Archives: Basics of China Business Law

Negotiating with Chinese companiesThis is the third in a series of posts in response to emails and comments asking us to expound upon how Western companies can better negotiate with Chinese companies on technology deals.

In part one, Negotiating With Chinese Companies: Be The Rabbit, we talked about using the Zen technique of “being the rabbit,” which in Western terms translates mostly into just being patient, hanging back and letting the Chinese side start negotiating with itself. In part two, Negotiating With Chinese Companies: Walk, Don’t Look Back, we talked about how Western companies must 1) convey a willingness to walk away from the deal and 2) actually be willing to walk away from the deal. In this third part, we again emphasize the need to patient, this time when facing the common Chinese company negotiating “death by a thousand cuts” tactic.

Chinese companies, both SOEs and privately held, are in a mad dash to purchase foreign technologies on the cheap. And when I say technologies, I mean just about every technology possible: health care, internet, Internet of Things, computer hardware, software, manufacturing. It is truly endless. I feel like I am in the middle of a gold rush. A severely flawed gold rush.

What are the flaws?

The biggest flaw is that the default option for these Chinese companies is usually to try to get the technology for literally nothing or next to nothing. And far too often, the foreign company goes along with this.

Let me explain.

The media covers the massive China tech deals. Deals like Midea Group’s $5 billion bid for Germany’s robotics specialist Kuka AG. Those are not the deals my firm is seeing. Not at all. The deals we are seeing involve — at least half the time — second and third tier technologies held by foreign companies on an economic precipice. The China company swoops in and offers a lot of money for the technology. The foreign company then retains us and we then explain why what looks like such a good deal is, in reality a terrible deal. The foreign company then tells us (and far too often the Chinese side) how if it doesn’t make this deal it may have to “downsize” or even shut down. Some of these companies are quite large and quite well known, but their ability to secure additional funding is marginal.

And then over the next few months the two sides negotiate and during that time the Western side reveals — either intentionally or unintentionally, its desperation to get the deal done. And during that time, the Chinese side constantly and unremittingly seeks to exploit that desperation, using the following tactics.

Death by a thousand cuts. The Chinese company starts out saying it will pay $20 million for the technology, as though that is the extent of the deal. Then it drafts some vaguely worded MOU that mentions $20 million in passing, but is nothing like a straight up deal and when analyzed either makes no sense, is clearly not achievable under Chinese law, or will almost certainly lead to the Western company never getting paid. When the Western company complains about this, the response of the Chinese company is usually to go silent for a few weeks and then to suggest to the Western company that it modify the  nonsensical/unworkable MOU. Our advice is to seize that moment by presenting a carefully drafted and realistic Chinese and English language contract that actually reflects the parties’ earlier discussions. The Chinese company usually will wait a few weeks and then respond with a reasonable number of objections to the contract. The foreign company and the Chinese company negotiate on these issues and reach resolution. The foreign company quite naturally then assumes that the negotiation process is complete and expects the next steps will be to execute and then implement the contract.

Instead, the Chinese company puts forth a brand new set of contract objections. The parties again negotiate and again reach resolution. The foreign company again assumes that the next steps will be to execute and implement the contract. But the Chinese company returns yet again with a new list of contract objections, including objections to some of the matters already decided on in the previous rounds of negotiation.

If the Chinese side has been forced to concede on important matters, this death by a thousand cuts tactic will likely continue until the Chinese side gets most of what it wanted from the beginning.

In negotiating the initial objections from the Chinese side, the foreign side will usually have made concessions that weakened its position, all as part of the normal negotiating give and take and all done on the assumption that both sides would be making concessions to consummate the deal. However, when the Chinese company comes back with new demands, it has already extracted concessions from the foreign side and it is now seeking additional concessions.

The Chinese company engages in this tactic to wear down the foreign company to that point that it concedes on important points to get the deal done. The Chinese negotiators are often quite clever at mixing important issues together with trivial issues and hiding important changes with seemingly minor changes in wording. Fatigue and changing negotiation staff from the foreign side can allow these matters to slip through at the very end of the negotiation process.

