available to the party whose product has been blocked by customs. Again though, you want to avoid these cases if at all possible because even if you end up prevailing, you will need to incur considerable time, trouble and money to get there.

The difference between the cases we have handled and the Apple one, however, is that in our cases the Chinese companies threaten to get an order blocking our client from having its product made in China, but they never do. They never do because they know the cost of doing so is high and the likelihood of their getting such an order and having that order stick is very low. I read somewhere once that something like 70 to 90 percent of all Chinese design patents get invalidated when challenged. These Chinese companies know that if we were to challenge their design patents we would prevail, so why spend big money only to lose in the end. The Chinese company’s power comes from the design patent threat, not from reality.

In the Apple case, the Chinese company has brought a lawsuit and by doing so it has increased its threat value. Did the Chinese company do this because it has a valid patent? Or is it because it views Apple has having such deep pockets it has decided to go strong in the belief that doing so will get Apple to pay big money in settlement to end the issue? I don’t have the answers.

Most importantly, I predicted both in my blog posts (“Based … on our own history with China design patents, I am guessing Apple will prevail in the end”) and in a CNBC article in which I was interviewed, that Apple would eventually prevail.

Well guess what. Apple just did prevail before the Beijing Intellectual Property Court: “The court ruled that the regulator {that previously ruled against Apple] did not follow due procedures in ordering the ban while there was no sufficient proof to claim the designs constituted a violation of intellectual property rights.” China design patents: fear them just enough to get your own as an offensive weapon, but not too much.

China AttorneysBecause of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

Though it is getting more difficult and expensive for foreign companies to do business in China, China’s burgeoning wealth means the number of companies wanting to sell one shirt to 1 percent of China’s middle class just keeps increasing. Many of those companies are realizing that one of the easiest ways to accomplish that is via their own distributer in China. See That’s Hot: China Distribution Contracts. One of the most common questions posed to our China attorneys about distribution relationships in China is whether they need to be exclusive or not. Oftentimes, these are not even in the form of a question, but rather the potential client or client telling us that they will be giving their distributor an exclusive for all of China because they “understand” the Chinese government requires that.

As we wrote in China Distribution Agreements: Exclusivity Is NOT Required, this is simply not true. Unfortunately, Chinese companies frequently claim this and sometimes even get away with it, sometimes with disastrous results for the foreign company.

Let me explain.

There is no exclusivity requirement in China. None. Nada. Zero. Zilch. 没有.

This means you can have five distributors of your product or in just Shanghai if you want, and then add ten more later. This means you can have an exclusive distribution relationship with one distributor for all of Shandong Province and still have ten distributors for just Beijing. You are legally free to do what you want when it comes to exclusivity in your distributor relationship in China; you are constrained only by the deal you are able to make.

Oh, and one more thing, Chinese companies love to use the term Greater China in their distribution contracts with foreign companies as many foreign companies do not realize that includes Hong Kong and Taiwan and Macao. So be careful about that also.

China Foreign PolicyForeign Policy Magazine just came out with an exceptionally clear-headed, exceptionally valuable article on the derivations/influences of China’s foreign policy, entitled (in part and when you see the full title you will probably understand why I shortened it) How China’s History Shapes its Policies Today.

I posted it on our China Law Blog Facebook page with the following lead-in:

Great article by some truly great people. Read it. Study it. This is the sort of article that could become seminal for understanding China foreign policy. Then read it again.

Not much more to say about it other than that if you have any interest at all in China foreign policy, in China’s place in the world, or even in China at all you need (yes need, not should) go read it. Now. Oh, okay, I cannot resist: Those who cannot remember the past are condemned to repeat it.

Your thoughts?

China lawyersDoes the Chinese company with which you are doing a deal have a United States subsidiary? Does this mere fact make you feel better about doing a deal with its China parent company? Why? Do you not realize that it is likely to be legally irrelevant?

The always excellent, always informative, Hague Law Blog (by Aaron Lukken) wrote about this in the context of service of process in its post, You can’t simply serve a U.S. subsidiary. Aaron starts out by discussing how you need a compelling reason to “pierce the corporate veil” of a subsidiary company to each through and assert claims against its corporate parent since “the whole purpose of a corporation is to be a separate entity, a separate being from its owners, shielding the owners from liability if they didn’t have a part in wrongdoing.”

