Basics of China Business Law

China attorneysIn the original post in this series, Getting Money Out of China: It’s Complicated, I wrote about how incredibly frequently Western companies have been seeking the help of my firm’s China lawyers in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.”

That has turned out to be no exaggeration. That post has already had nearly 8,000 views and over the weekend, I alone received four reporter queries and nearly a dozen e-mails from people asking for help to get money out of China. I assume that were I to survey my firm’s China attorneys they would report something similar. But as I noted in part 2 of this series, most of the requests deal with purchasing single family homes in the United States and “slapping together 3-5 single family homes and calling it a fund is not likely to make a difference with the Chinese government allowing money to leave!”

In part 2, I discussed how the Chinese government seems to apply a three part test in determining whether to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. In part 2, I looked at legitimacy. In this post, I will examine the “benefit to China” element.

There is no doubt in my mind that a key element to money leaving China is simply whether the Chinese government wants the money to leave for its intended purpose or not. Nothing scientific here and it is more art than science, but based on my experience and my conversations and my gut feelings, I would rank the likelihood of the Chinese government approving your deal in roughly the following ways.

  1. Near certain the money will leave deals. We have many clients who sell their products and their services to China for less than $10 million at a time, using China-centric contracts, and I cannot recall a single instance where any of them have had any trouble getting paid. These are real deals with real contracts with real parties with real pricing and it is pretty clear China so recognizes these and has little to no problem with them. These are the deals that help keep China businesses running smoothly. For what you need to do to make your contract work on these deals, check out Selling Your Product or Service Into China: The Contract Basics.
  2. It depends deals. Technology licensing deals fit into this category. The Chinese government wants its companies to acquire Western technology, but it is not clear that it wants its companies to pay too much for this technology, especially if a denial of payments will mean the Chinese company can pay less. For more on what is involved in doing a China technology transfer deal, check out Three Myths of China Technology Transfers and China Technology Transfers: The Relationship and Deal Structure Myths.
  3. It really really depends deals. Chinese companies investing in Western companies. Yes, you can read about this or that Chinese investment deal getting done, but you should know that many of these deals do not involve money going from Mainland China to the West: they involve money going from Hong Kong to the West. In trying to determine the odds of your deal going through the first question to ask is from where the money will be coming. If your Chinese counter-party has $200 million in an HK bank account and your deal is for $150 million, then what the Mainland will say about your transaction obviously becomes less important. But if you are counting on the money coming from the PRC, the nature of your business could well be determinative. If the investment is going to be in real estate, your odds are not good because it is difficult to argue how a Chinese company sending $150 million to the United States to buy a couple apartment buildings there will benefit China. But if the investment is going to give the Chinese company access to a technology needed or desired by China, the odds just went way up.
  4. Are you kidding me deals. We are not aware of a single instance where the Chinese government has said, “yes sure, go ahead and send that $5 million so you can buy a luxury condo in Vancouver or New York.” Sorry.

Determining whether money can come in on a specific deal — even when it is legitimate and the contract is good — is more art than science and nobody can get it right every time. For this reason, our advise is always to assume that getting the money will be difficult and act accordingly. We give this advice even for our lowest risk clients: the product sellers. See Payment Terms When Selling TO China: Possession Is Ten-Tenths Of The Law. This means setting up your deal to reduce your risk of not getting paid and to reduce your risk if you fail to get paid.

What are you seeing out there?

 

Chinese lawyers
Getting money out of China. It is super complicated.

In yesterday’s post, Getting Money Out of China: It’s Complicated, I wrote about how incredibly frequently Western companies have been seeking the help of my firm’s China lawyers in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.”

That has turned out to be no exaggeration. That post has already had nearly 5,000 views and despite it being the weekend, I alone have received two reporter queries and at least a half dozen e-mails from people asking for our help to get money out of China. I can only assume that were I to survey my firm’s China lawyers that half dozen number would be at more than a dozen. Again, though, most of the requests deal with the purchasing of single family homes and, people, slapping together 3-5 single family homes and calling it a fund is not likely to make any difference with the Chinese government allowing money to leave!

In this post, I will discuss the three factors the Chinese government uses to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. In this post, I will address “legitimacy.” In subsequent posts, I will address the other factors.

By legitimacy we mean exactly that. If a China company needs a $5 million dollar piece of industrial equipment for its factory and it pays $5 million for that industrial equipment, the deal will almost certainly go through. My law firm has a number of U.S. and European clients who sell this sort of equipment and for whom we have drafted contracts that work and none of these clients have reached out to us with any problems. Nor has any other company selling such equipment legitimately.

