Archives: Basics of China Business Law

China compliance ChecklistWith the last quarter of the year approaching and China increasing its scrutiny of foreign businesses operating in China, now seems like the right time to talk about what such businesses (WFOEs, joint ventures, representative offices) should be doing to protect themselves on the compliance front.

Let me start by saying that if you have familiarized yourself with the applicable Chinese laws and your business has done its utmost to comply with those laws, the odds of your company getting into legal hot water in China are low. My firm has helped countless foreign companies deal with China compliance failures, and very rarely have we concluded that our client was singled out for no good reason. Even when our client had done nothing wrong, we could still understand why the Chinese government had initially thought otherwise.

On top of this, the foreign companies we represent have become much savvier in realizing the need to remain in compliance. It has truly been years since any of our clients have excused their non-compliance by claiming that “everyone is doing it.

But what exactly should you be doing now to ensure that you are in compliance with Chinese laws? The following is a basic list.

Corporate Compliance. Are your company’s activities still covered by the scope of business used during registration? If you registered as an import/export company and you now own a factory, you should make some changes. Is your business in a different location from that listed on your business license? That requires a change also. Is the the person listed as your company’s legal representative still with your company and still the person you want in this position? What about the general manager? The supervisor? Have there been any changes to the parent company?

Employment Compliance. China’s employment laws are complicated, localized, and pro-employee. Make sure you have appropriate written employment agreements with ALL of your employees in China, domestic and foreign. Review and update your employee manual (a/k/a Employer Rules and Regulations). Review and update all other employment-related documents, from offer letters to severance agreements and everything in between. Make sure you otherwise stay in compliance: are all of your non-Chinese employees’ work permits and residence permits up-to-date? Have you secured approval from the local labor bureau for any employees under a non-standard working hours system? Have you secured all necessary renewals for such employees? Are you paying into the appropriate social insurance accounts for each employee?

Tax Compliance. It is essential to engage a competent local accounting firm. Your accountant must of course understand Chinese tax law, but they should also have at least a rudimentary understanding of your home country’s tax laws as well. For instance: make sure your transfer pricing is current and accurately reflected in your contracts and that your profit margins are high enough to keep China’s tax authorities at bay.

IP Compliance. We constantly get calls from foreign companies doing business in China that have let their China IP registrations fall into disorder (or never organized their IP in the first place). Even if you registered everything appropriately when you first came to China, have you kept up with newer products/services or brands? Are you registering design patents before you release your products? Are you keeping sufficient evidence of trademark use to fend off a non-use cancellation? Have you properly drafted and registered any trademark license agreements? Are you taking full advantage of the Chinese trademark system?

Contract Compliance. Many foreign companies do business in China in a way that makes it all but impossible for them to enforce their contractual rights. Do you have written agreement with all your major sources and clients? Are you using a lawyer to draft your design/manufacturing/licensing/purchase/etc. agreements? Are these agreements in Chinese? Enforced under Chinese law?

Spend the time now on the above to avoid having to spend a lot more time later.

China lawyersOne common mistake U.S. companies make is failing to understand that patents and trademarks are territorial.* That is, these forms of intellectual property only provide protection in the country in which they were registered. This means that trademarks and patents registered in the United States offer no protection in China. If a U.S. company has not registered its patents and trademarks in China, a Chinese company is free to make use of that intellectual property in manufacturing or selling the product in China. The U.S. owner of the intellectual property will call these products “knock-offs” or infringements, but the manufacture and sale of those items in China and from China is perfectly legal. Though selling those products in the United States will be prohibited, selling them in a jurisdiction where there has been no registration is also perfectly legal. To put this a bit differently, if you register your patents and trademarks in just the United States, a Chinese company will be free to make your products in China and sell them in China and elsewhere around the world.

This then leads to the following situation we often encounter in China. A U.S. manufacturer has its patented and trademarked product made in China under a contract manufacturing arrangement. The U.S. manufacturer does not register its trademark in China. The U.S. manufacturer does not register patents in China. And the U.S. manufacturer does not enter into a formal contract manufacturing agreement with the Chinese factory concerning ownership and use of the intellectual property in the manufactured items. When asked, the U.S. buyer explains that registration/contracts in China are not necessary because the U.S. trademark and patent mean no knock offs can be sold in the U.S. The manufacturer feels perfectly safe.

Then consider what happens. Say the product being manufactured in China is after market auto parts for U.S. automobiles. The Chinese manufacturer is aware that it is not possible to sell knock off parts in the United States. However, the Chinese factory also knows there is a huge market for used U.S. autos and small trucks in S.E. Asia, India, the middle East and Africa. Since the autos are used, the market for after market auto parts at cheap prices is also huge.

