Basics of China Business Law

Terminating a China employeeNot entirely sure what is happening, but it feels like about half of my China labor law matters these days involve botched employee terminations. Terminating a China employee is never easy but the following fairly easily remedied mistakes by China employers just keep showing up.

Failing to Pay Statutory Severance: China employers far too often just assume that they do not need to pay their terminated employee any severance, especially when the termination happens at the end date of a fixed term employment contract. Many think that if their employment contracts are silent about severance, they need not pay. The mindset that an employment contract is an agreement made by two completely equal parties does not work for China. Whether you owe statutory severance depends not so much on your contracts, but on the rules in your locale and on the circumstances of the termination. For example, if the employee wishes to renew their contract, and the employer refuses, the employer is usually required to pay statutory severance. If the employer wants to renew on terms not as good as the employee’s previous terms and the employee refuses the renewal, the employer is usually required to pay statutory severance. These are just general rules. Some places (Beijing being one) require the employer notify the employee in writing thirty days before the expiration of the current contract of its intent to end or renew the employment contract or pay in lieu of notice.

Failing to Get your Terminated Employee to Sign an Appropriate Settlement and Release Agreement. Think there is no need to enter into a termination/settlement agreement because your employee resigned (and thus no statutory severance is owed)? It is true that the employee quit, but what made her do so? Did she leave for a better job or because you failed in some way to comply with Chinese labor laws and felt compelled to leave? If the latter is the case, and if you don’t address the issues via a settlement, you could end up having to answer in front of a judge or an arbitrator. If your employee’s departure has nothing to do with your wrongdoing, you should document that and even then, you may want a signed agreement that releases you from any future claims. I cannot tell you how many times we have seen instances where an employer would have saved big money by paying an “unnecessary” severance to avoid the completely “unexpected” and costly litigation that followed.

Failing to Formally Execute Key Employment Documents. As a China employer you should have most of your employee-related documents formally chopped. Your legal representative’s signature alone is not enough. Your legal representative’s signature and your company chop is not enough if the employee’s signature is not there. Along the same lines, your employee agreements should specify their date of execution. If the document is long, it may be a good idea to fan out the pages and stamp your company chop across all the pages. Better yet— have your employee sign their name across all the pages.

Bottom line: I know this sounds harsh, but you should plan for your employee terminations pretty much the day you hire.

China Lawyers for China intellectual property When we recommend to our clients that they take advance steps to protect their product from being copied in China, they often push back by using the “first to market” argument. Their argument goes like this: you lawyers just don’t understand the modern market for electronic products. Product comes and goes. Fashion turns on a dime. We simply cannot take the time to plan carefully, to register our IP or to protect ourselves with contracts. Those are just frills that only established companies with settled, old fashioned brands need worry about. We new market entrants need to focus on designing an innovative product and bringing it to market as fast as possible. If we do that, we can stay ahead of the clones and the rip offs and this is the key to success in today’s market.

Though this argument sounds plausible, it is almost always false.

This first to market argument is based on an approach that was popular in the 70s and 80s for many sorts of products and in the 80s and early 90s in the shoe and sportswear market. when the view was that any style or model had at most a six month shelf life.

The approach in those days was to change models regularly. The idea was that it took the copiers about three to four months to get to market. So as long at the manufacturers changed their styles every six months, they could stay ahead of the competition. However, this approach is no longer used because the copiers can now get their clones to market in a matter of days, not months. The big shoe and sportswear manufacturers long ago abandoned this first to market approach in favor of the sort of aggressive IP registration and contract protection our China lawyers advocate for everyone.

The first to market approach similarly fails in the electronics manufacturing market of China today. The simple truth is that if you have not protected your product design, you probably will not be first to market. You will either never make it to market at all or you will be met in the market by your direct competitors who will beat you on price, destroying the market for your product. For most products, there is virtually no first to market advantage in today’s world of instant cloning.

How does this work on the ground? There are two types of Chinese factories that will copy your product. The first and most obvious is the very factory you have hired to make your product. See Your China Factory as your Toughest Competitor. Your manufacturer is in control of the molds and tooling. Your manufacturer has developed the production prototypes. Your manufacturer may even know your future or intended customers. All your manufacturer need do is quote you an unreasonable price or otherwise refuse to make the product for you. Or better yet, charge you a reasonable price for your product but delay production. Your manufacturer then enters the market with your exact product. You then are not only not “first to market,” you are “never to market.” For more on how this sort of thing can go down, check out China and The Internet of Things and How to Destroy Your Own Company.

