China bribery. Don't. Just Don't.
China bribery. Don’t. Just Don’t.

Earlier this week I gave a talk before the Chinese Chamber of Commerce in Cleveland. One of the things I talked about was how it is wrong to contend that contracts are not needed in China because of court corruption.

I talked of how most Americans don’t understand court corruption. Otherwise they would not so frequently say that there is no point in bringing a lawsuit in such and such a court because it’s corrupt. Corruption influences (sometimes greatly) court cases, but neither as often nor as much as so widely believed. When dealing with court corruption, one has to be sensitive to location, type of case, and relative influence of the parties. In other words, a $300,000 breach of contract case between a foreign company and a Chinese private company is much more likely to get a “fair trial” in a Chinese court in Shanghai than a case against a massive China State Owned Entity involving stolen trade secrets that might have military applications in the small Chinese city in which that SOE is based and employs a large percentage of the town Sometimes this is due to corruption and sometimes this is due to what lawyers commonly call getting “home-towned.” There are Wall Street lawyers who are as afraid of going to trial in a rural Alabama court as US companies are of going to trial in China.

But when Americans think of a corrupt court they usually think of the opposing party paying a judge in cash for the ruling of their dreams. But it is rarely that simple. I was taught the “finer points” of court corruption by a very smart, very honest Russian lawyer friend of mine who practiced law in the Russian Far East. What he explained to me works pretty much the same way in most of the other emerging market countries of which I am aware with a less than pristine court system — or at least that is what lawyers in some of these countries have told me.

My schooling on Russian court corruption was in “real time” as it involved a real case and a real client. It has been many years so I may be a bit off on the numbers and it is possible things have changed in Russia since then and it is also possible this information held true only for this one region in Russia. It is also possible the Cleveland Cavaliers will sign me to a multi-million dollar contract within the next few months.

My client had a contract with a Russian company under which the Russian company clearly owed my client $2 million, but the Russian company was refusing to pay and all but challenging my client to sue it in a Vladivostok court, the only place my client could pursue its claims. Legally, my client’s case was about as close to a slam-dunk winner as you are likely to see in a business dispute. But my client was rightfully concerned how corruption would influence its case.

Our Russian local counsel explained how we should view the case, corruption warts and all, and he did so by explaining the following:

Nine of the fifteen judges are corrupt. The other six are not. But I still like our case even before one of the corrupt ones. First off, there is a very good chance the opposing side will not offer any bribe at all. Second, our case is so strong it is possible that even if offered, none of the corrupt judges will take it. Third, if any do take the bribe, it will be really high because no judge wants to be thought of as corrupt and ruling against our client in this case will definitely raise eyebrows.

The Russian company will probably need to pay the lower court judge approximately $300,000 for the ruling it wants. And then we can appeal to a three judge appellate panel, made up of judges from throughout the province. A lower percentage of the appellate judges are corrupt and those that are require large payments, especially on a case like this. The odds of all three of our appellate judges being corrupt are quite low. The odds of the Russian company having close connections with any of the appellate judges are lower than when all of the judges are based in its home city. This means that to try to bribe two of the three judges will be very risky and very expensive. Risky because people sometimes do go to jail on bribery charges. Expensive because we are talking about 3 appellate judges. So in the end, I estimate that for the Russian company to be assured of winning through the appellate level, it will need to pay maybe a million dollars. And that ignores our ability to at least try to appeal to the Supreme Court in Moscow.

These numbers are just estimates but this means that even though corruption is a factor, we cannot allow our client to panic in the face of it. We can settle this case on good terms and that is what we should be trying to do. The Russian company would rather pay us to eliminate risk than pay a bunch of judges and take on new risks.

We ended up settling the case and at a figure not all that much lower than what it would have been in the United States.

I am not by any means trying to minimize the impact of corruption; I am merely trying to show that it oftentimes is not as overwhelming as it may initially appear.

Note also that we never discussed our client paying a bribe to anyone. That is always the worst alternative because it puts people at real risk of going to jail without anything close to a guarantee it will even work. When our Russian lawyer said that people in Russia rarely get arrested for bribery, he was talking about Russians, not foreigners. Do you really think you have the savvy to engage in risk-free bribery in a foreign country? I can tell you that none of our firm’s China lawyers would ever make that claim.