So the Chinese factory does the following in China:

  • Registers the trademark and logo of the U.S. entity.
  • Registers the design patents on each of the parts.
  • Registers the trademarks and design patents with Chinese customs.

Then the factory makes the parts using the exact molds and know-how transferred to the factory by the U.S. entity. Though the parts are technically “knock offs,” they are in reality virtually identical to the genuine parts being sold in the U.S. For this reason, the parts sell extremely well in non-U.S. markets. The Chinese factory then builds a major market selling these parts outside the U.S. Since no trademarks or patents are registered in these third-world markets, the sales do not violate any laws.

And because these parts are so good, they also just happen to find their way into the U.S. as well, sometimes using the trademarks, but more often under a different name.

Eventually, the U.S. company finds out about its Chinese factory’s “side door” sales program and instructs the Chinese factory to cease manufacturing “its” auto parts. The Chinese factory refuses, so the U.S. company threatens to move its manufacturing to a different factory in China. The Chinese factory then calmly tells the U.S. company the following: “You cannot switch your manufacturing to another factory in China because we own the trademarks and patents in China (in those situations where the U.S. company has not registered its patents in the U.S. or in China) in China, making manufacturing by anyone else of your products here in China illegal. In addition, if you attempt to export, we will have China customs block those exports from leaving China because they violate our China trademark and patent registrations. If you want to manufacture at all in China, you must continue to use us for that manufacturing.”

U.S. companies and their domestic legal counsel tend to think the only law in the world that counts is U.S. law and that the only market in the world that counts is the U.S. market. That kind of narrow thinking leads to disasters like the one I just described, which our China lawyers see constantly. This kind of result can be avoided by taking seriously Chinese laws and regulations and the reality of world markets.

* This post is focused on U.S. companies not because we believe U.S. companies are the only companies in the world, but because the above sorts of problems are more prevalent among U.S. companies that come to us, as opposed to European or Australian or even Canadian companies. And, perhaps more importantly, these problems are far more prevalent among U.S. lawyers than among lawyers from any other country of which we are aware.

 

China Lawyer
Intentional sharing is fine; unintentional sharing isn’t.

Use your China contract and China’s sophisticated and fair and relatively cheap (yes, those are the right descriptions) to clarify who owns what in China. Who owns your product design? Who owns your software? Who owns your IoT device? Who owns your molds and tooling? Who owns your trademark when you license it out? If you don’t have the appropriate contract in place, the answer will be the Chinese company (not you), way more often than not. Too many times I have had to inform Western companies that they have unknowingly relinquished ownership of XYZ to their Chinese counter-party and now we just need to try to try to limit that damage as much as possible.

We are constantly writing about the need to clarify “ownership” in China but always from the perspective of who we are: China lawyers. Today, while reading Seth Godin’s Blog, I had an aha moment regarding ownership in China. But let me digress just a bit.

I am a huge fan of Seth Godin, such that it would not be an overstatement to say that he has influenced my law firm. I must have read his missive, Small is the New Big, at least twenty times. We even used to post it on our website, we thought it so important. And his overall theme of always always always (no matter what) being truthful to your clients, is yet another constant Godin theme we try to embody. I regularly read Godin’s excellent blog, but more for my own law firm business than for China Law Blog ideas.

But Godin’s post today, entitled, Joint Ownership, is just so China relevant and so clear that I have to quote it:

Before you create intellectual property (a book, a song, a patent, the words on a website, a design) with someone else, agree in writing about who owns what, who can exploit it, what happens to the earnings, who can control its destiny.

This is sometimes an uncomfortable conversation to have, but it’s far worse to have it later, after the thing you’ve created has been shown to have value.

It’s almost impossible to efficiently split a soup dumpling after it’s been cooked…

As someone who spends a huge chunk of his time trying to split the IP soup dumpling after it has been cooked, I vehemently agree. As is true of so much in law, doing it right from inception costs around one tenth as much and is around ten times more likely to succeed than trying to fix things later.

China Due Diligence
China Due Diligence: Sherlock required

Every few months, one of our China lawyers will get an email from a company seeking to buy our due diligence checklist (as though we have just one) for their (usually not described) deal in China. My pat response is usually something like the following:

We don’t have just one due diligence checklist for China because the due diligence we recommend always varies depending on all sorts of factors, including the nature of the deal, the value of the deal, the industry of the parties, and even what we know about the parties before we conduct any due diligence. The location of the parties also can be important.