In the last year or so, we are seeing a new tactic, where the Chinese company will send back a revised contract in just badly written English, and without any redlining that would allow us to quickly see the changes that have been made to it. This new tactic has all of a sudden become quite common and it is an ideal way for the Chinese side to throw yet another cog into the negotiations, especially since Chinese is usually the official language of the contract and especially since their written English is almost never clear enough so that we can understand everything and it is virtually never clear enough so that we can use it in a real contract. When this happens, our typical response is to say, “no.” If you don’t have the time or the ability to put it into two languages, send us just the Chinese and send us a redline version showing all of your changes. We are not going to charge our clients lawyer rates trying to parse out what you have given us.

You can usually avoid the death by a thousand cuts tactic by being firm with the Chinese side. One good counter-tactic is to make clear (preferably in writing and in Chinese) that your Chinese counter-party has only one chance to comment so it should make sure that all of its comments and objections are included in its first communication. The Chinese side typically ignores this rule and will still come up with additional comments even after having been told that they will be ignored. The way to deal with this is to live up to your own commitment by telling the Chinese side to “take it or leave it.”

More to come….

Barcelona Law Office
In basketball too, the center has become less important.

During the first years of this blog (mostly from 2006 to 2010) we wrote often about the power dynamic between Beijing and China’s provinces and we also wrote constantly about China’s second tier cities. Since 2010, and especially in the last few years, we barely touch upon these subjects. What has changed? A lot.

In our early days, we were big believers in foreign investment going into China’s second tier cities and we were also witnessing China devolving power to its provinces. Back then, when people would ask us in what cities we did most of our work, we would usually estimate about 30% n Shanghai, 20% in Beijing, and the other half throughout China (but mostly in Shenzhen, Guangzhou, Xi’an, Nanjing, Tianjin, Xiamen, Qingdao, Dalian, Suzhou, Chongqing and Chengdu). Now, our answer would be more like 30% Shenzhen (China’s technology and Internet of Things center), 30% Beijing (China’s software and media center), 30% Shanghai (China’s center for corporate locations) and maybe 10% “other.” When I ask other China lawyers outside my firm about the geography of their China legal work, they report much the same.

So it is now mostly Beijing and Shanghai and Shenzhen, but really only Shanghai and Beijing are true “centers” in the sense that it is almost exclusively in those two cities where one will find the best lawyers and the best accountants and the judges and the best consultants and the best. . . . Shenzhen is mostly for manufacturing, not services. If a client of our firm seeks a recommendation for high level assistance, we virtually always refer them to someone in Shanghai (if they are located there or nearby) or in Beijing (if they are located there or nearby or maybe not so nearby.

And when it comes to government, Beijing is obviously the lead city, and that is truer today than five years ago. There was a period where Beijing was increasing the authority of jurisdictions outside the capital, but in the last few years — at least with respect to the sort of China legal work in which our firm gets involved — we are seeing authority shift back to Beijing. I thought about that today after reading a Guardian article, entitled, China punishes officials over sewage in first environmental case of its kind. This article highlights how Beijing is more strongly enforcing its laws/positions as against the provinces:

Chinese prosecutors have successfully sued a county environmental agency for inadequately punishing a sewage firm that produced dye without appropriate safeguards – the first such public interest case against a government department.

The Supreme People’s Procuratorate, China’s top prosecutor, said prosecutors had successfully proved that an environmental protection department in Shandong province had committed “illegal acts” in its dealings with the Qingshun Chemical Technology Company.

I have little doubt that this lawsuit was driven by Beijing or, at the very minimum, approved from there. It very much reminds me of what we have been seeing on the WFOE front for the last few years. What we are seeing is an increase in WFOEs being shut down after audits from Beijing reveal that they should never have been registered in the first place. We are learning about these via calls and emails from some of the companies that years ago chose not to use our law firm for their WFOE formations because we told them that what they were proposing for their WFOE would not work. In pretty much every one of these cases, the foreign company assured us that the Chinese company which with they were working had the “power” to get their WFOE approved, to which our response was and still is always: “great, then you should use them for the WFOE formation. But just as a warning, just because a WFOE gets formed does not mean it cannot and will not be shut down when Beijing or a new government sees that it should never have been formed in the first place.