Just to repeat. Chinese company needs $5 million in industrial equipment to make its factory run better, the Chinese government will almost certainly allow the money to go through. Why then do we get so many calls and emails from U.S. and European (usually for us, German or Italian or Spanish) companies who are not getting paid for their industrial equipment sales? Two reasons. Bad contract and an appearance or a reality of illegitimacy. I will save the contract aspects for a later post and address just the legitimacy element in this one.

Here are the situations where we have seen problems on what should be a routine equipment purchase:

1. The foreign company is selling the $5 million piece of equipment for $8 million. Come on. If you have sold your $5 million piece of equipment to China five times in the last year for $5 million and now all of a sudden you are selling it for $8 million, the Chinese government is going to assume that you have some sort of side deal with your Chinese buyer to funnel some large portion of the $3 million extra to a bank account held by the owner of your Chinese buyer in your home country. When we have been armed with evidence to the contrary (perhaps you have added all sorts of bells and whistles to the $5 million machine, for example), the odds are good on your eventually getting the money out. But if you are in fact planning to push over the $3 million or so extra to your Chinese friend, the odds are not so good that the money will ever leave China.

2. The foreign company is selling the $5 million piece of industrial equipment to an advertising agency in China. Come on.

3. The foreign company selling the $5 million piece of industrial equipment has never sold anything to China previously and the Chinese company buying the $5 million piece of industrial equipment has never previously bought anything similar from overseas before. If your deal is truly legitimate, you ought to be able to prove it and you ought to be able to get paid. If your deal is really just a scam, your odds are really more. Note: our China lawyers love taking on the former type of matter but we will not take on the later.

4. The foreign company selling the $5 million piece of industrial equipment is wholly owned or largely owned or even partially owned by an ethnic Chinese. Call it discrimination or call it whatever else you want, but we often see deals involving ethnic Chinese on the foreign side held up to much greater scrutiny by the Chinese government. I first wrote about this Chinese government criteria back in January of this year, in Getting Money Out of China: What The Heck is Happening?

Get this one: Money will not be sent to any company on a services transaction unless that company can show that it does not have any Chinese owners. The alleged purpose behind this “rule” is again to prevent the sort of transactions ordinarily used to illegally move money out of China. Never heard this one until this month.

Things were a lot better in January and this criteria has only become more real. There are various completely legal things that can be done to alleviate this problem and improve your odds on this one, but it would be better for our firm’s clients that I not mention them here.

Bottom Line: When I wrote yesterday’s post on getting money out of China, I envisioned a two, maybe a three part series. The deluge of questions I have received just since then has convinced me that this issue is too pressing, too important, and too multi-dimensional to be contained in a series that short. This seems to be THE big issue right now and we plan to write on it until we have exhausted it. So keep your questions coming.

China attorneysFor the last few months, I alone have been averaging a call or email a day from someone inquiring about getting money out of China. I had three phone calls and one email on this topic yesterday (and woke up to two more such emails this morning), and they run the gamut.

Two of yesterdays calls were highly typical. One was from a realtor wanting to know how the Chinese buyer of a two million dollar house could get her money out of China to pay for it. The other was from the General Counsel of a large housing construction company with essentially the same question, but more general.

I try to make the single house purchase calls as short as possible and I do that by spewing out the following as quickly as I can:

China law forbids anyone from sending out of China more than USD$50,000 in any given year without government approval and it is virtually impossible to get this approval to buy a house overseas. So the odds are overwhelming that we will not be successfully in helping this person get more than $50,000 out of China and we are not going to help in getting the money out illegally. There are sometimes some legal workarounds, but for us to know if there are any in this case, we would need to be retained and we would need to know a lot more facts. And doesn’t it make more sense for your buyer to retain her own Chinese attorney in her hometown since she is Chinese and this is an issue of Chinese law?

Our China lawyers have been hired on single purchase house deals, but only by sellers who want to use our services to justify getting out of the deal with their Chinese buyers because they now have a higher offer on the table and they are tired of waiting. This makes sense.

My phone calls with the real estate company and the home building company lawyers last a few minutes longer. I tell those callers the same thing about the law, but I also tell them that in light of this, they should consider requiring larger initial nonrefundable deposits from overseas buyers.

Then there are the near daily emails from people who think that they have come up with THE solution for getting money out of China. These emails propose things like bitcoin, loans, company to company transfers and various other things, far too often with a tone that they have discovered the one method that can trump Chinese government restrictions and would I just confirm this for them. It was one of those that spurred me to write this post:

What’s the best way for a Chinese investor to send RMB out of China to the U.S.? We are setting up this transaction as a services deal from corporation to corporation.

That’s it. No explanation of the parties involved in the deal. No explanation of the deal itself. No explanation of the money involved. Not even really a question; just a statement as to how they are going to do the deal, and essentially a request that we bless it. Here is my standard response to these kinds of emails:

There is no way I can even come close to answering your question on the best way for a Chinese investor to get RMB out of China without knowing, at the bare minimum, the following:

1. The nature of the transaction.
2. The nature of the parties (a lot more than just their structures).
3. The histories of the parties.
4. The location of the parties.
5. The nationalities and even the ethnicities of the parties (especially the receiving party).