Though we do use our previous due diligence checklists in formulating due diligence checklists for current deals, we never just re-use an old one for a new deal. For this reason, we are not willing to sell any of our due diligence checklists because the risk of their not working well for you are just too high and we do not want our law firm name in any way attached to what could very well turn out to be inadequate due diligence. Not to mention that I find it nearly impossible to believe that anyone without a huge amount of China legal and business experience could appropriately use a due diligence checklist even if it does perfectly fit the deal.

If you want to see what I mean about how important it is to tailor your due diligence to the China situation at hand, I urge you to read a just completed three part series on China partner due diligence best practices over at the Health Intel Asia Blog. Go here for Part 1, here for Part 2 and here for Part 3. Ben Shobert — a true expert on China senior care — wrote this three part series to set out due diligence “best practices” when dealing “with real estate developers, property management companies, or institutional investors” in the senior care industry.

Ben begins by listing out the following as the most important factors you should consider and then he provides a massive (yet no doubt too general to apply perfectly to your specific situation):

  • Financial ability of the partner to execute.
  • Reputation of the partner.
  • Relationships in the locality where development will take place.
  • Experience in real estate development or investing.
  • Track record in development – residential, mixed use, etc.
  • Track record in developing senior housing.
  • Commitment to senior housing vs. senior housing as a way to acquire land use rights.
  • Dedicated development team.
  • Dedicated senior housing team – familiarity with development and operational issues.
  • Long term investment horizon – commitment to operating senior housing vs. build and sell.
  • Common strategic vision for their involvement in the industry.
  • Experience dealing with foreign partners.

The above is about 15% of the information Ben advocates securing from your China senior care partner> I list it not merely to give you some flavor of how complicated it is to tailor your China due diligence to your specific deal. If you read the remaining half of Ben’s initial post and his two subsequent posts I am sure you will be convinced as to why no off the shelf checklist can be adequate.

For more on what is involved in China due diligence, check out the following.

 

China attorneys
Oh, but it can and it does.

The day before yesterday, I wrote a long post (with a long title), China, The World, Greed, Cognitive Dissonance, The Best and the Brightest, and Why People Seem to Encourage/Almost Enjoy Getting Scammed, on why people are so susceptible to getting scammed. My thesis is that once someone has convinced themselves that the deal is lucrative, they have a hard time convincing themselves that it might be a scam. I concluded that post by promising a part two describing how to avoid getting scammed. This is that part two and it too is going to be quite long, so please bear with me.

The first thing to avoid getting scammed is to have the right attitude, and that means you must question and doubt EVERYTHING. Why would a legitimate Chinese company in Shenzhen contact you for an oil and gas deal when you are just a school teacher in Vermont? And why would an oil and gas company be located in Shenzhen anyway (it’s possible, but not likely)? Why is a Chinese company contacting me out of the blue to make a $3 million purchase of my widgets when there are 3,000 other widget companies and when we’ve never previously made a sale for more than $30,000? How can this Chinese company charge $11 per widget when everyone else is charging at least $22? And after you have compiled your list of questions and doubts, do not pay a penny (other than perhaps to your own investigator) to anyone until you truly have compelling answers to all of your questions.

One of the classic tactics of a scammer when asked tough questions is to give complicated and convoluted answers. And then when you even hint at wanting an answer you can understand, the scammer seeks to paint you as an idiot and/or a bad person for not trusting them. Do not fall for either. Chinese companies spend weeks, sometimes months, conducting due diligence on their potential counter-parties and your doing the same will be viewed by legitimate Chinese companies as a sign of your savvy and your intelligence, not as a sign of any moral failings. As for your being made out to be an idiot, well just remember how you will feel like much more of an idiot after you are scammed than if you prevent a scam. Oh, and if you don’t understand how the business or the deal is going to operate, that, standing alone — fraud or no fraud — is a great reason for you to just walk away.

The second key to not getting scammed when dealing with a China company is to make sure you are actually dealing with a China company. Though our percentage estimates vary, all of the China lawyers in my firm estimate that at least half the time when a Western company is scammed by a “Chinese company,” the company is either not Chinese at all (oftentimes they are from Nigeria) or they are not a company at all because they have never actually registered with the Chinese corporate authorities. This means that just confirming you are dealing with a real registered Chinese company will lower your chances of getting scammed.

In China Due Diligence. The Most Basic Things To Do. I set out the following basics for how you can determine whether you are dealing with a legitimate Chinese company.

The first thing you do is ask the Chinese company to send you a copy of its business license. Do not be afraid to do this. Chinese companies do this all the time. If the Chinese company refuses to send this to you, walk away.