A couple years ago I was retained as an expert on corporate veil piercing for a case in Korea. As part of my work on that case, I researched the current state of corporate veil piercing and since that time I’ve probably stated something like the following to fellow lawyers at least a dozen times: “You know how difficult it is to pierce a corporate veil, well it’s even more difficult than you think. It seems that courts are now pretty much uniformly of the view that everyone now understands that Limited Liability companies and corporations protect the owners of those entities and corporate veil piercing is now nearly impossible unless there has been real fraud somewhere along the way.” Or to put it in non-legal terms, it ain’t gonna happen.

And yet again and again really smart in-house lawyers seem to ignore this when doing deals with big Chinese companies with U.S. subsidiaries. I cannot even count the times where such a lawyer has told me that they are not terribly worried about being able to pursue the big Chinese company on the other side of their deal because “we can always go after them here in the United States.” Wrong. Wrong. Wrong. Unless the U.S. subsidiary is a party to the contract or a guarantor on the contract, to go after that subsidiary you need to be able to pierce the corporate veil and that ain’t gonna happen. When I tell them this, they then talk about how they still can seize the Chinese companies ownership interest in that U.S. subsidiary as if that is no big deal. But the problem is that is a really big deal and any Chinese company worth its salt has structured its ownership of its U.S. subsidiary through various levels of Hong Kong and Cayman Island and Virgin Island companies. So yes, if you are willing to spend hundreds of thousands of dollars investigating the corporate trail and engaging in discovery on just this one issue, you might succeed. But really?

Our China lawyers see the result of this thinking with contracts between American and Chinese companies that call for disputes to be resolved in a U.S. court. At least once a month, one of our China attorneys will get a call or an email from a U.S. lawyer seeking our help in taking a U.S. judgment (usually a default judgment) to China to enforce. The thinking of the U.S. lawyer is that all we need do is go to a China court and ask it to convert the U.S. judgment into a Chinese judgment and then send out the Chinese equivalent of a sheriff to the Chinese company and start seizing its assets until it pays. As we have so often written, this will not work:

After we tell the American lawyers how difficult it is to collect on a U.S. judgment against a Chinese company (note that I say difficult and not impossible — it is possible to employ “other methods” to collect on such a judgment), they will sometimes explain that is okay because they can still go after the U.S. subsidiary of the Chinese company with which they have the contract. But as stated above, that is expensive and difficult and may or may not lead to a good result.

Aaron’s post focuses on how service of process on a foreign company’s U.S. subsidiary does not constitute service on the parent company and he uses Chrysler Motors as an example:

Take Chrysler, for example. When you sue Chrysler over a defective Jeep, you’re pretty solid in just serving the Michigan outfit. But if you allege liability on the part of the parent company, Fiat Chrysler Automobiles, N.V. (which we’ll just call FCA here– and I don’t mean the Fellowship of Christian Athletes), serving in Michigan ain’t gonna cut the mustard. You have to go abroad to get FCA on the hook. You can’t just hit Chrysler and assume that FCA is in the case, too.

The corporate veil doesn’t get pierced just because it hangs overseas.

Which means that if you want to serve Chrysler Automobiles N.V. you must do so in the Netherlands, where it is based. Again, it’s because the subsidiary is not the equivalent of the parent and vice-versa and as much as you may wish it otherwise, it ain’t. The same holds true for your China contract.

 

China intellectual property lawyersWhen our law firm started drafting manufacturing agreements on behalf of Western companies having their products made by Chinese manufacturers, we mostly dealt with simple items like socks, shoes, rubber duckies, etc. Those contracts were relatively fast and cheap and easy. The core of the contract was essentially something like this: “Your Chinese company will make rubber duckies out of these specific materials and with these additional specifications and you will deliver them to our facility in the United States or in Spain or in Australia within 45 days after we issue our purchase order.” Becuase these contracts were so routine and so simple, we virtually always always charged a flat fee for them.

Those days are mostly over for China, though these sorts of agreements are still relatively common for Vietnam, Cambodia, Thailand and Sri Lanka. These days the typical manufacturing agreement on which our China lawyers work is far more complicated because the products made in China are far more complicated. And with complicated products comes complicated intellectual property issues involving trade secrets, trademarks, copyrights and patents.