The other type of Chinese company that will copy your product is one of the many electronics manufacturers in China that specializes in reverse engineering the designs of other companies. This type of company has a very sophisticated system. They understand that manufacturing a cloned product is not enough. Even more important is the requirement that they sell the cloned products.

These clone shops therefore have developed a worldwide network of retailers that specialize in selling clones of the most recent innovative products and they make active use of the internet. Since these manufacturers do not need to worry much about quality control or brand reputation, they can normally get their clone to market at almost exactly the same time as your original product, if not before. These clone manufacturers then ride on the coattails of the legitimate manufacturer, making use of the legitimate manufacturer’s advertising, promotion and buzz for their own purposes. They set up their system so that most every search for the original product also produces a hit for their own cloned product. Since the cloned product is normally substantially cheaper than the legitimate original, they can make strong sales at the very outset of the product release. With Amazon’s recent push to bring on more Chinese sellers, this problem has only gotten worse. See Hundreds of frustrated sellers grilled an Amazon exec over Chinese counterfeit products.

In this way, your legitimate product never has any real first to market advantage. If you have not defended yourself from the clone manufacturers, your product will be drowned out in a sea of imitators and your hard work and innovation and great design are mere fodder for a clone manufacturer who thanks you sincerely for your hard work in helping it (not you) to succeed.

So enough with the first to market argument. It neither works nor even applies to the modern world of China manufacturing. In China, you must protect yourself from copying by your manufacturer and from copying by the clone factories. This requires substantial work in IP registration and in written agreements (such as NNN Agreements, Manufacturing Agreements and Product Development Agreements), all done before you take your product to market.

If you do not prepare properly you will not be first to market. You may never make it to market at all.

Forming a China WFOEOne of the features of China’s new Foreign Invested Enterprise (FIE) online filing registration for is the requirement that the foreign investor state who will be the “actually controlling person” of the foreign invested entity. Under the new rules, the management of all FIEs must complete an online registration form. This form defines “actually controlling person” is either a) the person or persons who collectively have 50% ownership in the foreign investor that will establish the FIE OR b) the persons who actually control the foreign investor through means other than ownership, such as contractual control over the foreign investor’s decision making body. For background information on China’s new foreign company registration laws, check out China’s New Foreign Investment Law — Less Than Meets the Eye.

For anyone who works with modern corporation ownership and management, it is obvious that this simply posed question of “who is in control” will in many instances actually be quite difficult to answer. Anyone who works in the field can give examples of complex structures for non-public companies that are intentionally structured to ensure that no single individual has actual control.

We represent many private company clients with multiple owners, none of whom as individuals have actual control. In some cases, the ownership structure is complex, involving individuals, family trusts, angel funds and employee ESOPS. For these clients, my first response to the form was to reply “none” when asked who is the actually controlling person, since that is the only sensible answer. However, the new form does not allow for this simple response. The new form only allows two answers: either the controlling person is an individual or group of individuals OR the controlling person is a public corporation. No “in between” answer is allowed. We all know this simple scenario does not reflect the reality of modern corporate finance and governance.  But the new PRC regulations do not allow for any alternative response.

How does all this work? In the section on “actually controlling person”, the new form gives the following options that must be chosen through a checkbox (translation supplied by me):

从以下类型中勾选 Select from the following categories:
□境外上市公司 Foreign Listed Company
□境外自然人 Foreign Natural Person
□外国政府机构(含政府基金)Foreign Government Agency
□国际组织 International Organization
□境内上市公司 Domestic Listed Company
□境内自然人 Domestic Natural Person
□国有/集体企业 SOE/Collective

Note that NO private business entity of any kind is listed here even though that is one of the most common types of business entity my firm sees; the system allows only for a public company or natural person. That means that for every investor that is NOT a public company, we will need to identify the natural person or persons who control the private entity. In many private companies, no individual owns a controlling share. In this situation, it will not work to say that each owner has a 10% share, so no one is in control. It appears instead that the required response will be that the group of individual shareholders are natural persons who are collectively in control, so we will have to list every one of them. And, if one of the owners is an entity, we will need to drill down and report the ownership of that entity until we finally reach the point of reporting the name of a natural person or the name of a public company.