In our experience all of these things (and a whole host of other things) are factors in whether the Chinese government will allow money to leave. If you think just doing it corporation to corporation will get the money out, the odds are overwhelming that you will end up being sorely mistaken

The more legally interesting calls — and the ones on which our China lawyers can often help — come from Western companies facing the following sorts of situations:

  • Western company selling some really expensive item (usually a piece of industrial equipment) to a Chinese company and the money isn’t leaving China.
  • Western company waiting for funds to arrive on an IP licensing deal.
  • Western company waiting for funds to arrive from a Chinese company which is supposed to be investing into the Western company.
  • Western company waiting for funds in payment of services provided.

In part two of this series, I will set out the framework our China attorneys believe the Chinese government uses in deciding when money leaves and when it does not and start analyzing how China treats the various situations it sees from the list above. Most importantly, we will set out what exactly you can and should be doing to increase the odds of money leaving China.

 

Cover_design,_A_Book_of_MythsIn my previous post Three Myths of China Technology Transfers, I focused on the misconceptions Western companies so often have regarding China technology transfer deals. In this post, I focus on two commonly held misconceptions foreign technology owners have regarding “partnering” with Chinese companies.

Due to a partnership relationship, the foreign side often wrongly believes it is somehow better protected against IP theft. The foreign side then lets down its guard, only to learn that its China partner has appropriated its core technology. This sense of partnership is most common with SMEs and technology startups, especially those companies whose owner is directly involved in the relationship with the Chinese entity.

The two primary “we are partners” myths our China lawyers see are the following:

Myth One: Our personal connection will protect us. The Chinese company will not appropriate our technology because I (the owner of the U.S. company) have a close personal relationship with Mr. Zhang (the owner of the Chinese company). Usually this statement is followed with some bit of personal data, such as: “He came to my daughter’s wedding” or “I sponsored his son’s admission to college” or “I helped bring his family to the United States” or “He is my son’s godfather.” Trust me when I say our China attorneys heard them all. This idea that a close personal relationship will somehow insulate your company from China IP theft is probably results in more technology transfer disasters than any other myth about China. It is a myth for two quite different reasons:

On the most basic level, personal relations are not a barrier to committing acts of appropriation or other breaches of trust or contract. For most Chinese business people, personal relations, such as attendance at weddings and other shows of friendship are strategic matters, done to achieve some form of business benefit. When that benefit involves breaching a contract and appropriating technology, the Chinese side will often do it. Of course, this is not always true, but it is certainly true often enough that this possibility cannot and should not be ignored.

When the foreign party points out that this is a breach of trust, the Chinese side will often reply with something like the following: “In China, business is like warfare and contract like a treaty between nations. We will honor the treaty when it benefits us, and we will breach when it benefits us. Personal matters are not relevant. As soon as we see a benefit, we will take it. The situation is really all your fault. You should not have presented me with a situation where I had the opportunity to betray you. By leaving me an opening, you forced my hand, because the rule in China is that when an opportunity presents itself the prudent businessperson must take advantage of it opportunity.”

I have many times heard a Chinese company owner state this sort of argument with a certain amount of bitterness. They actually say: “It’s your fault. You made me do it.” They resent you for having forced them to the friendship in a way that was painful to them. But again, the common Chinese view is that when a foreign company provides an opportunity to seize a benefit, the Chinese company is obligated to seize. Personal feelings do not count; action is required.

In many cases, however, the Chinese company owner has no reason to appropriate your technology, so it is safe not because of an emotional commitment but because there is no benefit from the theft. But, the technology is still stolen. This is because the technology is stolen by an employee of the Chinese entity.

In fact, for technology that requires a small investment to commercialize, theft by a Chinese company employee is probably the most common way foreign technology gets appropriated. This is particularly true of software products, where no large capital investment is required. In these low barrier to entry businesses in China, senior technical employees are constantly on the look out for an opportunity to steal technology and leave their employer to start out on their own.

This is part of the aggressively entrepreneurial mindset of Chinese technical personnel. Appropriating a nice piece of foreign software is often seen as the perfect way to get a head start on forming a new company. In the same way, if an employee can make off with a full set of production molds, he or she can start up a small factory at a very low cost in China. So the opportunities abound and the foreign technology disappears, leaving both the Chinese owner and the foreign entity frustrated as their mutually advantageous business relationship is destroyed by a low cost Chinese competitor.

Myth Two: Our partnership is secure because of investment by the Chinese side. We hear this argument a lot and it is essentially that it is not necessary to formally protect the technology because the Chinese company plans to invest significantly in the foreign company.