I called up an email this morning to review a China intellectual property issue on an existing matter. That first email led me to a couple more emails and today’s idea for a blog post. The below is a merger of three emails (further modified to remove any identifiers), which should be helpful to anyone looking to manufacture IP sensitive products in China, especially those that include software.

Oh, and for further incentive to get you to parse through the below email, go read China and The Internet of Things and How to Destroy Your Own Company to see what can happen if you fail to realize how critical intellectual property protections have become when having your products made in China.

 

We still need more clarification regarding the issue of ownership of the various technologies that will be going into your product.

Based on my review, there are four separate forms of technology embodied in this single product:

  1. The case or external shell.
  2. The internal mechanism: electrical/mechanical.
  3. The internal mechanism: firmware.
  4. The smartphone/computer application software.

Based on this, my questions are as follows:

1. For the external shell (Item 1):

a. Who will do the design? Who will prepare the actual CAD drawings for the mold? Who will fabricate the physical molds?

b. How and when will you pay for the molds to be made? Will you do this as part of a separate contract or will you fold this process into the manufacturing agreement?

c. Note that you will need to be clear that you own the shell design. If it will be done before/outside the manufacturing agreement, we will a clear document that provides for ownership and control. Note that if a third party does the mold (which is likely), there is a risk of the third party appropriating the design and selling it to someone else. However, for this specialized product, the risk is low.

2. For the application software (Item 4):

a. Who will create the application software? If it will be outsourced, you need to know. If it will be done in-house, will it be done by _________? You need to know.

b. Has a fee and timeline been determined for the software application? If so, what is it? If not, when will this be done?

c. What if the application software does not work? What if the application software does not have the “look and feel” you want? How will you work with the programmers to ensure all this is done how you want?

d. The fee, once determined, will be amortized against the purchase of the first 200 units. Does this mean the price of each of the first 200 units will be increased by 1/200 of the application software fee? What happens if you never buy more than 200 units? What happens if you end up buying only 100 units? You need to determine the fee to be sure this makes economic sense for you.

e. Will you own the application software copyright for the entire world? If so, we will need to specifically provide that the application software will be done as a “work for hire” and that your company will own the copyright on it. If you own the copyright, the Chinese side cannot sell the software to anyone else or use it for their own purposes. Will they agree to this? If the Chinese side is sophisticated, they will NOT provide you with the software copyright because they plan to reuse the core software for other projects. In fact, they may not even own the copyright to the core software. They may instead agree only to provide you with the rights to the “look and feel.”  Many U.S. buyers ignore these software issues, leading to many problems down the road. You may recall that the multi-billion dollar legal battle between Apple and Samsung is centered on these difficult “look and feel” issues.

3. For the electro-mechanical/firmware (Items 2 and 3).

It is not clear who will own and control this item because there is an internal contradiction in the description. On the one hand, the Chinese side says it will provide you with all data necessary for your company to patent and copyright items 2 and 3 in the U.S. (Note that firmware is protected by copyright, as are mask works and related). This means you would then own 100% of the rights to items 2 and 3 for the United States: permanently and forever, to the exclusion of everyone, including _________. This means you would not even be required to purchase the product from ________ because you could have it manufactured by anyone in any location where a conflicting patent and copyright has not been registered. It also means even if you do not secure a patent or copyright on this, you still have an exclusive and perpetual license to the technology for the U.S. This perpetual license would have essentially the same effect as a patent or copyright registration with respect to your relation to __________ and its attempts to license to any third parties in the future. The point here is that a patent is not revokable; once you have it, it is yours for the term. On the other hand, the Chinese side wants to have the right to allow other U.S. entities to make use of the technology to sell competing products in the United States if your company does not meet certain sales quotas. Under this approach, the Chinese side is providing you with essentially a limited license with these terms: a) the product must be purchased from _________ and no one else, b) your sales territory is limited to the United Sates, and c) your license terminates if you fail to meet the sales quota. This has in fact become the normal approach for sophisticated Chinese companies making products like yours.

The issue though is that these two approaches are contradictory. Only one can stand. So which one is it? As I have noted, the second option (limited license) is most common. However, that means your company’s product development would be placed on a very weak footing because your entire product line could be terminated if you fail to meet the sales quotas. This termination could come either from the license becoming non-exclusive, (allowing the Chinese side to license to and manufacture for other U.S. companies) or from the Chinese side terminating the agreement.