China’s intent with this new system is clear. The PRC government will no longer allow the use of special purpose vehicles and related entity structures to hide the actual ownership of the investors in PRC foreign invested enterprises. And any attempt by a foreign investor to invoke foreign law that allows secrecy with respect to ownership will almost surely be ignored. MOFCOM has plans to carefully audit all FIEs and that audit will include careful reviewing their ownership structures. More important, however, is that a response that does not list out owners will simply not be accepted by the automated system. A response is therefore forced. A false response is a violation of law that can result in penalties and other legal/administrative action by the PRC government and its agencies.

The way the online form is written does not provide any way around this. We often have clients whose situation is such that listing out their ownership structure as required by the new online company registration system would reveal that Chinese individuals are owners of the U.S. investor, and for that reason the whole investment constitutes a round trip investment. This new company registration system is designed to root out just such round trip investments. Note that Chinese individuals are generally not allowed to have ownership in foreign companies without prior Chinese government approval.

For U.S. investors who are not in this category, this requirement will still be a problem because the actual ownership of the investor is often complex and not public. Think private equity, VC funds, angel funds, family trusts, and limited partnerships. It also is not normal in the United States for private entities to publicly reveal their shareholders. In fact, there are private entities that do not even know who their ultimate individual shareholders are.

The new rules go beyond requiring identifying the controlling persons; they require identifying of each source of investment in the FIE. The online form requires the investor state a) the amount of the investment, b) the type of investment (cash, equipment, land, buildings, intellectual property, etc.) and c) the specific source of each of those types of investment. Under this approach, it is not possible to bury round trip investments from China under other investments that come from outside China. Even if a small part of the total investment is sourced from China, this source must be clearly identified.

As I noted in my earlier post, this new online registration system will not reduce the amount of information that must be provided to MOFCOM. It is just the opposite. To properly complete the online form, substantially more information will need to be gathered and provided to MOFCOM. In addition, local governments will still require their own documentation, and that documentation will still require authentication and other similar procedures. So in the end, China’s new foreign company registration system will end up being even more complex and cumbersome than its current system.

To make it worse, since the MOFCOM report is filed online, there will be no government official available in a local office from whom we can obtain clarification on what is required. This means the form will be submitted without a prior “pre-approval” from the local agency. This will have two negative results. First, it could result in numerous submissions to the online system as an attempt is made to do it right while operating in the dark. Second, due to the vagueness of the requirements, there is substantial risk that MOFCOM officials will find a mistake or defect on subsequent audits.

Registering a China WFOE just got tougher.

Risks for foreign companies doing business in ChinaMy post yesterday, How to Do Business in China AND Sleep at Night, highlighted a very thoughtful comment from an experienced China businessperson. That businessperson emphasized how his China business philosophy is to figure out the laws that apply to foreign companies doing business in China and comply with them.

As China lawyers, my firm wholeheartedly agrees with that sort of philosophy. We have to. We are hired to help our clients discern China’s laws and how to comply with them. If a company is comfortable with violating Chinese law, they don’t have a lot of need for a China attorney. Yesterday’s post concluded with my saying the following:

Yes, scrupulously following the law in China can at times be difficult and expensive, but it is the ONLY way to achieve long term success there. It also is the only way — at least for most people — to sleep soundly at night.

*      *      *      *

Bottom Line: If you want to succeed in China and avoid legal problems, work with the right people and do things the right way. It is that simple. The foreign company doing business in China that operates this way will virtually never get into trouble in China.

A reader who clearly did not like this blog post left the following comment:

It bothers me that you’re a victim of confirmation bias and don’t seem to realize it. You ONLY hear when people have problems. And, let’s face it, there is a tone of “you deserve all the grief you get, you morons!” running through the posts. It’s like this blog is a form of therapy to allow one man to vent his anger at being forced to be highly paid to deal with problems.

This attitude is sorely lacking in real-world, shoe leather experience. What do you do when you call the labor bureau about your question, and they just shrug and tell you “chabuduo”? What do you do when the tax bureau can’t even get you the right forms to file in a timely manner? Or when there’s one strict, expensive standard for foreign companies and another totally lax standard for local companies? One that will drive you out of business if you actually follow it? Or, or, or, a thousand times or. “Go bankrupt” isn’t an option so let’s just eliminate that one already, shall we?