When I talked about the above at my Cleveland talk, an audience member, Kimberly Kirkendall, commented that in her experience many of the times where she was aware of someone having paid a bribe in China they had done so essentially because they wanted to, not because it was necessary they do so. We then talked of how some companies seem almost to delight in paying bribes but that our China lawyers — believe it or not — had never once been asked to pay a single bribe in China, even though we are constantly dealing with the Chinese government to register trademarks and copyrights and WFOEs and Joint Ventures. Kimberly commented on how foreigners sometimes brag about paying bribes and how troubled she was by that. I then mentioned how stupid and risky it is to pay bribes in China.

I spoke with Kimberly after the event and learned of her extensive experience and of how she had recently written on China bribery. When I got back to my computer I read what Kimberly had written and I loved it, and with her permission, I am running an excerpt from it below.

 

In China 30 years ago it was very common to incentivize someone to do their job by giving them a gift. Why? The China of the late 1980’s and into the 90’s was a communist economy that relied on 95% government controlled business. And in that communist economy there was very little difference between the salary for the GM of a factory and the guy who mopped the floor. So how were they compensated for their relative value to the organization? The GM could “gift” some of the company’s products to someone else, who often then re-gifted that to someone they wanted to influence and so on and so forth. By gifting them, the GM was able to get a slightly larger apartment, or their child in a better school, or some other economic benefit. People recognized their relative power in the economy by giving and/or accepting gifts. Sometimes cash, but frankly there wasn’t a lot of cash to go around. Much of this was actually bartering, trading your goods/access/influence for someone else’s.

In the booming late 1990’s and into the early 2000’s, as people were allowed to own a business in China, things changed a bit. How do you move a government owned or controlled economy to a privately held one? Where do individuals get the money to buy apartments or companies if they weren’t making much cash beforehand? In this period of transition there were many instances of people using their power and influence for economic gain. From how these government companies were taken private (and ownership and shares divided up) to how people came up with the money to buy apartments or build new ones. In this environment people in high positions saw the money being made and they wanted their share – and now there was the cash to pay them.

Towards the late 2000’s and into today, we are looking at a China where many people (but not all) are in a position to make money in direct ways. Through entrepreneurship, increased education and wages, investment, taking risks on new ventures, or changing jobs to accelerate their careers. Much of the population are no longer stuck in a powerless place where bribes are their only way to obtain value from their position of authority. Certainly it still exists, and there are still people who feel that they can’t get ahead so they exact a little extra money on the side.

When I hear that a US company has used bribes I start wondering about the reason for the bribe. Was it a payment to someone to do his or her job or a payment for them not to do their job? In almost every instance these days, it seems it is the foreigner who initiates the bribe. The below examples of matters on which I personally worked highlight the important difference between these two reasons.

Example: A U.S. company was importing components from China, using both its own team in China to find suppliers and control the orders and a trading company. The US management came to be for help in figuring out why some in their company were claiming that they needed to use a trading company for some of their China business, even though the trading companies were increasing costs by taking their own payments from the transactions. They wanted to know why they were paying a trading company to buy and export goods when they could do all of that themselves. It turned out that a group within the company wanted to utilize lower HTS custom codes for export to save money and Chinese Customs didn’t agree with that custom code classification. The US company was using the trading company to pay China customs a bribe so they could export their products under the “wrong” code and save money. In other words, there was no need to pay bribes, just a desire.

Example: A company was setting up a factory in China and the local government was concerned about air emissions from its manufacturing process. In the U.S. the company had shown that emissions were well within range of EPA guidelines. The local Chinese agency was not convinced and asked for more tests and documentation. The company was left with options – see if there was an “economic incentive” that would encourage the regulatory official to approve the paperwork, or spend a few months and thousands of dollars doing the research to prove their manufacturing met the guidelines. They chose the “economic incentive” route. Again though, an example of a company choosing to pay a bribe out of a desire to get a government official not to do his or her job, not a bribe necessary to get that official to actually do his or her job.

The point I am trying to make here is that the excuse foreigners make about having no choice but to pay a bribe rarely if ever holds true. The foreign companies I hear about paying bribes had plenty of choice; they simply chose wrong. They were not responding to a request for money but offering money as an incentive for a Chinese worker to deviate from his or her professional responsibility.

China litigation
Owed money by a Chinese company? Sometimes you just have to sue.

Nearly every week, an American or a European company (or sometimes an Australian company) will write to one of our China lawyers asking what it can do to get paid on its contract. The amounts typically owed are between $50,000 and $250,000, but sometimes they run deep into the millions.