This issue goes to the core of your agreement and so it is crucial that we get clear on on this for the agreement. As noted, most Chinese manufacturers/designers will take the limited license approach instead of terminating the agreement. If this is their approach here, their offer to provide you information for a patent application is not consistent because a limited license and absolute ownership rights are contradictory.

4. There is an additional issue related to the rights of non-U.S. entities to sell into the U.S. market. This can only be resolved after we get answers to the questions above.

5. There is an additional issue concerning what to do if _________ is unable or unwilling to manufacture your product at an acceptable price, at acceptable quantities, with acceptable delivery dates and at an acceptable level of quality. If ________ owns the core technology and is merely providing you with a limited license you could find yourself “stuck” with bad pricing, bad quantities, bad delivery times and/or bad quality products. The normal remedy would be for us to state that if any of the above problems occur, you have the right to have your product made by some other manufacturer and that ________ will provide you with a license to the technology that will allow this. Though this is the normal remedy, many Chinese manufacturers strongly resist this, putting you in a difficult position. You have indicated that ____________ will be required to accept purchase orders that meet the price agreement. You have also provided for penalties for late delivery and for defect issues. Though this is not ideal, it may be the best you can do in your current bargaining position. So the key issue is whether you are required to purchase from __________ or not. If you are required to purchase exclusively from ___________, you will need to face the fact that you are in a very weak bargaining position on many critical business issues and ____________ can fairly easily make life difficult for you by forcing you to fail to meet the sales quotas that will then enable it to start working with U.S. company that competes with you.

Please advise on the above. After we get clear on these various issues, I can begin drafting the agreement. I realize these issues are difficult, but it it is best to take a clear position from the start. Please let me know if you have any questions or if you need any additional explanations.

China lawyersMany years ago, a very good client of mine in the international food brokerage business learned that one of its employees had set up a rival company and was using my client’s resources to generate business for that rival company. To grossly oversimplify, whenever this employee would find a particularly good deal on product, it would buy and then resell that product on behalf of its own company, not on its employer’s behalf. I lead with this to emphasize that this sort of thing can and does go on everywhere. It also gives me an opportunity to relive how much fun it is for us lawyers when a US company discovers an employee doing this sort of thing.

We also once had a client that sold $1500 consumer products and received a complaint email from one of its retailers claiming to have received more than $80,000 of product in less than stellar condition from “XYZ distributer.” This email alarmed our client as it had NO distributers and it had no record of any sales to this retailer. To make a long story short, the profit margins from selling millions of dollars of products that cost you nothing to make are astronomical.

This sort of thing — what some call a company within a company is very common in China. See this classic Financial Times story from many years ago. So common in fact that when our China lawyers have been involved in confronting employees that engaged in such conduct, their usual reaction is not one of “I’m really sorry, go ahead and fire me, but rather something more like the following:

  • You never told me I could not do this.
  • The employer rules and regulations do not prohibit this so I did it.
  • If you fire me, I will sue you for xyz.
  • If you fire me, I will report you for xyz.

We typically advice our clients not to confront China employees that have gone rogue without first making sure that they have good grounds for termination and that such a confrontation will not be putting the company at great risk. See China Employee Termination: Avoid These Mistakes.

What though can and should you do to prevent this sort of thing from happening to you in China?

  • Recognize that you cannot just turn over your China operations to any one person and essentially just walk away. Do not have a business in China unless you are prepared to operate it and monitor it.
  • Do not put too much trust into a small core of employees, shutting out the lines of communication to the other employees, and failing to engage in even basic monitoring of the business.
  • Listen to your China employees and talk with your China employees. It is a big deal for one Chinese employee to “rat” on another, but in most instances where we have come across “a company within a company situation” there has been at least one employee who has been hinting at problems and the foreign office has just shrugged them off. Oftentimes, the employee will have sought to convey information about the problem in the form of a question, such as “do you think it might make sense to have our books audited early this year” and then been “shot down” by a foreign office that does not press for why this question is being asked.
  • There are certain “tells” for which you should also be looking. Is there a small group of employees that seem to want to block other employees from receiving critical information or data? Are you seeing invoices or purchase orders that do not make sense? Does what is happening on the ground look or even feel very different from what the books say.