As mentioned in yesterday’s post, just about whenever we talk about foreign companies getting into any sort of trouble in China, we get emails from readers who accuse us of exaggerating. This comment hints at that by accusing us of unrealized confirmation bias. We do not dispute that as attorneys we get contacted a lot after companies have already had a China problem, but by the same token, most businesspeople do not reveal these sorts of problems openly, so there is a confirmation bias going the other way as well. But be that as it may, all we do here is report on what we see and we see a whole lot of foreign companies get into big trouble in China for not following the law. Does anyone really believe this is not the case?

I really don’t know how to respond to the accusation that I believe people “deserve all the grief” they get because they are “morons.” you morons, other than to say that I do not feel that way at all. I also am not the least bit angry at “being forced to be highly paid to deal with problems.” I love my job and I actually find it more interesting to help extricate companies from problems than helping them prevent them. Anyone who accuses me otherwise on this doesn’t know me.

But enough about me; let’s examine the substantive portion of this comment.

The reader asks “what do you do when you call the labor bureau about your question, and they just shrug and tell you “chabuduo”? First off, we don’t just go to the labor bureau with a question. We go to them with a question and with our own analysis of how we see the answer, based on our extensive legal research. When you go to a Chinese governmental body like this, it is the rare time where they give you no answer at all. And in those rare instances, we analyze the situation and give our client our best recommendation, based on a totality of the circumstances.

The reader also asks what do you do “when there’s one strict, expensive standard for foreign companies and another totally lax standard for local companies?” We have written about this situation many times on here and the answer is that you follow the law. Pretty much every country (and even state and city) favors its locals. If you are a foreigner, that is just a cost of doing business, not an excuse for violating the law unless you are willing to pay the penalties for doing so. We have never said that businesspeople in China have no choice about abiding by the law there. Of course they do. But our job as lawyers is to be clear about what the law is and what the risks are for not following it. If someone wants to take those risks, it is entirely up to them, but they should not shoot the messenger for calling out the risks.

And here’s the thing. The commenter is right that there are plenty of times where a foreign company simply cannot operate profitably in China and abide by its laws. See e.g., Buying A Chinese Company? Why China Deals DON’T Get Done. In those sitautions, we examine the alternatives, which often include things like licensing or distribution or other sorts of contracts/agreements that allow the foreign company to take its product or service or name into China without having to go into China at all. In a recent post, entitled, Uber Couldn’t Make it Alone in China, Why Do You Think You Can? we explicitly discuss how foreign companies are often at a disadvantage in China and we lay out concrete alternatives:

Chinese companies will almost always (though not always) be able to maintain lower cost operations in China than a Western company and so Western companies without other advantages generally don’t succeed in China. For some of the reasons why this is so, check out Buying A Chinese Company? Why China Deals DON’T Get Done. I guess all I am saying is that companies — especially SMEs — should not be so quick to demand “full control” over what they do in China (via a WFOE or a Joint Venture), and should think longer and harder about how they can stick their toes into China via licensing deals and distributorships. See Negotiating with Chinese Companies: Distribution Agreements with no Joint Venture Required.

Our China lawyers get calls all the time from America, Australian, and European companies seeking our help in getting them out of China by extricating them from their joint venture or by helping them close down their WFOE. But I truly cannot remember an instance where we have been called to help a company get out of a well crafted China licensing agreement or China distributor relationship. Of course, the lack of these calls may be due in equal parts to the fact that getting out of a contract — especially one at the end of its duration — is usually a piece of cake, but still.

So yes, we fully realize that operating a foreign company in China is usually very difficult. Our solution to that, however, is not to advocate that people just ignore the laws and risk massive penalties and even jail, but that they figure out how to profit from China in other — fully legal — ways.

Doing Business in China lawyersWe recently wrote two posts (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). Whenever we blog about foreign companies getting into trouble in China, and especially when we write about foreign personnel being detained or held hostage in China, we receive angry emails from readers. These readers always insist that we are exaggerating the problem and that China is pretty much perfectly safe.

These angry readers have a point. They have a point because it is a really small percentage of foreign companies doing business in China that get in big trouble in China and that is because it is a very small percentage of foreign companies doing business in China that do anything that will get them in big trouble in China. The big question I always have though is what percentage of those doing those thing that will get them in big trouble in China end up getting into big trouble in China? That is the percentage I think is much higher than people realize. And I say that because it just seems that a large percentage of companies our law firm turns down as clients because of how they intend to operate in China are eventually forced to leave China.