A couple months ago, my firm opened an office in Barcelona, headed up by Nadja Vietz, who joined our firm (in Seattle) way back in 2004. Nadja is licensed to practice law in Spain, Germany and the United States (Washington State) and she oversees a Spain lawyer and a Spain business professional. Truth be told, we chose Barcelona as our European beachhead not after having analyzed a slew of other city options, but simply because Nadja had chosen to live there. But ex post facto, I have come to realize that it may just be the perfect city for us. It is well-located as within Europe, it is moderately priced (at least as compared to London or Brussels or Paris or Luxembourg or even Munich) and it is incredibly international.

I mention Barcelona because before we opened an office there and before I started communicating so often with all sorts of professionals there, I failed to realize how seriously Catalonians view their independence. I was under the mistaken impression that Catalonia’s professional class would uniformly oppose independence for economic and business reasons, but whenever I broach the subject of an independent Catalonia, one of the first arguments I hear in favor of it is the economic/business one.

England is obviously facing similar issues right now regarding Brexit. And I have to confess that after having read dozens of articles predicting either financial ruin or a financial renaissance should Britain leave the EU, I am of the view that nobody really knows and that either way the impact will likely be far less than predicted.  I am fairly certain of one thing though and that is that whether Britain stays or goes, Brussels’ power over its provinces (the EU countries) will probably never reach a level greater than today and will almost certainly decline.

So I just find it interesting that just as so much of the world is seeing power in the center being questioned and/or weakened, China seems to be moving in the opposite direction.

What are your thoughts about that?

 

 

China lawyers

Our China lawyers have seen a spike in queries from foreign companies encountering problems getting paid by Chinese companies. I’m talking mostly about private Chinese companies without affiliates or assets abroad. This is the first post in a series I will be writing on the new issues in getting money out of China.

An excuse commonly offered to the foreigner by the Chinese company is that the rules have recently changed so foreign payments are no longer possible or practicable. Another one is that the Chinese company is simply not allowed to send more that $50,000 at a time or even $50,000 in total each year. Is there any truth in this?

The underlying regulations have not changed and there is no limit on the amount that can be remitted abroad by a compliant Chinese company. But Chinese banks are becoming much stricter with certain types of remittances. This new strictness has come about in an effort to limit fraudulent capital outflows and to make sure tax is paid in China before money leaves the country.

Chinese law generally requires a Chinese company to obtain a “tax certificate” from its local tax bureau before more than $50,000 worth of RMB can be converted into a foreign currency and remitted abroad. As the name might suggest, the certificate confirms that the Chinese company has made all necessary tax payments on the money or has some kind of exemption for the money. To obtain the certificate the Chinese company needs to submit copies of the relevant contracts (and oftentimes invoices) and provide particulars of the transaction. The tax certificate must be presented to the foreign exchange bank before the payment transaction occurs.

The regulations provide for a blanket $50,000 exemption from approval. No proof or justification is required, up to the $50,000 limit. However, in June of last year, Chinese banks began arbitrarily denying requests for RMB conversion of amounts below the $50,000 limit.

Sometimes, the real problem, especially with larger remittances, is simply that the Chinese company can’t get a tax certificate, or doesn’t want to get a tax certificate, because that would require it to pay tax it wasn’t planning on paying. To be fair, problems sometimes arise when the Chinese company genuinely wants to make a remittance and is prepared to pay the applicable taxes. These problems vary depending on the type of payment. They mostly affect payments for services, royalty payments and Foreign FDI or M&A payments. Payments for the purchase of goods are generally not as complicated, so long as the foreign side has its own paperwork in order as well.

In my next post I will look at the delays and complications affecting different types of payments.

 

China Lawyers Because 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.

The below is a compilation of a fairly common email we are getting with increasing frequency as China expands its consumer sector.

My company entered into an exclusive distribution agreement with a Chinese company for it to sell our product in China and then the Chinese company did not do a single thing to try to sell our product in China. Why did it waste its own time on the contract?