You then have someone fluent in Chinese and with knowledge about Chinese business licenses examine the one that you have been sent.

Our China attorneys typically look for the following:

To determine whether it is real or not. This is done by comparing the information on the business license provided with the corresponding information on the relevant Chinese government website — usually the local State Administration for Industry and Commerce (SAIC). If the business license you have been provided is fake, you walk away.

To see when the company was formed. We like to compare what the real business license says against what we were told (by email or whatever) and also what the Chinese company says on its English language and its Chinese language website. If different years are given in different places, we get suspicious and we ask more questions.

To see where the company is located. We like to compare this against both what we were told (by email or whatever) and also against what the Chinese company says its English language and its Chinese language website. If there are different addresses in different places, we get suspicious and we ask more questions.

To see what the scope of the Chinese business is, as listed on its registration. If the scope is “consulting” and our client thinks it will be ordering five million dollars of widgets from a factory, we get really suspicious. Looking at the scope is a good (though not always fool-proof) way to determine whether you are dealing with a manufacturer or a broker.

To see the amount of registered capital. If the amount is too low, the odds are good that it is not a manufacturer. If the amount is really high, the odds are good that this is a big company. Note that this information is not going to be as commonly listed in the future.

Lastly, you should go visit the Chinese company or send someone you truly trust to do so.

Doing the above is not nearly enough due diligence for big deals, but it is a relatively fast, relatively cheap way to at least get some sense about the Chinese company with which you are thinking of doing business and it oftentimes will be enough to let you know whether or not you even wish to conduct additional due diligence or just walk away.

In China Business Due Diligence, I went into a bit more depth on some of the basics that should be undertaken to prevent fraud, and I listed out the following:

Construct your own fraud scenario. Ask yourself how the Chinese company could have staged everything it has shown you. Did it switch the factory signs before you arrived, so that it looks like it owns the factory, rather than someone else? Did it paint the old machinery to look new? Is the person with whom you are speaking really a PwC accountant, or just someone paid $100 to pose as one? We have encountered fake factories, fake Chinese lawyers, fake documents, fake accountants, fake foreigners, fake owners….

Focus on the operations. Look carefully at the Chinese company’s operations. Why does the company have only 100 boxes in storage when it claims to be selling 5,000 widgets a week? How can the company make 5,000 widgets a week with only enough of x material to make 100 total? Why did the company have a completely different set of employees on the same day and time two weeks apart? It pays to visit two or three (or more) times — a good fraudster can put on a show, but they are unlikely to be able to do it the same way each time. Watch for the subtle differences.

Get the official records yourself. Use your own people to get the Chinese company’s official corporate records from the official Chinese government sources. Though doing this is neither inexpensive nor easy, information gleaned from the official government records can often be helpful. Then compare the official records with the documents the Chinese company gave you. This is key.

Take company-provided introductions with a grain of salt. Speak with your target Chinese company’s vendors, neighbors, employees, and customers, especially those you find on your own. When talking with people to whom your target Chinese company has introduced you, take everything that is said with a grain of salt. It is not difficult for an unscrupulous company to buy someone’s loyalty for the duration of a meeting or a phone call and this sort of thing goes on all the time. And again, do you really know whether these people are as claimed? We love sending our own people to just hang out around the Chinese company for a week or two as it is amazing what they can learn just by watching and by talking with employees and others in the vicinity.

Speak with the Chinese company’s competitors. Competitors with real businesses can and usually will tell you about their competitors, but, of course, any information gleaned this way should be taken with at least a bit of salt as well.

Do not delegate. Use your own trusted network to gather information on your potential Chinese counter-party. If you don’t have such a network, get one. If you can’t get one, don’t do the deal.

Co-blogger, Steve Dickinson, wrote a post, entitled, Three Keys to Spotting a Fraudulent Chinese Company, describing some of the things he looks for to determine the legitimacy of a Chinese companies listed on foreign stock exchanges for investors that have retained Steve because they are concerned about the value of their investment. Steve’s first step in these situations is to determine whether the Chinese entity is an empty shell. If the Chinese entity is an empty shell, then there is no value in China to protect and further analysis of the company is a waste of time. Steve describes this analysis as follows:

I have done this research so many times that I have developed a three step test to determine whether a Chinese company is a fraud. I take a look at the annual or quarterly report of the Chinese company and if it meets these three tests, it is virtually certain to be a complete fraud, with no operations, no assets and no funds in the bank.