But enough with the negative. This post is going to focus on the positive. A very experienced China businessperson, Ward Chartier, left the following comment on here the other day:

Based on what I’ve read since repatriating from China and what I observed in the seven years I worked there, many Western businesspeople regard doing business in China as a sort of Wild West, anything goes situation. This is exacerbated by Chinese nationals hired as consultants or general managers saying things like, “If you want to be successful, this is how we do things in this district. No, it doesn’t meet the requirements of the law, but this is how we get things done here.” “But what about auditors from Beijing?” the hapless Westerner asks. “The mountains are high, and the emperor is far away (old Chinese maxim).” the consultant replies.

The media doesn’t help by reporting on malfeasance in China, thus encouraging readers to think that money (bribes) and influence will pave the way towards success and riches doing business in China.

What worked for me was scrupulously following both the law and the local regulations, involving the local government bureaus in any legal and regulatory gray area decisions to gain their input before taking action, and treating Chinese employees absolutely correctly. Doing these things fully avoided very unhappy surprises from the government.

Thank you Ward for advertising exactly how my law firms’ China lawyers conduct their legal work in China and exactly how we advise our China clients to conduct their business in China. Yes, scrupulously following the law in China can at times be difficult and expensive, but it is the ONLY way to achieve long term success there. It also is the only way — at least for most people — to sleep soundly at night.

Oh, and just to follow up a bit on what Mr. Chartier says about advice from locals (or in this case ersatz locals) I strongly urge you to read one of my favorite blog posts of all time, Your Chinese-American VP Don’t Know Diddley ‘Bout China Law And I Have Friggin Had It.

Bottom Line: If you want to succeed in China and avoid legal problems, work with the right people and do things the right way. It is that simple. The foreign company doing business in China that operates this way will virtually never get into trouble in China.

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.

One of the most common questions our China attorneys get asked, is “whether it is safe for me to go to China” or “whether it is safe for me to stay in China.” In light of the very recent and highly covered Crown Resorts detention, we have been getting these questions even more often of late. For more on the Crown Resorts situation, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think and Doing Something China Doesn’t Like? Don’t Go There, and for more on getting held hostage in China, check out China Hostage Situations With a New Twist).

As lawyers, we have to answer both questions pretty much the same way, which is that we have no way to quantify the exact risk of someone being detained by either the Chinese government or by some private Chinese party using (or not using) the Chinese government for the detention, but detentions happen a lot more often in China than widely realized and it would no doubt be safer to wait out your problems from the safety of your home country or from a country near to China but not China.

In the end, the risk assessment will usually be up to you.

China Lawyers for foreign companies doing business in ChinaIt is not uncommon for foreign companies doing business in China to brag about how they have not been forced to comply with a particular Chinese law. Much of the time when our China lawyers hear this sort of thing, our response is that there are many laws in China that are not vigorously enforced until they are. And oftentimes they get enforced at the worst possible moment, like when the foreign company seeks to engage in a new and different transaction or get money out of China, or pay taxes.

I was reminded of this the other day when a friend of mine wrote me the following email, regarding the same sort of thing happening regarding newly enacted requirements for factories in China to export their products:

Are you aware that China Customs has issued a new edict requiring all 加工贸易 companies to provide a renewed 商务証 and that in order to get this they (or some other agency) has specified that we must have current land title, workplace safety certificate, environmental certificate and fire safety certificate? If not, you will be hearing more soon. Most of the factories in China cannot come up with all of these because they are illegal. The s**t has really hit the fan here in ________ over this and the edict is said to apply to the whole of China. It was announced in the last week of August and came into force on 1 September and nobody can open a new customs book 手册 until they can come up with the documents.

I have been in my current factory, which is in an industrial park and owned by the local government (镇), for _______ years and just discovered that although my land title is okay, they actually built ___% of the park over farmland. One consequence of this is that they have never been able to issue a proper fire safety certificate, which actually I never knew I needed because they do regular inspections and sign off on something or other. But the fire hydrants in the factory have never been connected and I never understood the reason until now. They were unwilling to explain the real reason and have just fudged all these years saying that it was going to happen soon. Now the chickens have come home to roost. One of the problems is that, as well as being illegal, the underground reticulation system that feeds into the factory fire fighting systems was substandard because the officials seem to have pocketed much of the budget that was set aside for it, probably in the form of kickbacks from the contractor. So all have dirt on their hands and want to keep this quiet. At this stage it seems they have come up with a fudge-around solution in cooperation with the next level up (区) and so I can probably get the docs I need. I hope so. Anyway typical s**t that we have to deal with here, although this one is a magnitude more serious because without the right to import we are out of business.