These companies writing us are not our law firm’s existing clients because we so strongly advocate not doing deals with Chinese companies without getting a substantial payment upfront. See Want to Get Paid by a Chinese Company? Do These Three Things:

Demand a large amount upfront and make clear both orally and in your contract that you will not begin work or ship your product until you receive the full amount of this initial upfront payment. Having a large upfront payment works both to prove good faith by the Chinese side and to prove that the Chinese side is able to make large payments outside of China. China’s currency, the renminbi, is still a nonconvertible currency and any time a Chinese entity wants to send US currency to a foreign entity (greater than $50,000 a year), it needs approval from the transmitting Chinese bank. This generally requires the parties to have executed a contract (in Chinese) for goods or services that are acceptable for foreign entities to provide, and that the foreign company has submitted a formal invoice in a form acceptable to the bank — because the bank in turn usually needs to get approval from government authorities. For the specifics on what is required to get paid by a China company, check out Service Companies In China. How To Get Paid.

These companies writing us for help in getting paid are obviously past the point where a well-crafted contract can help them and they want to know exactly what they should do to get paid. One of our China attorneys recently responded as follows to such a company with very large amounts owed to it by two Chinese companies, one a State Owned Entity (SOE) and the other a privately-held Chinese entity (I have modified the email a bit to hide any possible identifiers):

Usually the best way to collect money owed to you by a Chinese company is to file a lawsuit. Otherwise, the Chinese company will probably just ignore you. The problem, of course, is that lawsuits by WFOEs against SOEs are not favored in China. If your claim has any defect, that defect will normally defeat the claim. However, filing a suit can provide you with leverage in any settlement negotiation. Your case against the privately-held company will probably be easier. But for both cases, much will depend on the quality of your contract and until we review those contracts we would only be guessing at your chances.

Sending demand letters to Chinese companies tends to be a waste of time, though they often make sense to confirm the default, if such confirmation is required under the relevant contract. Most Chinese companies ignore demand letters and this is especially true of SOEs. These two companies have been the clear decision not to pay you and unless and until you sue them, they probably will stick by that decision. In fact, sending a demand letter from your lawyer is seen by many Chinese companies as a sign of weakness. They are of the view that if you are really going to sue them, you would do so and not just send out letters. Those who send demand letters are too cheap to hire a lawyer to do anything more.

So that leaves filing a lawsuit against these two Chinese companies. But lawsuits are rarely inexpensive and filing one will permanently affect your relationship with these buyer and it could hurt your standing in the _______ industry in general. Litigation should therefore be initiated only after careful consideration. I cannot assess your chances of prevailing in litigation until after a review your contracts and other documents and get a much better sense of the entire factual situation. But I can tell you that just like in the United States, litigation in China is expensive (though usually considerably less expensive than in the United States, slow (though usually considerably faster than in the United States) and uncertain. So pursuing litigation is not a course to be taken lightly. However, when you are being ignored, it is the only affirmative action you can take.For what it is worth though, the World Bank recently ranked China as the fifth (5th) best country in the world in terms of contract enforcement!

Using an “intermediary” is a standard “old school” Chinese practice. Provided no bribe is given to this intermediary and provided this intermediary acts pursuant to China law, using such an intermediary is not illegal. [This was mentioned because the company owed the money said that someone had told it to collect the debt in this way]. These intermediaries typically charge a percentage of what they collect and you should measure that percentage against the cost of litigation. The problem with using an intermediary though is that you become dependent on the intermediary and your contract with that intermediary may make it difficult or impossible for you to sue your creditor if and when you wish to do so  and you become liable if your intermediary for whatever it does that is irregular or illegal. Most importantly, its chances of success are uncertain and we have seen instances where intermediaries have not only failed to collect, but the things they have said and done have essentially ruined the chances of succeeding in any lawsuit.

Using an intermediary in your case seems particularly problematic for two reasons. How is an “intermediary” going to convince an abusive SOE to pay its bill to you a WFOE? It sounds far fetched to me, but I don’t have all of the facts. Two, you are coming up against a statutes of limitations that may prevent you from ever being able to sue these two companies. The last thing you want to do is miss out on your opportunity to sue because you are bogged down using an intermediary. I do not know enough about your case to tell you how to proceed, but I can tell you that we generally advice against companies using intermediaries to collect on their China debts.