The three indicia of fraud are as follows:

1. The company has a large amount of cash in the bank. I often see supposed cash holdings greater than 50% of the company’s annual gross revenues. Interest rates at Chinese banks are very low and legitimate Chinese companies do not usually keep large amounts of their cash in interest bearing bank accounts. Usually the supposed large cash account is accompanied by bogus explanations explaining why the Chinese entity is unable to repatriate the funds to its investors as dividends. Later investigation usually reveals that these funds were never actually deposited in the bank. That is, these large deposit accounts are simply falsified. The odd thing is that auditors will normally verify that the accounts are real. Once the fraud has been exposed, I have asked auditors what they did to verify the account. They usually state that they relied on reports from the management of the company. In China, the only way to verify the authenticity of a bank account is to arrive at the bank unannounced and look at the computer screen while standing BEHIND the counter as the clerk makes an unplanned query. Virtually no bank in China will allow this, which means that audit verifications of Chinese bank accounts are typically of no value.

2. The company reports profit margins in excess of 30%. I often see fake companies report profit margins of 50%. Doing business in China is difficult and I have never seen a legitimate Chinese company with profit margins even approaching this level, not even state owned monopoly companies. These high margins are then the explanation for why the company has so much free cash; they are so profitable they are printing money. The claim is that they have some unique product or some technical monopoly. In my experience, these claims are never true, as just a few minutes of careful thought would reveal.

3. The company is formed as a VIE (variable interest entity) when it is operating in a business sector where foreign investment is not restricted and the VIE structure is not required. A VIE is required only when a foreign invested company intends to operate in a restricted sector such as the Internet. This is why Baidu, Sina, and AliBaba are organized as VIEs. But most Chinese business sectors are open to foreign investment. When a company that operates in manufacturing or retail sales chooses to organize as a VIE, there is typically only one reason: the organizers are planning to commit fraud against the foreign investors.

 

I cannot resist closing out this post by talking about how to avoid getting caught in what I see as perhaps the most common, most insidious scam of all: The China bank switch scam. This is the scam where someone hacks into either your computer or that of your Chinese counter-party and then sends you an invoice (and you actually do owe the money) directing you to make payment to a bank account held by the scammer, not by your Chinese counter-party. In How to Conquer China Payment Scams I discuss this scam in more detail and advocate engaging in the following actions to prevent it from happening to you:

1. Get to know your suppliers who speak English (if you don’t speak Chinese) and get your supplier’s landline phone numbers as that cannot be hacked. Call if you have any concerns.

2. Get your supplier’s bank account information in advance and ask them to refer to “bank account information document” on their invoices, rather than listing out full bank details every time.

3. Ask your suppliers to fax you their invoice and make sure the sending fax number belongs to your supplier’s company.

4. Do a first small wire to confirm the account.

5. Have a special procedure for confirming the company name. Note also “that paying a Chinese company in mainland China is safer for you” than paying them overseas, be it Hong Kong, Taiwan or anywhere else.

6. Have a special procedure for confirming bank account changes. “Follow the same procedure as point 5, but also call several people in the company. They will understand your attitude if you tell them you are worried about the “different bank account scam” — they are also a victim when it happens to their customers.

7. Have an internal procedure for confirming all payments over a certain amount.

Anyone have any additional scam prevention tips? If so, please share them in your comments below.

 

 

China employment lawGone are the days when China allowed pretty much any foreigner to work in China, with or without the proper visa. Foreigners may be employed in China only if all of the following conditions are met:

  1. The candidate is in good health and over the age of 18;
  2. The candidate possesses the skills and work experience required for the job;
  3. The candidate has no criminal record;
  4. The candidate has a specified employer;
  5. The candidate holds a valid passport or any other valid travel document in lieu of passport.

Where we often see foreign companies get into trouble is when they fail to meet applicable local requirements. Like pretty much everything related to employment law in China, the rules for hiring foreigners varies by locale. See China Employment Law: Local and Not So Simple. For example, some municipalities impose an upper limit on the candidate’s age. Beijing, for instance, requires the candidate be less than 60 years old (subject to certain exceptions). Some cities, such as both Shanghai and Beijing, require that foreign candidates have a certain number of years of work experience relevant to the job they will be taking in China.

China companies seeking to legally employ a foreigner generally need to complete the following steps. First, you will need to obtain an employment license with the local labor authorities for the foreign employee and then you will need to apply to the relevant foreign affairs office for a work visa invitation confirmation letter. The employee will then need to take that letter and apply for a work visa at the Chinese embassy in his or her home country. Upon arrival in China, the foreign employee needs to obtain (1) an alien employment permit from the relevant labor bureau and (2) an alien residence permit from the relevant public security department. Note that these permits need to be updated periodically.