I could go on and on with how to prevent this sort of thing and there are tons of articles out there on this as well. I will instead simply conclude by saying that this sort of thing is far more likely to happen to the company that believes it cannot happen to them than to the company that believes vigilance is necessary.

Not trying to scare anyone here, but do be careful out there.

 

In the last week, from most recent to oldest, we wrote about the following:

1.  How Chinese companies steal your intellectual property.

2. How terminating your employees in China can come back and bite you.

3. How difficult it can be to figure out the capital requirements for your WFOE.

4. How complicated it can be drafting a China sales agency contract. This post not only started out with the following preamble: “With China getting more expensive and more difficult for foreign companies, and with many foreign companies choosing to leave China rather than risk getting caught for operating there illegally.”

5. How China companies will counterfeit your products.

6. How China is cracking down like never before on companies with “independent contractors” in China. This was I think our third or fourth post on this just this month as we just keep seeing the number of American companies getting caught for this increasing and the penalties become more onerous. We titled this article Doing Business in China with Deportation or Worse Hanging Over Your Head and we used the following picture with that post:

China WFOE lawyer

7. A Chinese Law Bibliography.

A psychologist would look at the above seven and quickly find that they all have one theme in common. China is a difficult, even dangerous place for foreign companies doing business there, seeking to do business there, or even doing business with Chinese companies. And your salvation comes from knowing and obeying the law and being able to use the law to your advantage. Hey, that’s what we do for a living: we are China attorneys and we help foreign companies gain an advantage over Chinese companies by using the law.

But I have to admit that this all can get a bit unrelenting and that there is more to life than gloom and doom. And hey, if you knew us, you would quickly learn that in real life we are some of the nicest most optimistic upbeat people  you could ever hope to meet. Truly.

And today I aim to show that with the following link to an amazing video on North Korea/South Korea relations by a true expert in the field. Now I could tell you that I am posting this video because the relations between North Korea and South Korea are in many ways a proxy for the relations between China and the United States, and then I could go on to discuss how the relations between these four countries might impact your business with China. But I won’t even try that. Instead, I will admit that I am posting this for one reason and one reason only. Because I found this to be one of the funniest things I’ve ever seen. Maybe it is because I have done many a TV (and radio) interview myself (too early in the morning or too late at night) in a room with the door closed and sometimes with one or both of my daughters making noise in the background, and always living in fear that one just might burst in while I am talking, as they so often used to do when I was on my cell phone talking to a client. Heck, at a certain age, they used to mimic me or try to get me to laugh while on those calls. So maybe I find the following video and article so incredibly funny simply because I can so relate to it. Be that as it may. No ulterior motives here. No China business scare tactics here. Just an attempt to get you to laugh and enjoy.

Watch the video first then read this article (please, please, please read the article, which analysis heightens the video and is almost as funny as the video itself) and then watch the video again. Then let us know what you think. I’m guessing many of you have already seen it, but enjoy it again; it does not get old.

Nobody panic, we will eventually return to our regularly scheduled programming. In the meantime though, have a great day. China attorneys

China IP LawyersOur China lawyers do the legal work on all sorts of transactions with China, ranging from relatively simply manufacturing contracts to purchase widgets to relatively complicated joint venture deals to technology licensing deals to mergers and acquisitions (involving both the purchasing of a Chinese company by a Western company to the purchasing of a Western company by a Chinese company). Nearly all of these deals have one thing in common: intellectual property. And on many (most?) of these deals, our lawyers will be far more skeptical of the intentions of the Chinese side than will our clients. We are perpetually concerned that the overriding goal of the Chinese side is to walk away with our client’s intellectual property without fairly compensating our client for that. That leads us to today’s question, which is one we are constantly asked in some form resembling the following: Do you really think XYZ Chinese company wants to steal our IP? To which the answer is pretty much invariably yes.

You can give all sorts of politically correct or politically incorrect answers as to why this is so, but it generally is. The answer I give is that Western companies want to steal your IP also, but because IP laws in the West are more developed and more likely to be enforced, their cost-benefit analysis is going to be different and so it will far less often make sense for them to try to steal your IP than it will for a Chinese company.