This argument has two variants, both of which are false:

Variant Number 1: The Chinese side plans to purchase a majority ownership interest in our company. In effect the Chinese side will own the technology in the end. Since the Chinese side will eventually own it, there is little reason to try to protect it from appropriation by its future owner. In this way, the Chinese side convinces the foreign entity to transfer the important technology to the Chinese entity prior to the date with the investment occurs.

But, then, there are always delays in closing that investment transaction and in many (most?) cases the full (sometimes any) investment never occurs. The Chinese side assures the foreign entity that the investment funds are on the way; the delay is only temporary. In the meantime, the Chinese entity obtains all of the relevant technology. Finally, the Chinese side announces that it sincerely regrets the transaction cannot be concluded. There is always some good reason. Either the bank that was going to finance the investment deal got cold feet or the Chinese government withdrew its approval of the transaction at the last minute. Either way, the deal is off with no liability on the part of the Chinese side. But the Chinese side got what it wanted. It obtained the key intellectual property without having to pay anything approaching market price for it.

Now that Chinese companies are perceived as wealthy, this investment promise has become a standard technique Chinese companies use to convince foreign companies to drop their guard. The way to prevent the unfortunate result is simple. Up until the day the purchase transaction closes and the funds are clearly in your bank account, treat the Chinese entity as a neutral third party. Protect your intellectual property in exactly the same way you should (or at least would) if you were dealing with an unrelated third party. The Chinese side will complain about the expense and inconvenience, and your reply should be: if you do not like it, pay the money now.

Variant Number 2: The Chinese side will purchase a minority interest in your company, just to provide support for developing the technology. In this variant, Western companies believe protection of their intellectual property is not required because: “Why would the Chinese company want to harm the interests of a company in which it is a part owner?”

This argument assumes that the Chinese company sees greater future benefit in the earnings it will get from its minority share of the U.S. entity as compared to walking away with the American company’s technology.  The U.S. side often tells us that “when we go public, the Chinese side’s share will give them a huge profit. Why would they screw things up now and prevent that public offering from ever happening?”

The Chinese side rarely sees it this way. First of all, few Chinese companies focus on the long term. So for many, the promise of a future IPO or other monetary benefit from their minority investment means little or nothing to them. Second, when the Chinese side makes a minority investment, they do not see it as a investment in stock. They are making the payment to hire the foreign entity to do research and development work on their behalf and usually what they pay for such work (via the minority investment) is far less than they would pay for an arm’s length R&D program.

The investment in this R&D work is valuable to the Chinese company, but only to the extent it can take control of the technology. So the Chinese company will invest in the foreign development efforts for only so long as it receives direct benefits in the form of transfer of technology. The Chinese side has no intention of allowing the underfunded foreign start up to commercialize that valuable technology. Instead, the Chinese entity will transfer the technology to one of its many well funded subsidiaries for entry into the market. Normally, the Chinese entity expects the foreign start up to then simply die. They do not see this as a loss of their investment. Instead, they figure they see themselves (usually rightly) as having received an excellent return on their payments. It paid the money and the foreigners did the development work which it (the Chinese company) now owns. That is the end of the analysis.

The solution here is the same as the solution for Variation 1. Treat the Chinese entity like you would any third party entity. Disclose as little as possible to the Chinese entity and thoroughly protect what you disclose. If the Chinese side continues to seek access to your technology, consider carefully why it is  making such requests. A normal investor does not need such information. If the Chinese side is asking you for more than a normal investor would ask, you have to ask why. The answer will almost certainly be that the Chinese company wants access to the intellectual property underlying your technology and it wants  that for its own use.

In this situation, if the Chinese side complains or says something like “Don’t you trust us? We’re your partner.” This is sure sign of trouble. If the Chinese side requests access to your proprietary technical information, you have to ask: why are they making such a request? The real reason is seldom what you will want to hear.

Bottom Line:  Do not be lured into believing that the nature of your relationship with your Chinese counter-party or the structure of your deal will be enough to protect your intellectual property from being appropriated. Or as my co-blogger, Dan Harris, always likes to say: Be careful out there.

China labor lawyerWorking hours for most China employees are usually determined under China’s “standard working hours system,” and in most places in China, that means a 40-hour work week — 8 hours a day and 5 days a week. This system does not allow for a lot of flexibility since work done outside the normal working hours is considered overtime that obligates the employer to pay overtime. I am finding that foreign employers are often (virtually always, actually) confused about China’s working hours and they often believe (and repeat to me) the following six myths regarding working hours and overtime in China, all of which are daily costing foreign companies extra money in China.

Myth 1: China’s overtime rules are similar to the exempt employee rules in the United States. Wrong. For example, it does not matter how much your China employee gets paid. Your China employee might be making three times the average salary in the city where you are located (this amount is a common threshold for a number of things under Chinese employment law). Generally speaking, you must pay all overtime.