A couple of cities recently promulgated new policies to encourage talented foreign citizens to establish permanent residence in China and to streamline the application and renewal process. Beijing issued new policies to attract senior level foreign talents, foreign nationals of Chinese ethnicity returning to China after studying abroad, foreign students, and foreign members of entrepreneur teams. This new program is starting in the Zhongguancun area — a technology hub in Beijing known as “China’s Silicon Valley.” Among other things, the new policies for the first time permit foreign students to do short-term internships in Zhongguancun and allow foreign students enrolled in universities in Beijing to start their own businesses. Certain foreign talents, such as those who are members of an entrepreneur team in Zhongguancun, will be able to obtain long-term residence permits and entry visas.

Now back to the “old” rules. Under the old rules (which are still the rules virtually everywhere in China) require China employers to have written employment contracts with their foreign employees and no matter how many “foreign elements” in that contract, it still must comply with national and local labor laws and requirements. Note that expat compensation packages with the parent company outside China will almost never be deemed a compliant employment contract for China’s labor law purposes. Foreign employees in China are generally entitled to the same benefits and protection as Chinese employees, including vacation and rest time and overtime pay.

I will write more about foreign employees’ benefits in a future post.

China LawyersBecause 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.

Last week, I talked about how we so often get asked by American lawyers to help them enforce a U.S. court judgment in China. I then explained how China pretty much never enforces those judgments.

In response to that post, one of our own international trade lawyers stopped by my office and essentially chewed me out, by posing the following to me: why do you write about how China does not enforce U.S. court judgments without also explaining the various other options companies have for collecting on those judgments?

Good point, and so here goes.

If you have a U.S. judgment against a Chinese company, your inability to enforce it in China does not mean you should just give up. On the contrary, you have a whole host of other options, including the following — all of which are real life examples of how we have been able to collect money owed to our clients by Chinese companies:

  1. Go after the Chinese company’s assets in the United States. Obviously if the Chinese company owns real estate in the United States, it’s pretty easy. But there are also all sorts of non-obvious assets that can be seized, including (my personal favorite) any U.S. trademarks, copyrights or patents held by the Chinese company. You would be surprised at how often it is that Chinese companies own such things. Another non-obvious asset is funds owed or to be owed to the Chinese company by American companies. Just by way of one example, many years ago we seized millions of dollars in funds owed to a Chinese company that passed through a New York bank.
  2. Take your U.S. judgment against the Chinese company to some other country that enforces U.S. judgments. Canada, the United Kingdom, Taiwan and South Korea immediately come to mind. Hong Kong does not semi-automatically enforce U.S. court judgements but it does give them a lot of weight.
  3. Sue the Chinese company in China. Chinese courts used to mostly reject such lawsuits but that is rapidly changing.
  4. Make the Chinese company’s life so miserable that it eventually pays. You can threaten to go after the company owner’s assets in the United States or elsewhere. You can threaten to do whatever you can to prevent the company owners from ever setting foot in the United States. You can threaten to do whatever you can to publicize the non-payment. In certain situations, these sorts of things can be incredibly effective.
  5. Sometimes the U.S. company has multiple contracts with the Chinese company that owes the U.S company money and sometimes one of those contracts provides for disputes to be resolved via arbitration, not litigation. And sometimes you can bootstrap your claim onto that one contract and get an arbitration award, which has a much better chance of being enforced (once converted to a Chinese court judgment) in China than a U.S. court judgment.

So, in other words, just because you may not be able to take your U.S. court judgment to China and enforce it there, does not mean you should not be looking at all sorts of other options to collect.

China LawyersLet me start with the following two propositions:

  1. I have zero inside information about Uber in China and about all I know about Uber’s business anywhere is that I love Uber and use it all around the world and I order my lunch from Uber Eats probably twice a week.
  2. I think Uber did the absolute right thing by selling most of its China operations to Didi. I base this less on what I know about Uber’s business and more on what I know about doing business in China.

The Washington Post, in its article, Why Didi Chuxing is buying Uber in China, has this to say about the deal:

Didi Chuxing, Uber’s archrival in China and the largest ride-hailing service in the country, is buying Uber’s China operations.

The deal has a lot of advantages for Uber, which is privately valued at $68 billion. The San Francisco company will receive a $1 billion investment from Didi, according to individuals familiar with the agreement. Uber, which will maintain its brand in China under Didi’s ownership, will receive a 17.7 percent stake in Didi, according to a press release sent from Didi. The terms are evidence that Uber put up a strong fight and that both sides had a lot to gain from a partnership.