The problem in China is that you never know what it is that you do not know until it is too late. The say here that the “water is deep” and that is certainly the case when it comes to the doings of the local authorities.

One of the China stories I love telling is of an American company that retained my law firm many years ago to form a WFOE in a fairly remote part of China. This American company had a Chinese General Manager based in that remote city on whom it relied for pretty much everything. Early on in the WFOE formation process, it became clear that there was a lot of tension between how our China lawyers wanted to form the China WFOE (completely by the book) and how the Chinese General Manager wanted to form the China WFOE (really quickly and without dealing with most of the formalities). So at some point we put it to the American company: either give us full control over how this WFOE formation is going to be done or just fire us. Because having us involved and paying lawyer fees to do this “the Chinese way” (the General Manager’s term, not mine) makes no sense at all. The American company agreed with our assessment and told us that it had to go with its General Manager because without that person it would have no Chinese company. We parted on very amiable terms.

So amiable in fact, that about two years later the owner of the American company wrote me to say that though it had managed to get the WFOE formed really easily and really quickly, Beijing had come in and audited the local government and shut down a bunch of improperly formed WFOEs, including theirs.

Bottom Line: You can fool some of the people some of the time, but eventually, if you are not operating legally in China, there will come a time when you will pay the price for that. The Chinese government has stepped up its law and order efforts and that has meant that time is coming more often these days for foreign companies doing business in China.

China WFOEs and Joint Ventures and JV
China WFOEs and JVs: Still tough navigating

On October 1, China changed its system for government control over foreign investment. The change was accomplished by revising the statutes concerning wholly foreign owned entities (WFOEs), equity joint ventures and contractual joint ventures and by promulgating a new basic regulation governing registration of foreign invested entities (FIEs).

The big change under China’s new system is that government regulation of foreign invested entities will move from a system that requires MOFCOM (China’s Ministry of Commerce) approval to one that will now just require simple registration with MOFCOM. This change will be implemented through the issuance of a National Negative List. For FIEs that are not restricted or regulated under the National Negative List, MOFCOM requires online registration through a national website employing a standard set of documents. This registration will apply to initial formation of the FIE and to most changes in FIE structure, such as changes in management, ownership and registered capital.

The following essential elements of this new system have already been implemented:

  • Final regulations for management of the new registration system were officially promulgated.
  • The national website for online filing became operational.
  • MOFCOM announced that the 2015 version of the already released Catalogue of Foreign Investment will be treated as the National Negative List. The status of the existing negative lists from the Shanghai and other Free Trade Zones is unclear.

All future Foreign Invested Entities (FIEs) formed in China will now follow the following five-step procedure:

Step 1. Obtain name reservation from the local administration of industry and commerce (AIC).

Step 2. If not restricted by the National Negative List, register online with MOFCOM. Provided the registration is accurate and complete, the regulations require MOFCOM to issue a registration notice within three days. Though the new regulations allow for registration with MOFCOM after issuance of the AIC business license, all of the AIC agencies with which we have spoken have told us that they will require MOFCOM registration prior to issuance of the AIC business license.

Step 3. Register your FIE with the local AIC. Since the local AIC may impose special procedures for FIEs, it is not yet known what impact of the change on this step will have overall. The most likely result at the outset is that each district will impose its own rules. Some districts may impose rules to make things easier. And some districts may impose rules that increase the time and documentation effort required at this stage. Though this result would be contrary to the spirit of the new laws, such a result would be consistent with past local government practice in China.

Step 4. Each local AIC will require compliance with other regulatory requirements such as environmental impact statements, building construction safety reports, neighborhood impact reports, energy usage reports, local employment impact reports, reports required for access to local special benefit programs, land usage and price analysis reports, and similar. The list of required studies and reports can get shockingly long and must be determined on a local AIC to local AIC basis. Dealing with these requirements typically requires a major amount of time and effort and expertise in forming a FIE in China.

Step 5. After receipt of a business license, comply with AIC, tax agency, regulatory agency and banking registration procedures. These requirements may be local, provincial or national, depending on the nature of the FIE business. Compliance with all these requirements is required before the FIE can formally begin business. Such compliance typically adds at least a month to the formation process.