Our answer is usually something like this:

The Chinese company did not waste its time on the contract as it no doubt got exactly what it wanted from the contract, which was to prevent anyone else from selling your product in China. I am guessing that this company already makes or sells a product that competes with yours and by contracting with you for the exclusive right to sell your product in China (and then doing nothing), it has effectively shut you out of the China market for however many years it has that exclusivity — assuming you do not have appropriate provisions in the contract that allow you to terminate due to the Chinese company’s inaction.

Unfortunately, we see this a lot.

China trademarks
China trademarks are worth way more than their weight in gold.

I spend a huge portion of my waking hours talking to companies doing business in China or looking to do business in or with China. One of the things I virtually always try to discuss with all potential and actual clients at least once (and usually during our first conversation) is the need for them to protect their IP in China. Maybe one out of fifty of our clients has no IP to protect, but the rest do and it is surprising how many of them do not realize the need for them to do so when dealing with China.

Above of all else, I talk about the importance of filing for trademarks in China and how if you don’t get your trade names and logos registered as trademarks in China, someone else eventually will and then you will be facing all kinds of trouble. And then I talk about the trouble. That is nearly always enough to convince Western companies of the need for a China trademark.

But the other day I was talking with a very young, super-smart owner of a start up tech company and after I recited my “trouble speech” on China trademarks, he asked me why trademarks are important. As he put it, “I understand that someone else could end up with our trademark in China, but why are trademarks so valuable in the first place?

“Great question,” I responded and then asked him what kind of car he drives. He said BMW (I was all but counting on this) and then I proceeded to ask him if he knows or even cares how many patents BMW has on the car he drives and of course he did not. I then asked him what then made his BMW distinctive enough that he would buy that car over, let’s say a Honda. His response was that he knows BMW makes great cars. I then explained that he knows BMW makes great cars and he knows his car is a BMW because it is the only car company in the United States (and in China too, I presume) that can brand its cars “BMW.”

Fortunately, he seemed satisfied with my answer. But, really, what makes a trademark so potentially valuable? Some or all of the following:

  • Your trademark can give your business its identity.
  • Your trademark can give your goods or services brand recognition.
  • Your trademark distinguishes your goods or services from others in the marketplace.
  • Your trademark can be used to stop others from using (infringing on) your name or your logo.
  • Your trademark can be used to show that you own a particular name or logo.
  • You can license or sell your trademark.

Did I miss anything?

China contractWhen my law firm writes contracts for our American and European clients doing business in China or with China, we write the contracts in both Chinese and in English. We do not translate these contracts into Chinese. Let me explain this distinction because it is a very important one.

We price many of the more routine China contracts on a flat fee basis, and that fee includes our drafting the contract in English for our client’s review, and then putting that same contract into Chinese, as its official language. But every so often, one of our clients will ask what we would charge if we were to draft the contract in “just English” and allow the client’s “fluent Chinese” speaker to translate it into Chinese. I usually respond by joking that we not only do not give any reduction, we actually increase the fee by $5000 to help cover our increased risk of a legal malpractice lawsuit. I then tell them that in reality we simply cannot agree to anyone outside our firm drafting the Chinese version.

Why do I say this?

Because every word matters in a contract and this is as true in Chinese as it is in any language. Words have very particularized meanings in contracts and those meanings are sometimes different in a contract than in real life. Contracts also have terms that have become recognized and defined over time. The only people who can truly know how to use these specialized and particular words and terms are lawyers who know both China’s contract laws and who are completely fluent in written and spoken Chinese. On top of this, it is critical that the Chinese version explicitly reflect our client’s goals. To put it another way, we pretty much never see a “translated” contract that works as intended.

We draft our Chinese language contracts in Chinese so that they can be understood by our client’s Chinese counter-party and so that if there is ever a dispute and our client finds itself before a judge or an arbitrator in China, that judge or arbitrator also can understand the Chinese language contract in the context of Chinese law.

China LawyersWe got a whole new look today. For two reasons. One, we needed to change to look better on mobile devices, which is where about half of you now read us these days. And two, because it was simply about time.

We tried for a new look that at least has a nod to our old look. Do you like it. It was designed by our good friends over at LexBlog.