If want me to review the contracts and other documents that would support your claims, I am available to do that.

China complianceThe below post was written by Richard Bistrong, who recently returned from a long China trip where he met with all sorts of companies to assist them in their compliance efforts. Richard is CEO of Front-Line Anti-Bribery LLC  and a contributing editor of the FCPA Blog (a truly great blog, BTW). In 2010 he pleaded guilty to a conspiracy to violate the FCPA and served fourteen-and-a-half months at a U.S. federal prison camp. He now consults, writes and speaks about compliance issues. He was named to Compliance Week’s list of Top Minds in 2017 and was one of Ethisphere’s 100 Most Influential in Business Ethics in 2015. 

 

In today’s compliance environment, though we see a robust debate on what the new US administration might mean for anti-bribery compliance, the new ISO standard, and the recent DOJ “Evaluation of Corporate Compliance Programs” memo, those weren’t on anyone’s “what keeps me up at night” moments during my recent visits to  China. Yes, those are all meaningful topics for the field of practitioners, but from conversations at graceful Buddhist restaurants (with thanks to my hosts for indulging my vegan preferences) to live engagements and panels, much of the focus was on the “what happens when local customs conflict with the rules” dilemma. And that’s not to say that there’s an inherent conflict in China between ethical business practices and commercial success, but in an emerging market environment, with a young, dynamic and engaged workforce, the challenge is daunting, and not to be ignored.

The Importance of Defining Success. Compliance programs in China, like anywhere else, address the importance of lawful and ethical conduct, but during my visits, I saw a profound focus around “how to execute on both values and objectives,” in an environment where people are extremely focused on success, and the rewards of success. This desire to succeed manifests itself in a way that’s much different in an emerging economy than in a developed one. Employment with western based brands are coveted jobs, and commercial teams are anxious to demonstrate their ability to execute on financial objectives – in other words, to succeed. But that goal driven model often widens what’s a cultural and operational disconnect between the support functions at HQ and those forward based teams which are deployed in less supervised locales. And you can’t bridge those gaps with compliance paperwork and contracts.

Servant Leadership. One executive’s initiative was to call on mid-level leadership to be “servant leaders.” That really captured my attention, as he empowered his executive teams to push power down into the organization instead of up. As defined in The Center for Servant Leadership, a “servant-leader focuses primarily on the growth and well-being of people and the communities to which they belong.” Though traditional leadership generally involves the accumulation and exercise of power by one at the “top of the pyramid,” servant leadership is different. “The servant-leader shares power, puts the needs of others first and helps people develop and perform as highly as possible.” Yet another reminder as to why it’s so exciting to be back in the field — these are the business practices that one can only learn via immersion, and you don’t get that from the home office.

As to some more of the challenges, yes, anti-corruption was a big part of it, but not the only part. In China, corruption can intersect a work-force in both directions, as bribe payers as well as receivers. Commercial personnel who are responsible for dealer, intermediary and distributor networks might be subjected to requests for bribes, passed through those third parties to government officials — a set-up that’s familiar. But in China, employees are also exposed to the receiving side of corruption, as dealers might want to curry favor for discounts, product allocations or marketing allowances through corrupt offers.

In an environment based on relationships and hierarchy, that’s a complexity that might be hard to appreciate unless you are in front of it. It’s much more than anti-corruption compliance; it’s about ethical conduct in a broader sense, on hours and off. And those offers don’t come, or they don’t start, with brown bags of cash or numbered off-shore accounts. A dealer offering his beach flat for a holiday weekend to an employee might seem innocent enough, until a situation arises where that dealer might need a special allowance or discount. It’s a peril that often hides under the radar of friendship and association.  It’s part of what’s called the “dangerous charm” of third parties. After all, who wants to say no to a friend?

That’s just part of how I engaged in a discussion where there was an appreciation and focus on how to develop a commercial workforce free of conflict of interest, and how to inspire commercial leaders to embrace their roles as brand ambassadors. And those efforts were backed up, including by my own experience, with a “you can’t hide bad conduct behind your third parties,” and “what you don’t know can hurt all of us.” We spent a lot of time sharing with the workforce how they have an obligation to know the values and integrity of the people they do business with, and not to switch their ethical radar “off” after the third-party vetting process. In China, with state investment and divestment in industry and commercial entities, risk can quickly change over the life of a relationship.