Myth 2: Managerial employees are exempt from overtime pay. If a manager works under the standard working hours system overtime incurred must be paid. If your manager(s) have been approved to work under an alternate working hours system (usually the flexible working hours system) you can avoid paying overtime on most occasions, except for (and this depends on the locale!) time worked on a legal holiday such as New Year’s day, Chinese New Year, National Day, etc.

Myth 3: An employer and employee can contractually agree to have the employee work under an alternate working hours. Nope. Most places in China require prior government approval for an employee to work under a non-standard working hours system. The employee’s written consent alone is usually not sufficient.

Myth 4: Comp time can negate overtime obligations. Not necessarily. This depends on the employee’s situation and the locale in China. If an employee working under the standard working hours system stays beyond the normal 8 hour work day, you must pay overtime, which is usually 150% of that employee’s normal wage. But in most locales in China, an employee who works during a weekend can be compensated with comp time. However, if you are unable to give the employee comp time (perhaps because you mistakenly failed to do so or because you simply were too busy), most locales in China will require you pay 200% of the employee’s normal wage or 300% if the work was on a legal holiday.

Myth 5: An employee on an alternate working hours system needs never be paid overtime. Be careful. Again, this — like pretty much everything else employment related in China, depends largely on the locale. Most places in China require the employer pay even alternate hour employees overtime for time worked during a Chinese legal holiday. Also, we cannot even count the number of times a foreign employee has insisted that such and such employee is under the alternate working hours system and one of our China labor lawyers has discovered that was never the case or is no longer the case due to a failure to timely renew.

Myth 6: The employee (not the employer) is required to keep track of time for overtime pay. Tell this to the many foreign employers who thought this was the case and then ended up having to pay all sorts of back overtime pay when the employee has left, to avoid getting sued for having done so. You as the employer need to document what is going on with your employees on overtime and just because an employee has not yet hit you up for it, does not mean you don’t owe it. Your rules and regulations should contain a section setting out your company’s overtime policy, including your internal procedures your employees must follow for securing approval before incurring overtime and your procedures for reporting such overtime.

Bottom line: Make sure you understand the national, the regional, and the local laws that apply to overtime in the city in which you are located.

For more China employment myths, check out Six Myths About China Employee Probation.

China trademark lawyersOne of the most common things our China lawyers do is help protect our clients’ IP when they first go into China. One of the most common subsets of that work is protecting our clients before they start to manufacture their products in China.

On that front, one of the things we virtually always discuss is what the client can do to protect itself from its own manufacturer by contract and overall in China from everyone (including the client’s own manufacturer) by registering their intellectual property in China.

The intellectual property we help our clients register can be an invention patent, a utility patent, a design patent, or a trademark or a copyright, all depending largely on the particular sort of intellectual property needing protection and the client’s particular situation and stage.

On the contract front, early on we typically recommend an NNN Agreement, a Product Ownership Agreement, a Product Development Agreement, and/or a China OEM Agreement (a/k/a a China Supply Agreement or a China Manufacturing Agreement) again, largely depending on the particular IP needing protection and the client’s particular situation and stage.

In an ideal world, our China lawyers work with our clients to pick and choose from the above with cost as now object. But rarely do our clients have unlimited budgets and so most of the time we have to work with them to determine which of the above are absolutely necessary, which of the above will have the most “bang for the buck,” and which of the above are not all that necessary or can wait.

One of the most common questions with which we have to grapple is whether our client should focus on its China IP registrations or its China manufacturing contracts. If the client has only enough funds for one thing, should it use those funds to register its trademark in China, its design patent in China, or to have an China-focused NNN Agreement it can use with all China companies to which it will be revealing its secret sauce?

Unfortunately, there is nothing even close to a one size fits all China IP protection strategy because there is nothing even close to a one size fits all China IP situation. So there is little I can tell you here about how to prioritize the above.

We would though love to hear from you-all on how you have prioritized your China IP protective measures and why you did what you did and, most importantly, how it has worked out for you.

China lawyers
Three myths of China technology transfers

Many technology transfer licenses in China fail. Though it may be true that not all Chinese companies plan from the very start to violate the terms of their licensing agreements, you must not ignore that many do. A fascinating thing though is that when Chinese companies plan to breach their licensing agreement with a foreign party, they almost always cannot help but reveal this from the outset.

A Chinese company that intends to violate a licensing agreement and run off with the foreign company’s IP will usually have a very clear plan. What the China lawyers in my office call the Standard Plan works as follows. First, the Chinese company will negotiate in a way that guarantees a weak license that cannot be enforced against them by the foreign party. The tricks used to do this are quite standardized. Second, the Chinese company will ensure that it does not make any (or else it makes very few) payments until after it has already received the technology. If the Chinese company makes any payment at all, it will make a minimal number of payments, usually late and in violation of the agreement and then once it has received enough of the technology it seeks, it will cease making any payments entirely.