It then gives us the obligatory company quotes about how the two companies working together will be able to achieve so much more than had they remained apart and how their deal will set the “mobile transportation industry on a healthier, more sustainable path of growth at a higher level.”

Yada, yada, yada.

Many years ago, I spoke at a high level conference in Hong Kong for a particular industry. My talk was on what these companies needed to do from a strictly legal perspective to get into China. I talked about the logistics of going into China as a joint venture, as a WFOE, and by staying outside of China and simply licensing their brand names and technology to Chinese companies. I was originally supposed to speak for around 45 minutes and I prepared my talk accordingly. But about an hour before my talk, the organizer asked me to do whatever I could to “stretch it out to 75 minutes” because one of the speakers scheduled for later that day had fallen ill. I had no problem agreeing as I speak without notes and always adjust the length as I go by adding or subtracting examples or by riffing more or less on a point.

So this day I would obviously need to riff more and I did. Oh how I did. Whoops.

At one point, I started riffing on the differences between joint ventures that work and those that don’t and on how joint ventures tend to fail as soon as the Chinese side believes it no longer needs the foreign side. Then after I said that, I decided I would use this particular industry as an example and as I started doing that I starting musing out loud on how I did not understand what it was that Western companies in this industry had to offer Chinese companies and that when I had asked Western companies what would allow them to to outcompete their Chinese competitors, their answers were vague at best.

This did not make the audience very happy at all, and after my talk a handful of participants rushed me to give me the same weak explanations I had already heard — all given with near religious zeal. As far as I know, no Western company has succeeded in this industry in China yet and it is looking like one never will.

Why do I bring up event in this post? Because 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.

Is this what happened with Uber?

Uber founder Travis Kalanick pursued the China market fiercely, and has made dominance in China a top priority. He visits the country frequently — attempting to woo everyone from local government officials to city police forces, which had cracked down on ride-hailing services (China legalized ride-hailing services in July). His first call in the morning was to his colleagues in China, the individuals said. The company entered the China market in 2014.

But the battle with Didi was costing both companies huge sums of money. Uber reportedly spent $1 billion last year. In China, they were neck-in-neck in a race to the bottom, frequently lowering their prices to lure consumers and constantly raising money to outdo the other. In the end, neither company was profitable in China.

At some point, it looks as if reality set in.

If true, Uber’s sale was both brilliant and timely. Uber gets a stake in China’s ride hailing service without taking on massive risk. Equally importantly, Uber gets to contribute and profit from its core expertise, without having to so much get into the muck:

Selling itself to Didi was a way for the company to stay competitive in China without burning through its cash. The merger will tie the fates of the two companies, both of which have global ambitions, together. As part of the deal, Baidu and other Chinese shareholders of Uber will also receive a 2.3% economic interest in Didi Chuxing. Under the agreement, Didi Chuxing will also obtain a minority equity interest in Uber. Cheng Wei, founder and chairman of Didi Chuxing, will join the board of Uber. Kalanick will join the board of Didi Chuxing.

One big benefit Didi may get from the deal are software algorithms that Uber has developed. For far longer than the four-year-old Didi, Uber has invested in hiring data scientists and engineers who write code to match drivers with passengers, essentially triangulating people’s locations in real-time and then predicting supply and demand. Top talent in data science is still hard to come by, said Didi Vice President Stephen Zhu, in a recent interview with The Washington Post. To help identify and recruit talent, the company announced a $100,000 prize in machine learning — a branch of computer science associated with artificial intelligence, prediction, and data mining — in the U.S. earlier this year.

In the long term, Didi’s success will depend on its artificial intelligence algorithms, Zhu said. “Every user and driver have their own preferences and patterns — and we have to match them all in a second,”he said. “The core is artificial intelligence, in essence, the pattern of how people move around in big cities.”

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.

Just something to consider….

Money from ChinaOver the last year or so, China has made it much harder to get money out of China for pretty much anything. Because of this, our China lawyers get a steady stream of calls and emails from people who want us — oftentimes via a ten minute phone call — to tell them what they can do to move money from China.

No way.

The problem is that as lawyers the last thing we want to do is give people advice that will get money seized or — even worse — put people in jail. And giving someone advice on moving money internationally via a five minute phone call is just far too risky. For us to be able to give money moving advice, we need to gather up all the relevant facts and conduct legal research, oftentimes of the laws of both China and of the country in which the funds are going to be sent.