In sum, those are just a few of the elements to which I was honored to engage. Having spent the better part of ten years living and working overseas 250 days a year, this was my first visit to mainland China. It left me wanting more, to return, and to read more about China’s role in today’s global economy along with its internal struggles as to how that gets implemented. China is experiencing what I heard called the “new normal,” where the period of exponential growth is slowing down, creating yet new challenges for commercial teams to succeed in a tightening marketplace. It’s a fascinating place, I found it personally contagious, and felt privileged to play some role in how to engage and inspire China’s commercial and compliance leaders to work together as each other’s ambassadors.

China hostage situationsWe used to write frequently about Westerners being held hostage in China over debts and over layoffs. Then we pretty much stopped.

We stopped because these posts always seemed to anger someone. Actually many someones. And they did so without really pleasing anyone.

But I am getting the strong feeling that the number of hostage situations involving Westerners is increasing at the same time the Chinese government and its police (both national and local) are more concerned with maintaining harmony among its own citizenry than about one foreigner being held in a mediocre hotel room. Getting a Chinese company paid on a debt will do more to advance social harmony than busting in and freeing a sole foreigner.

So why am I writing about it now? I can only very vaguely explain, but let’s just say that I am aware of a foreign company that had one of its employees seized in China over an alleged debt and it was anything but pretty.

But what I can tell you — what I will scream to you — is that HOSTAGE TAKING in China is real. Most importantly, I can tell you the advice my firm’s China lawyers give to our clients laying off workers in China or closing a facility in China or in a financial dispute with a company in China is — if possible — to stay outside China when negotiating resolution of these issues and to heed the following:

  • If you are in a financial dispute with a Chinese company, the best thing to do is not go to China at all. if you have to go or if you truly believe there is little risk, at least take precautions.
  • If you must go to China, think about using a bodyguard or two and think very carefully about where you stay and where you go. Most importantly, be careful with whom you meet. If you owe money to a company in Xiamen, meet with them in a hotel lobby in Shanghai or Beijing and not in their conference room in Xiamen.
  • Consider preemptively suing the Chinese company that claims your company owes it money. This allows you to plausibly claim that you (or your employee) have been seized not because your company owes a debt, but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China. This shifting of reasons can be very powerful when seeking police help.
  • Do not believe sending someone who is not a company owner to China will make any difference.

Hostage situations in China are rare, but not as rare as most believe. In the end, you are the one who knows the situation and the Chinese company(s) with which you are dealing, so you are the one who must make the decisions on whether to go or not. All I am saying is to at least be mindful of the risks.

 

China lawyersAnker is not a client of our law firm, so my gushing is not any sort of payback. But here goes.

I am a huge fan of Anker. Whenever I would talk about how I was not aware of any Chinese consumer goods company with a super high end stellar reputation in the United States, I would always qualify it by saying, except Anker. I would then usually say, “and that is who other Chinese consumer goods companies need to follow.” Then I learned that Anker is not really a Chinese company. Oh well.

But Anker still very much deserves to be followed (read “follow” and “followed” as a euphemism for “copy” and “copied”). So how convenient that Nick Statt just came out with an article for the Verge setting out the roadmap for doing exactly that, with How Anker is Beating Apple and Samsung at Their Own Accessory Game.

But first, please allow me to gush a bit about Anker. I’m not sure for how long I’ve been buying Anker products, but I know my first buy was many years ago and I know the first product was a predecessor to the PowerCore Mini, a phone charger. I remember how my research revealed that product to be the best product like it on the market and one of the cheapest. It came, I loved it, and within weeks I had bought the same thing for everyone else in my family. In my house (or in my eldest daughter’s apartment or my youngest daughter’s dorm room) we now own and love the following Anker products:

  • Pretty much every PowerCore size and shape possible. The Anker PowerCore 20100 sits on our treadmill so we can charge our iPhones and iPad for weeks without having to recharge–it’s in the middle of the room, far from an outlet.
  • I never leave town without my trusty PowerCore Fusion 5000 2-in-1 Portable Charger and Wall Charger, which cuts down on the number of moving parts I need to bring.
  • A ton of Anker car chargers and cables.
  • And when Anker expanded into home products with its Eufy line, we snared a vacuum, a scale and night lights at great prices, and — no surprise — all work exactly as advertised.

I buy Anker/Eufy products because they work well and forever, look good, and because they virtually always cost less than anything comparable. There are few brands that combine all this and those that do win my admiration.