When our China attorneys encounter a Chinese company clearly working on the Standard Plan, we warn our clients. However, it is also typical for our clients to nonetheless want to forge on ahead. The client will usually explain how their situation is unique and that means the Chinese could not possibly be planning to breach.

These explanations are often based on common misunderstandings about how China works, or on what so many call China Myths. Here are three of the many such myths I have heard from clients in just the past six months:

1. Myth One: The Chinese company will not breach our technology licensing agreement because it needs us. The usual argument is that the technology is complex and the application know-how is critical and the important/critical information will not be disclosed until the Chinese company has made its last payment. The problem with this argument is that even though it may be factually true that the Chinese company cannot successfully implement the technology without the final data and continuing support from the foreign licensor, what really matters is that the Chinese company believes otherwise.

Far too often the Chinese company is convinced that once it gets some relatively small percentage of the technology from the foreign licensor, it no longer needs the foreign licensor. First, Chinese companies commonly believe with respect to the technology itself that the whole package is not important; the only thing truly important is the magic formula. Based on this the Chinese company will seek to extract the magic formula as soon as possible in the transfer process and with as few payments as possible, and once it has done that, they see no reason to continue the relationship with their foreign licensor. The Chinese company believes (often with good reason) that once it knows some key portion of the technology it can just hire key engineers to assist them in the implementation phase for considerably less than it would cost them to continue making their licensing payments. And get this: many times the Chinese company will bring in your former employees and consultants and former employees and consultants from your competitors to do this work.

2. Myth Two: The Chinese company is acting this way because it is inexperienced or incompetent, not because it plans to breach. This myth is based on Western arrogance and it is the rare Chinese company that does not know how to exploit it. Our China legal team sees this myth in a number of settings, including the following:

  • The Chinese company submits its response to a carefully crafted technology licensing agreement 2-3 days before the deadline for executing it. The document comes back from the Chinese company with substantial revisions to the agreement terms, but with no redlining and no explanation.
  • Immediately after executing the technology transfer or the technology agreement, the Chinese side insists on assigning the agreement to a newly formed subsidiary that has no assets.
  • When the Chinese company’s payment is due, it reports that the bank has imposed restrictions that either make its payment impossible or that require substantially revising the agreement. And no surprise, the revisions the Chinese company contends must be done to free up payment are the exact revisions it sought but was denied during the technology license negotiations. The Chinese company will then press for the foreign company to continue transferring technical information while this payment issue gets resolved.

When we describe the above tactics as standard tools of the Standard Plan, used almost by rote by Chinese companies planning to breach their license agreement our clients will sometimes counter by arguing that these are not indicators of an intent to breach, but rather just mistakes that reveal the Chinese company’s lack of international experience and general incompetence.

This argument is based on a myth and it is seldom correct. First, Chinese companies are not incompetent. They know what they are doing just as much as Western companies and on international technology licensing agreements, probably better. If you can read Chinese, you can go to any bookstore in just about any Chinese airport and find books (yes plural) that explain exactly how to take advantage of Western companies on technology licensing deals. Second, Chinese companies are not inexperienced in the procedures that apply in international technology transfer agreements. Tech transfer has been a core of Chinese business since 1981. Chinese companies, together with their lawyers, bankers and government/private consultants know exactly how the system works. What is true is that Chinese companies know exactly what to do to get Western companies to let down their guard and give them what they want. In this way, Chinese companies that intend to breach are masters at fooling foreigners into thinking (wrongly) that they are inexperienced and incompetent. Our Chinese lawyer friends readily (and laughingly) admit all of this to us.

3. Myth Three: The Chinese company will not breach this technology transfer agreement because it takes a long view of business and it will not want to sour relations for the future. This myth is based on a general view that due to their long history, the Chinese take a long term view toward business relations. This is often explained by some vague reference to a Confucian ethic that still underlies Chinese culture, even in the PRC, a communist country.

This is just a cultural stereotype not based on recent Chinese history. I am not going to discuss Chinese culture or Chinese history in this post, but I am going to tell you what I have seen over the decades in which I have been providing legal representation on Chinese transactions (coupled with what the other China lawyers have seen in their practices as well) and that is that Chinese companies — if anything — tend to take the long view far less often than the Western companies (mostly North American, Latin American, European, and Australian)  I represent. In fact, many of the Chinese business people I know and with whom I speak (in Chinese) are very skeptical about the future and tend to evince a “get it while I can” attitude about business, particularly when dealing with foreign companies, who tend to come and go and have little power or even relevance. Benefit now is real, calculation for the future is for suckers. See Is There A Chinese Mindset, And So What If There Is?