Some China attorneys see the change in China’s FIE laws as a move to “open up” China to increased foreign investment. At this point, and for the following reasons, we do not foresee much change:

  • The basic structure of foreign investment does not change. Foreign invested entities are still essentially confined to the former categories of WFOE and Joint Ventures (JVs). Foreigner persons are still prohibited from directly investing in Chinese owned entities. See The China Stock Option Scam.
  • There is no change in the industries open to foreign investment. Many analysts hoped that China’s  new National Negative List would be simple, short and unrestrictive, but it is identical to the current Catalogue of Foreign Investment, which is complex, long and highly restrictive. The vast areas of the Chinese economy that have been off limits to foreign investment remain off limits. There has been no “opening up” and there is no indication that there will be any opening up. What you see now is what you get. See On Doing Investment Research In China As A WFOE. Not Legal.
  • There is no significant reduction in the time required to register a foreign owned entity. The only change in the current registration process is the elimination of MOFCOM approval; registration is still required. This means that the MOFCOM stage of the registration process will, at best, be reduced from one month to three weeks. This is a minimal impact. Under the old system, MOFCOM approval was virtually never a substantial source of WFOE or JV formation delays. The delays nearly always were at steps 4 and 5 described above and the new system has no impact on those two steps. Moreover, under the new system, step 3 (AIC registration) may become an additional source of delay.

So the net effect is that China’s new FIE rules do not provide for any major change in the structure of the PRC system of management of foreign investment. There has been no opening up and the time and effort required to form a FIE is not likely to substantially change.

So what has changed for registering WFOEs and Joint Ventures in China? I will discuss that in my next post.

China copyrightCopyright is an essential part of any substantive IP protection plan in China, but many companies fail to take an extremely important step: registering their copyrights in China. One of the most common misconceptions our China lawyers frequently hear is that copyright registration in China is optional, because you do not have to file anything to have a valid copyright in China.

Like so many China misconceptions, this one has an element of truth to it. As a signatory to the Berne Convention, China has the same basic definition of what is protected under copyright as the 171 other Convention parties: an original creative work that exists in a fixed medium. A “creative work” could be anything from a video game, song, or toy to a database, map, or product design. A songwriter in Nashville, a programmer in Auckland, a furniture designer in Helsinki: all of their creative works are protected by copyright at the time they complete the work in question, and that copyright is just as valid in China as it is in the U.S., New Zealand, and Finland. But there’s a big difference between having a valid copyright in China and having an enforceable copyright in China.

In most situations, the key issue is one of proof. A copyright registration in China is presumptive evidence of ownership, and in some situations it’s the only evidence that is acceptable. Whether you’re trying to take down an infringing video on Youku Tudou or an infringing photograph of your product on Alibaba, have counterfeit dolls seized at Customs, or sue a publisher who is selling your book without permission, a certificate issued by the Copyright Protection Centre of China (CPCC) is the easiest and most efficient way to enforce your rights. And copyright registration is almost always a prerequisite to getting royalty payments from Chinese entities that have licensed copyrighted material.

Meanwhile, if you are trying to prove ownership of a creative work and you don’t have a Chinese copyright registration, it could take weeks or even months – and that assumes a clear, well-documented chain of title. If you’re at the point where you need to enforce a copyright to stop infringement, it’s almost certainly going to be time-sensitive.

China’s copyright registration process is fairly straightforward, and it does not involve substantive examination at the time of registration, but it usually takes a couple months to receive a copyright certificate. In our experience, when our clients have China copyright certificates we usually secure takedowns of infringing materials relatively quickly and easily. But without a copyright certificate, takedowns take considerably longer and sometimes they do not happen at all.

Don’t get caught flat-footed. If you have copyrightable IP that you want to protect in China, register it with the CPCC. Now.

China lawyersAccording to the media, Chinese authorities have detained a number of Australians from Crown Resorts for gambling-related offenses and have launched a criminal investigation into their actions. According to the Australian Financial Review, It appears that 18 Crown Resort staff have been detained, including three Australians, “as other foreign casino operators…scramble to safeguard their China-based staff.” The Crown staff were detained in a series of overnight raids “in an apparent crackdown on illegal marketing by offshore casinos.”

This news is relevant many companies doing business in or with China. I say this because our firm constantly hears from companies that have personnel in China that market some product or service (oftentimes an internet service) from China that is illegal in China. I repeat: many foreign companies have sales people and executives in China who market products or services in China that are illegal in China, with offshore and foreign casinos just one example.