But of more relevance (probably) to most of our readers is how Anker managed to pull all of this off, which is where the Verge article comes in. Two things struck me from the Verge article. One is how Anker has set up shop in Shenzhen. The interview with Anker’s founder, Steven Yang, took place with Yang “from his office in Shenzhen.” The article explains how Yang and “his core team” set up shop in Shenzhen to find its manufacturers:

It was a long and painful process. After he quit his job at Google in July 2011, Anker took 12 months just to prototype its first laptop battery. That was even after Yang and the core team moved to Shenzhen to find reliable manufacturing partners. “I knew that if I stayed in California and had people FedEx me prototypes in a week, it was just not going to work,” he says.

Many hardware companies, especially crowdfunded ones in the US, learn that lesson the hard way, missing deadlines and hitting snags that lead to months-long delays. A solid supply chain is so crucial to a hardware company’s survival that there’s an entire consulting industry around helping startups find suppliers and set expectations.

Amen. If you want to get connected with the best Chinese manufacturers and you want those manufacturers to do their best work for you, the fastest and best way to accomplish this is to get on an airplane yourself and spend massive time meeting in person (multiple times) with a ton of Chinese manufacturers and then meet even more times in person with those you like the best. There is no substitute for you or someone important from your company having these in person meetings in China. And this is true pretty much no matter what you are looking to have made in China.

I am always saying the following to clients, potential clients, and even start-up companies that ask me for quick advice via email:

  • “A day on the ground in China is worth a month in your office in ____________, USA/Canada/Latin America/Europe/Australia.”
  • “Just going and meeting with potential factories or with your existing factory will do wonders in terms of product quality and timeliness.” I cannot back this up with hard facts, but I truly believe that those companies that meet with their Chinese suppliers in person in China at least once have 80 percent fewer problems than those who never do, and those who meet regularly with their Chinese suppliers have 95 percent fewer problems. Going to China for live meetings humanizes you, says that you care, and that you will be watching what the Chinese factory does and holding them accountable. This is hugely powerful.

And number two, be relentless yet patient with product quality:

“The challenge wasn’t selling products,” Yang says. “It was making products and making sure they were high-quality as well. That’s why we spent a majority of our effort on R&D and product development.” The company does a majority of its sales directly to consumers over Amazon Marketplace, where a combination of strong reviews, low prices, and prominent placement in search rankings can turn a single product into a lucrative line.

I cannot tell you how many companies my firm has represented that never recovered from having rushed their first product to market (oftentimes to meet or even come close to meeting shipping dates they had promised on Kickstarter). These companies shipped a defective product and then could never recover from the expenses they had to incur in fixing or replacing or providing refunds for their one bad product. Not to mention the damage they suffered to their new brand.

Follow Anker. For further ensuring your China product success and for ensuring that once you get it, it will not be seized from you, be sure to check out Having Your Product Made In China: The Basics on Protecting It and You.

Oh, and one more plug/gush. If you are working on developing a hardware product you should be aware of a hardware accelerator in Shenzhen called HAX. Our China lawyers speak frequently there and our law firm has represented a good number of its participants. Its slogan is “When building hardware all roads lead to Shenzhen” and its pitch is “Come and plug yourself up to our ecosystem, leverage our curriculum and build meaningful products.” Very briefly, if you are working on a great product, HAX will help fund you and plug you into their ecosystem and by doing so, give you a chance to spend three months with them in Shenzhen and better learn the lay of that land. It is worthwhile. HAX cannot make your company into the next Anker, but it certainly can help.

China NNN Agreements The below is an email from one of our China lawyers to a client explaining why our client needs to stay firm in its position regarding its proposed NNN Agreement. This email involves an initial NNN regarding a product the Chinese company wanted to review to help it determine whether it wanted to buy stock from our client to make a large stake investment in our client. This email is from quite some time ago on a deal that has already concluded. It has been modified slightly so as to camouflage any possible identifiers.

I reviewed the NNN agreement we provided you and I reiterate that there is no basis to make changes to what we drafted for this deal.

There are three provisions of the NNN Agreement that restrict the Chinese company’s right to make your product for themselves or for other entities.These provisions provide that the recipient (Chinese Company) shall not:

— Make any commercial use of Confidential Information in competition with you.

— Sell any Product or goods similar to the Product which make use of your Confidential Information to anyone other than you.