These are three commonly held myths by foreign companies that do technology transfer deals with Chinese companies. They are not true; they do not reflect reality. If you are negotiating with a Chinese company based on any of these myths, you will likely fail. Don’t do it.

China attorneysIn China to Charge Three Australian Crown Resorts Executives The Wall Street Journal (Wayne Ma) reports that Chinese authorities will be pursuing criminal charges against at least three employees of Crown Resorts Ltd., an Australian gambling company. The article states that three Australians — among 18 people initially detained last month — remained in custody in Shanghai and …. [that one] of the Australians detained was Jason O’Connor, vice president of Crown Resorts’ international VIP operations. The status of the other 15 taken into custody is not clear.

As noted in the article by Peter Humphrey, who himself served time in a Chinese prison for alleged violations involving corporate investigations, “after someone has been charged, ‘the chances of getting them out have diminished by several times,’ said Mr. Humphrey, who maintains his innocence. ‘Whoever laid these charges now has a political stake in making them stick,’ he added.”

The kicker in all this actually comes from a quote by co-blogger Steve Dickinson in this Bloomberg article:

“In the old days, people would insist to me that the only risk was deportation. This is no longer the case,” said Steve Dickinson, a lawyer at Seattle-based Harris Moure, which produces the China Law Blog and has advised companies in the gaming sector. “Foreigners can expect to be treated exactly like Chinese nationals.”

And here’s the thing about the Crown case: the Chinese government had for some time been signaling its intentions:

Under Chinese law, casinos aren’t allowed to promote gambling in China. Organizing a group of more than 10 Chinese nationals to go to casinos overseas also is a crime.

Overseas casino operators sidestep that ban by marketing only their hotels and entertainment in public promotions.

The detainments appeared to be foreshadowed last year in comments made by Hua Jingfeng, deputy chief of China’s Ministry of Public Security.

Mr. Hua told reporters that his department was investigating a “series of cases” involving foreign casinos in China.

“Overseas, a few countries are treating our country as a big marketplace,” Mr. Hua said, adding that he was aware overseas operators were establishing offices in China with the goal of luring citizens abroad to gamble.

Eight months later, Chinese authorities arrested more than a dozen South Korean casino managers and a number of local agents allegedly for the practice.

Why should you not look away from this post if you are doing business in China? Because it is vitally important to you and to your company that you understand that China will arrest and imprison foreigners and that it has only become increasingly willing to do so.

In a post we wrote back in 2014, China’s Anti-Corruption Drive. What Next? we mused about China’s then nascent anti-corruption drive what it all might mean, and we noted the following:

  • China is serious about corruption and it is starting with the pharmaceutical industry because corruption is so entrenched there. China is going after both domestic and foreign companies, but we are just hearing more about the foreign companies. This is just part of China’s desire to reduce corruption because the Chinese people are really sick of it.
  • Nobody really knows where and when the Chinese government will strike next when it comes to corruption. We all just know that it is striking a lot more often than it used to and striking against a much more varied list of companies (the smaller foreign companies that have gotten hit have for the most part managed to stay out of the news).
  • If you are a foreign company doing business in China in an industry the government deems important or politically sensitive, you should be extra worried/cautious.

And here’s the latest rumor we are getting: China is going to start criminally pursuing those who earn income in China with  independent contractors in China and no company in China and who pay no employer or income taxes in China. For what this situation looks like, please check out my Forbes article, China’s Tax Authorities Want You (written before we started hearing of criminal implications).

So whatever you do, please don’t look away. Better yet, have a full-on audit done of your company to ensure there is nothing lurking there.

For more on the Crown Resorts case and the lessons to be learned from it for anyone doing business in China, check out Doing Something China Doesn’t Like? Don’t Go There and How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think.

China employment lawyerIn China’s new two-child era, couples are allowed (even encouraged) to have two kids, but no more, unless an exception applies.

Can an employer in China unilaterally terminate an employee who is having more than two kids or otherwise violates the relevant laws on family planning and population control? This is an easy question to answer regarding employees of state-owned enterprises and government agencies. Employees at such organizations are subject to more stringent regulations because they are government employees and they can be unilaterally terminated for having more than two children (still, the legality will depend on the local regulations).

The question that most concerns China employment lawyers and China employers alike is what can privately owned companies do in this situation. As is so often the case when it comes to China employment law, the answer(s) is localized and complicated. For example, Shenzhen generally prohibits employers from unilaterally terminating an employee for violating family planning laws, but it also gives its employers some leeway by allowing them to deal with this issue in their employment contracts, collective contracts and/or their employer rules and regulations. But since the basis for my statement regarding the rules in Shenzhen are based on seminar minutes from a Shenzhen Human Resources and Social Security Bureau meeting minute, the legal authority for even this in Shenzhen is somewhat unclear.