If the stars had aligned, our new look would be coming out on our tenth anniversary, but that day passed on January 4, with nary a mention — I forgot! Continue Reading Do You Like Our New Look, Ten Years On?

China employee probationChina’s labor laws allow employers to set a probation period for an employee to see if the employee works out for the company. Before the probation period ends, if the employer can prove that the employee does not meet its recruitment requirements, the employer can unilaterally terminate the employee without having to pay statutory severance. However, to prevent the employer from abusing such probation periods, Chinese law makes clear that the employer may set only one probation period for the same employee and it imposes a limitation on how long the probation may be. The rule on the maximum length of the probation period is not very complicated and can be found here. Nonetheless, if you don’t set it right, things can get complicated and messy fast and you may find yourself at risk. We have reviewed many offer letters and employment contracts that provide for a term of probation period that does not comply with China’s employee probation laws.

As noted before, the employer is permitted to unilaterally terminate employees that do not satisfy the conditions of employment during the probation period without having to pay severance. Now consider this: an employer sets a probation period longer than the statutory maximum, and before the term of probation period ends (but after the statutory maximum period has passed), it decides to terminate the employee because the employee failed to meet the conditions of employment. Can the employer legally do that? Probably not, because the remaining probation period is no longer considered a probation period under China’s labor laws, and the employee is thus no longer on probation and this specific ground for termination no longer exists. Can the employer still terminate the employee? It depends on the circumstances AND on the jurisdiction. Among other things, it depends on whether a permissible ground exists that justifies the termination and if the employer is able to prove it.

Another big issue is compensation. Suppose that the employer sets a probation period longer than the statutory maximum and the employment contract provides a basic salary during the probation period and a higher salary after that period. The employee continues to work after he or she has completed the probation period. Because the probation period in the employment contract does not comply with China’s employee probation laws, the employer will owe the employee the wage difference for the period between the statutory maximum and the probation period specified in the contract. In addition, the employer could also face an administrative penalty from the labor authorities.

If your specified probation period is longer than the statutory maximum, your company may also be at risk when it seeks to extend this period. For starters, even where the agreed-upon probation period is within the legal limit, the extension of such probation period may be illegal in your location. Furthermore, you may be exposing your company to additional risks if you extend a probation period that already violates the law.

And oh, just because the employee is on probation (and you don’t know if the employee is going to work out) does not mean you can wait until the employee passes the evaluation/performance review to enter into a written employment contract with him or her. For more on the importance of having a current written employment contract, see here.

Bottom line: Make sure your employment contracts comply Chinese law and it is better to do this before it is executed rather than after. All of the examples we gave above were based on China employment matters I handled, usually in a crisis, and usually at a cost way more than we would have charged had the company sought our employment law assistance at the very beginning.

China Manufacturing Contracts Interesting article in today’s Wall Street Journal by Mark Magnier, entitled, How China Is Changing Its Manufacturing Strategy. The article deals with how China cost increases are slowly eroding its low end manufacturing base and how the Chinese government is seeking to replace that with higher end manufacturing. Not much new with this, but the article does a terrific job explaining how this is happening and even not happening in China, including with the following numbers:

  1. “China doesn’t release data on factory closings or relocations. But according to an analysis by researcher Justina Yung of Hong Kong Polytechnic University for the Federation of Hong Kong Industries trade group, the number of factories owned by Hong Kong companies in the Pearl River Delta near Hong Kong fell by a third to 32,000 in 2013 from a 2006 peak. Many of those that left moved to lower-wage countries.”
  2. “Labor costs in China have grown faster than consumer inflation for years, according to consultancy BMI Research, and are currently nearly four times those in Bangladesh, Laos, Cambodia and Myanmar.”

The article also notes how “China has managed to hold on to low-end industry far longer than its Asian neighbors at a similar stage of development,” thanks in large part to “government incentives, subsidies, the large domestic market and good infrastructure that encourage companies to remain onshore.”

The article also discusses how China’s slow move away from low-end manufacturing is costing jobs and it ends with the following quote from a Sina Weibo user: “Low-end manufacturing goes to Southeast Asia while high-end industries go back to North America and Europe. We migrant workers can’t find jobs.”