To be clear, we have no knowledge regarding Crown Resort outside what we read in the mainstream media.

There are many things illegal in China (either completely or just for foreign companies) that are widely legal elsewhere, with the following just those that quickly pop into my head:

  • Gambling
  • Certain types of education services
  • Certain types of internet services
  • Certain types of communication services
  • Many publishing services

Many foreign companies get around China’s laws prohibiting their business by operating all or a large portion of their business outside China. But if you have people working for you (either as employees or otherwise) in China or if you are marketing to China, your people may be at risk for getting “detained” in China. I know I am being vague here, but for many reasons that is deliberate, so sorry.

Our China lawyers are constantly being asked to provide legal risk assessments to companies that may be skirting the edge in China (yes I know I am again being vague here). One of their most common questions is “should I go to China.” Our most common answer — by far — is no, because we simply cannot quantify the risks of their getting detained, nor really can anyone. As attorneys, we are going to be extremely cautious because the last thing we want is for us to give carte blanche to someone going to China and then having that person detained.

We tend to be a bit more positive about our clients going to Hong Kong, but even for going there we are not willing to unequivocally say yes. The below is a brief excerpt from one of many memoranda we have written on the issue of going to Hong Kong in the above (vague again, I know) sort of situation:

This memorandum addresses the risks of _Mr. __________’s going to Hong Kong. Our conclusion is that we see __________’s going to Hong Kong as a low risk endeavor.

If _________ were to travel to China, there is a risk his presence would be reported to the police. If this happens, an arrest could occur. Though it is not possible to quantify this risk, the risk is not low. There is always a very slight chance of spillover risk from the PRC to Hong Kong. However it is important to note that to date, the Hong Kong authorities have not cooperated in China’s _______ crackdown and we have not seen anything to indicate that they will. Though we are not prepared to say that Mr. ________’s going to Hong Kong is wholly without risk, we do not believe the Hong Kong authorities are following the situation with _______ in the PRC and we do not believe that they would do anything to _______ in Hong Kong even if they were to become aware of _________’s situation in the PRC. We also do not believe the PRC would seek Hong Kong’s help against someone from a company like _______. So again, we do not see much risk in Mr. _________’s going to Hong Kong at this time.

We often are asked to give similar legal risk assessments for clients involved in legal disputes with Chinese companies and our advice in those situations is usually (but definitely not always) short and simple: it would be better if you can delay going to China until you have resolved your dispute.

The thing that gets to me about all of this though is how so many companies either have no clue about their risks or willfully choose to ignore them. One of our China lawyers loves to tell of how he met an expat bragging in a bar about his China business and when our lawyer told him that what he was doing was flat out illegal, the response was that the Chinese government didn’t care and actually wanted this sort of business in China, the written laws be damned. And everyone else at that table joined in on this sentiment. Just a few years later this person was arrested and convicted and served not insubstantial time in a Chinese prison.

The area where we see this most often and the area where there is far too little concern is taxes. China is cracking down hard on foreign companies that make money from China (especially those foreign companies that have “independent contractors in China) and do not pay their taxes in China. If you want to operate this way, at least recognize your risks and act accordingly. See China’s Tax Authorities are After You, an article I wrote for Forbes Magazine on how China is stepping up its tax collection efforts, especially as against foreign companies with China-based “employees” but no China company. Most foreign companies though are either blissfully unaware of those risks or downplay them.

If you or your company are doing anything remotely marginal in China, step back a minute (really for at least a few hours) and ask yourself whether what you are doing or about to do is really worth it. I know this sounds simple, almost trite, but far too often hard-charging businesspeople fail to ask this question.

I love telling a story about a long-time client and friend. This person’s business empire stretches across at least four continents and his net worth has to be well north of twenty million dollars. Many years ago he mentioned that he would be going to Iraq the next week to finalize the negotiations on some big construction deal. When he told me this, I immediately told him of how I had met a businessperson who went to Iraq and never came back. I basically asked my friend why with the entire world available to him (and with three kids) he was even considering going to Iraq. He poo-pooed my concerns but then called me back the next day to say that he had given my advice more thought and he had cancelled his plans.

I am not telling you to be afraid of the world, nor am I telling you not to take risks. I am just saying that before you jump, familiarize yourself with where you will be landing.

For more on what can happen to you in China legal difficulties there, check out the following:

Bottom Line: Pause and think before you act and pause and think before you go.

What are your thoughts?