It is also important for any employer in China to understand that because female employees are a special class for whom Chinese laws provide extra protections, unilaterally terminating a pregnant employee is almost always going to be more difficult and problematic than it may first appear under the written laws and regulations. For this reason, when our employer-clients seek our counsel on unilaterally terminating a pregnant employee we nearly always seek out alternatives, including usually a mutual termination with an appropriate Chinese language settlement agreement. See China Employee Termination: Avoid These Mistakes.

A related question is whether an employer can put in its rules and regulations that violating relevant family planning laws warrants employee termination. As noted above, such a provision may hold water in Shenzhen, but not necessarily elsewhere in China. Many cities in China are of the view that because the employee who has violated China’s family planning laws will be or already is facing fines imposed by the authorities overseeing family planning and population, it would be too harsh to also allow the employee to be unilaterally terminated for the same thing, no matter what is in the employer’s rules and regulations and no matter how “flawless” the termination. Beijing used to split on this question, with some of its labor bureaus believing that employers may rely on their rules and regulations to fire an employee for violating China’s family planning laws, while others held the opposite position. Around the time of International Women’s Day in 2015, Beijing’s Second Intermediate Court made clear its position in a press conference: employers cannot unilaterally terminate employees for violating China’s family planning laws. An employer may discipline such an employee (but not terminate her), provided there is an applicable provision in the employee rules and regulations. In other words, if you have no such rules in place, you do not even get to discipline the employee. However, whether this Court pronouncement settles the issue even for Beijing is still unclear.

In a follow-up post, I will discuss what China employers can and cannot do regarding various other protections (overtime, workload adjustments, etc.) normally provided to pregnant employees, when one of their employees violates China’s family planning law.

China lawyersIn yesterday’s Quick Question Friday, China Law Answers, Part XXXV, I posed what is probably the single most common question our China lawyers get from our fellow lawyers: “What should we put in our dispute resolution provision in the contract we are drafting with a China company.” And then I very briefly explained how there is no one fits all answer and that the right dispute resolution clause should be determined based on a totality of the circumstances. I also promised to expound on that answer today, and so here goes, part I of how to draft the right dispute resolution clause for your particular situation.

The dispute resolution provision you put into your China contract may be the most important provision in the contract. If you put in a dispute resolution provision that makes sense, your Chinese company counter-party with whom you are contracting will be afraid to breach the contract. Conversely, if you put into the contract a dispute resolution provision that will not work, you are signaling to your Chinese company counter-party that it can breach its contract with you with impunity. Yes, it really is that important.

In fact, whenever I am asked to review a contract between a US company and a China company, the first provision I look at is the dispute resolution clause. Far too often when I am asked to review such a contract, it is by a new client who did not use one of the China attorneys at my law firm to draft the contract and I am now being asked to review the contract because something has gone wrong and the new client wants to know what it can do.  I review the dispute resolution clause first to see if there is even any point in determining the strength or the weakness of the US company’s claims against the Chinese company. If the contract calls for litigation in the United States, before a US Court and the Chinese company has no assets in the United States, the quality of the case just went way down.

China does not enforce US court judgments. It just doesn’t. Since China will not enforce any judgment that you receive from the US court, your winning in the US court will likely be meaningless.  Getting a US judgment against a Chinese company with assets only in China is of no use.  Getting a US judgment against a Chinese company that has assets in the United States or in some other country that will enforce a US judgment (Korea and Canada spring immediately to mind) might have some value. This means though that if you have an existing contract that requires disputes between you and your Chinese counter-party be resolved in a US court, you probably have a contract that does not work and you should be seriously considering trying to negotiate a new contract.

Way back in 2006, in Enforcing Foreign Judgments In China — Let’s Sue Twice, we wrote about how a typical phone call goes when someone calls us for help enforcing their US judgment in China:

Caller:  I have a two million dollar judgment against Chinese company X in China, can you help me enforce it?

Me:  Is it a default judgment here in the United States?

Caller:  Yes.

Me:  Chinese courts do not enforce United States’ judgments and they don’t give any credence whatsoever to United States default judgments. Did you discuss this possibility with your U.S. lawyer before you sued here in the United States?

Caller:  [long silence] …. Yes.  He told me getting a judgment here couldn’t hurt?

Me:  Did your lawyer charge you to get it?

Caller:  Yeah.  I had to pay him and I had to pay all sorts of people to get that company served in China.

Me:  Sorry.

So much of the time in your China contracts, it will make sense to draft a dispute resolution clause with your Chinese counter-party that calls for disputes to be resolved by a Chinese court (or sometimes by arbitration in China or outside of China).

In the next post in this series, I will discuss the pros and cons of using arbitration outside China (foreign aribitration) to resolve your contract disputes.