With graphs, the article shows how some of China’s apparel and shoe manufacturing has moved elsewhere in Asia, but again, not that much.

Our China lawyers have been seeing the following:

  • Many manufacturing companies in China have always been owned by companies out of Taiwan and Hong Kong.
  • We are getting far fewer new clients going to China to have their apparel, shoes or rubber ducky type toys manufactured in China.
  • We are getting far more new clients going to China to have far more sophisticated products manufactured in China.
  • A much higher percentage of the sophisticated China manufacturers seem to be owned by Hong Kong and Taiwan companies than was the case with the apparel and shoe companies of years past. This is particularly true of the (mostly Shenzhen) Chinese companies involved in manufacturing internet of things products.

What we China lawyer geeks find so fascinating about these shifts in China manufacturing is how much they have complicated the legal and IP issues both on the high and on the low end. On the high end, we have to deal with complicated quality issues and issues revolving around who owns what when it comes to the IP. When manufacturing socks, IP is not that big a deal and certainly not terribly complicated. But when manufacturing a product with hundreds of components that has been jointly developed (or at least refined for manufacturing) by both the Chinese manufacturer and our client, the IP issues can seem nearly infinite. For more on this, check out China and The Internet of Things: Who Owns What?

But surprisingly enough, we are also finding that low end manufacturing is getting more complicated as well. Take socks as the example. Ten years ago, we drafted a relatively simple manufacturing agreement between our client and the Chinese manufacturer and that was that. That agreement would make clear that the Chinese company and its factory were not to manufacture or sell the same socks to anyone else and that the quality had to meet XYZ standards and if it didn’t, then ____ would happen. But now what we are seeing a lot more often is that even a sock manufacturing deal with a Chinese company will involve a Vietnamese subsidiary that might make some of the socks. So with whom do we draft the agreement? Just the Chinese company? Just the Vietnamese company? Or both? And if both, what law applies? You get the picture, right?

What are you seeing out there?

Negotiating with Chinese companiesThis is the second in a series of posts in response to emails and comments asking us to expound upon how Western companies can better negotiate with Chinese companies on technology deals.

In part one, Negotiating With Chinese Companies: Be The Rabbit, I talked about using the Zen technique of “being the rabbit,” which in Western terms translates mostly into just being patient, hanging back and letting the Chinese side start negotiating with itself. In response to that post, I received the following email from a China business consultant I greatly respect who has been in China for at least twenty years:

I liked the post on negotiating with Chinese companies. I found the best trick is to lay out terms and when the Chinese side balks, be super polite and say when you can agree to these terms please, email, call or text me. Then give them your card and leave. I always tell people the mentality of bargaining in China is the same whether buying fruit on the street, clothing in a market or doing mega deals in the boardroom. A lot of people act like they are dealing with a Japanese company. They are not. You have to have a walking away point in place before you start so that you don’t lose your cool.

Most of the negotiating techniques we are seeing Chinese technology companies employ are similar to those we have seen Chinese companies employ for decades. A classic example of an old tactic Chinese technology companies seem to constantly employ is to “lure” in Western companies to do a deal by promising the moon and then backing down from nearly every promise with each new contract draft. The best response to this tactic is usually a simple statement that you will not agree to the change and then to wait. In other words, be patient and be prepared to walk.

We are also seeing massive Chinese technology companies agreeing to a do deals with Western companies and then at some subsequent point in the negotiations substituting in some other “related” company as the signatory for the contract instead of the massive Chinese technology company. The company substituted in for the massive company is usually a brand new company created just for this one deal. When we explain that our client wants to do the deal with the massive and well-funded company and not the newly created one, we get pushback and excuses.

The Chinese technology company will claim that it “needs” to do it this way for IPO purposes or for investor purposes or because it will be able to move quicker this way. They will sometimes mouth platitudes about how “it doesn’t matter because the big company will be behind it all anyway,” but when we ask them to have the big company give its own guarantees on the deal, the big company balks. The only way to handle this sort of company switch is to be patient and 1) be willing to convey from day one that you are willing to walk and 2) actually be willing to walk.