What so many people fail to realize is that many countries (the US and many European countries, for example), make it illegal to take in money via methods that violate laws of the foreign country. What is the jail risk for someone who does this? Who knows? How do these people often get caught? When one government starts investigating the sender and then all hell breaks loose.

I can tell you that the FBI on more than one occasion has come to our office to ask about our clients. As lawyers, we assert the privilege, but on one occasion, the FBI came to our office at the request of the Russian government to ask 1) how much a particular client had paid us and 2) whether we knew were our client had secured the funds. Our client — truly one of the best and most honest people I know — authorized us to give answers to the FBI and we did. It turned out that our client’s legal fees were being funded via a bankruptcy trustee and the Russians just wanted to make sure that our client was actually paying us, rather than using the funds to purchase oceanfront property in Cyprus, or something similar. So we turned over our invoices to the FBI and all was then good with the world. Just shows you though that these things can and do happen. And more often than you think.

I thought about this the other day because an American company called us after having received a large sum of money from China and then realizing that those funds were very likely highly tainted — yes I am being intentionally vague here. I spent all of five minutes with him insisting that what he needed at this point was a white collar criminal lawyer who deals with international money transfers, and nobody in my firm fits that bill. Having already received the money, I realized that he had the following issues, at minimum, needing resolution:

  • Had his company received the money illegally? If no, end of research.
  • If his company received the money illegally, should it send it back to China, as he was proposing to me he wanted to do? If you rob a bank and then return the money, you are still criminally liable for having robbed the bank, though returning the money may lessen your sentence. Would it be the same way here?
  • If his company returns the money, should he alert Federal criminal law enforcement of having received it and returned it? Many years ago, a client came to us after having realized that it had failed to report a transaction with North Korea. We brought on a Federal white collar criminal law attorney and working together our advice was to report the transaction to the appropriate federal government agency. Our client did so and nothing more ever happened. In this instance, we determined it would be far better to report than to get caught and not having reported. Is it the same thing here?

I kept stressing to the recent caller that he had done the right thing by caller and that far too many people do crazy things, knowing in their hearts that something is wrong but so much wanting to believe otherwise, and then burying their heads in the sand, rather than confronting the issues head on. We hear of those sorts of things all the time. At least once a year we will get a call from someone who has not been paid for products they sold to China and our first response is: you sold what to China? Is that even legal? Same sort of thing.

So what should you do when you are looking at a transaction with China and your gut is telling you something may be wrong? As a huge fan of the book Blink, by Malcolm Gladwell, I am convinced that gut instincts are right more often than generally credited. I certainly believe this true when one’s gut is saying, “maybe I shouldn’t take this money.”

Bottom Line: If you are looking to get money from China and your heart just isn’t into it, our advice is to either walk away or conduct the research necessary to confirm that what you plan to do is legal. An opinion from a lawyer can be worth its weight in gold in these situations, even if your lawyer turns out to be wrong. Would you rather go in front of jury and say, “whoops, I didn’t care enough to check on this, please forgive me” or “I hired the best, most knowledgable law firm I could find to help me determine whether this was legal or not, and as you can see from this memorandum from that firm, they told me it was.”

UPDATE: A loyal reader emailed us a Wall Street Journal article, US Prosecutors Probe ‘Panama Papers’ Law Firm Employees, and muses how this is not going to be good for the clients of this law firm and of how he thinks spin-offs of this one law firm will be facing similar investigations shortly. Good points.

China LawyersBecause 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 questions we often get — usually from American lawyers — is whether our firm might be interested in helping them enforce a U.S. court judgment in China. To explain the typical situation that compels such a question, I will use the below exaggerated and partially fictional email composite.

American Lawyer: After more than a year and billings of more than $50,000, we just secured a default judgment against XYZ China company in XYZ County Superior Court in Iowa –not sure why but we get a truly disproportionate number of these from Iowa. We got Hague service of process on the Chinese company (that is a long story too) and so we are now ready to take this judgment and enforce it in China and collect what we are owed. The judgment is for $3,239,987.44. It’s for a kid who was badly injured by a Chinese manufactured lighter. We would expect you to take this on a contingency fee and we are wondering how long you expect this will take and what the out of pocket costs will be.

Our typical answer: Sorry, we would not be interested in this case even for a 150% contingency fee. China does not enforce U.S. court judgments. It just doesn’t. And to the extent this is even possible, it is even less likely to enforce a default judgment for a tort. What we can do is charge you hourly to try to figure out if you have other collection options (maybe seizing payments made to this Chinese company or its assets in the United States or in some other country (Hong Kong, Taiwan, Canada, or South Korea can sometimes work) that actually gives some recognition to U.S. court judgments.