I was reminded of this ultra-common question today upon reading Mark Cohen’s always good China IPR Blog and his most recent post, entitled, Stealing IP from the Steel Sector. Mark’s post is about another article, Make the Foreign Serve China: How Foreign Science and Technology Helped China Dominate Global Metallurgical Industries, by Michael Komesaroff. Komesaroff nicely sums up China’s general thinking on IP with the following:

Chinese companies will infringe the proprietary technology of national champions as readily as they do to foreign competitors and the absence of an enforced intellectual property law accelerates diffusion of any new technology….with an endless supply of smart engineers and scientists, why pay for technology, something that you cannot touch, see, taste, or smell.

A reporter called me yesterday to check in on the “hot topic’ issues my firm’s China attorneys have been seeing lately. I told her of how my firm was getting a ton of matters involving Chinese companies claiming to want to invest in or buy out US technology companies, but in many instances, just using that claim as an excuse to “kick the tires” to see if there might be some way they can walk off our client’s technology for little to nothing. Just a more recent version of what Komesaroff describes in his article. For more on how Chinese companies have updated (but only slightly) their tactics of making off with Western IP and, more importantly, how to prevent that from happening to you, I urge you to check out the following.

Oh, and be careful out there.

China lawyers for forming a China WFOEThe below is what our China lawyers have been telling our clients about China’s new rminimum capital requirements rules when forming a WFOE. Note that China the country has its laws/rules on this and many of China’s cities have their own rules on this as well. And in addition to the rules, you also must consider local “customs” in addition to what is on paper. With all of  these provisos, here is a fairly recent email we have been using with our clients for whom we are forming a Shanghai WFOE.

We are required to set forth the registered capital for the WFOE. The rules on registered capital have changed substantially in the past two years. Here is the basic current situation:

1. Registered capital is the amount of capital (not earnings) required to get a WFOE started. This amount is typically based on the amount of money needed by the WFOE before the WFOE starts earning sufficient income to cover the WFOE’s financial obligations. This amount is unique to every WFOE. For a WFOE that will build a petrochemical plant, the number may be over a billion dollars. For a two person consulting WFOE, the number is often quite small. For a WFOE that will _____________ and also ____________ in Shanghai, the number is somewhere in between.

2. China now has no formal requirement for the amount of registered capital. In general, the JIngan local government recommends that registered capital be at least equal to the first two years expenses of the WFOE. However, there is no fixed rule.

3. There is also no longer a requirement on when the capital must be contributed and there is no fixed rule on the amount of each contribution of capital. The rule is now a business standard: there must be enough capital to cover the operations of the WFOE. In particular, there must be enough capital to cover employee salaries, rent, utilities and government charges and taxes. It is a violation of law to start a business/WFOE in China if these basic expenses are not covered with a capital contribution. The government generally requires that the total registered capital be contributed within 20 years, which effectively means there is no time pressure on the contribution.

4. But it is a mistake to set the capital number too low. The source of both capital and income for this WFOE will be payments from the shareholder (your U.S. entity). Under Chinese law, payments from the shareholder that exceed the registered capital amount are treated as income to the WFOE and are taxed at China’s normal income tax rates. Capital contributions, on the other hand are not taxed.

5. The following are the two common approaches for determining the appropriate registered capital amount:

a. Use the local government recommendation of an amount equal to the first two years expenses of the WFOE (the “rule of thumb” approach).

b. Work with your accountant to determine an appropriate amount (recommended). If your accountant is not familiar with China (and most are not) and also able to handle international and cross-border accounting issues (again, most are not), let us know as we work with a number of such accountants and we would be happy to recommend one to you.

For us to assist you in determining an appropriate registered capital amount, we need to see the following:

i. Projected expenses for the first two years of WFOE operations.

ii. Projected sources of income to the WFOE in the first two years of WFOE operations:

a) As payments from the shareholder.

b) As payments from the affiliates of the shareholder (if any).

c) As income payments received from unaffiliated third parties (if any).

iii. Five year projected pro forma for the WFOE.

We do not need this financial data if you will make the decision working with your accountant or by adopting the rule of thumb method.

6. We need to provide the registered capital amount at the very beginning of the WFOE application process. You therefore should make the determination of the registered capital amount a top priority matter.

Please contact me if you have any questions on this.