— Use any Confidential Information provided by you in any manner to create any goods for any entity other than for you.

These provisions only apply to the improper use of your confidential information and there is no way any party acting in good faith could interpret these provisions to provide for any restriction on their right to manufacture and sell their own products or to manufacture and sell products designed by some other entity. Since the Chinese manufacturer’s concern is without basis and makes no logical or legal sense, there is no revision that should be made.

Note also that we have used these “offending provisions” hundreds of times in China (and their predecessor provisions hundreds of times as well). In the early days, some Chinese factories expressed concerns with these provisions and so we carefully revised them to deal with those concerns.

If ___________ [China manufacturer] continues objecting to this clear and restricted language you should assume you have a problem. The only way ____________ [China manufacturer] could have a problem with this language is if it believes the Confidential Information is not unique and has already been provided to them by one of your competitors and is not owned by you. This is one reason Chinese entities object to an NNN agreement: they do not believe what you will provide them is unique or owned by your company.

When this specific objection is raised and we think the objection has merit, we add a provision stating that if the Receiving Party proves the Confidential Information was previously disclosed to them by a third party and if the Receiving Party proves it is currently making use of the Confidential Information in current production for itself or for a third party, the provisions of the NNN will not apply. However, it would be a mistake to add this language to the current NNN agreement because this type of objection is never made regarding companies in your situation and because __________ [China manufacturer] is not making this specific objection and there is no reason to suggest such an objection is conceivable with respect to your Confidential Information. This kind of “you don’t really own the information” objection is raised only in the case of new designs from bare startups where the design is not patented or trademarked and where the product has no history of having been manufactured or sold. No one would consider raising this objection to mature products from a mature company such as yours. But that is not what _____________ [China manufacturer] indicates as their current concern. They say their concern is that the quoted language will prevent them from manufacturing and selling to __________ [a competitor]. The simple answer is that this language does not mean that and no one reading the actual written terms in good faith would read them that way, and prior to this, nobody ever has.

As we have discussed, given that you are dealing here with a direct competitor, you do not want to allow for any ambiguity at all. You have a 100% right in all Confidential Information and _____________ [China manufacturer] is not permitted to make any use of the Confidential Information in any way that competes with you. It’s pretty simple. They either agree or they don’t. When a Chinese company raises these kinds of meritless objections, all you should say is: “Sign it or we will not go any further with our discussions.” And that is exactly what you should  do here. Any company raises this kind of objection regarding clear and unambiguous language will be hard to deal with in working on a full scale sale stock agreement.

Note that when we draft a final Stock Sale Agreement, we will include transaction specific confidentiality provisions that will involve additional customized language not included in the current NNN. For now, however, the most important issue is to test out ______ [China manufacturer]. Will it act reasonably or will it continue to make arguments that make no legal or business sense? It will be good for you to know this right away.

As always, please feel free to contact me if you have any additional questions.

China M&A lawyersThe below is an email from one of our China corporate transactional lawyers to a client in the midst of dealing with a Chinese company interested in buying our client. Though it is from quite some time ago, I have modified it slightly to remove anything that might pass as an identifier. I pass it on because it shows a fairly typical issue that comes up when a Chinese company is seeking to buy a company overseas.

The response from the Chinese side is the normal endless negotiation approach. I doubt this is what you want, and your offer to [Chinese company made it clear this is not what you want. If you concede to their approach, your advantage is lost.

This happens often in company sales. It is not unique to China. The response depends on who is most desperate. Here is what we normally do in this situation where we are not desperate.

1. The buyer has two weeks to perform due diligence during the period required to draft an agreement.

2. If the buyer wants to extend due diligence into the period after the definitive agreement is executed, it can have an additional 2 weeks but only if they pay a substantial non-refundable earnest money deposit. “Substantial” means something like USD$ _____million or more. If they want another two weeks, it requires an additional non-refundable deposit. Chinese companies rarely agree to this kind of proposal, but if they truly believe they are onto a “good thing” (and it does appear they believe that here) they will likely pay for your company with no real due diligence at all. So you need to find out where you stand with these people.

To be clear: what the Chinese side is saying is that they don’t know anything about [client company_] and they don’t know whether they want to purchase you at all. Your position should be: [Chinese company] should be hot to purchase you or the whole project is a waste of time.

You have stated you are a terrific market opportunity for [Chinese company] and you are convinced [Chinese company] already understands this. If [Chinese company] does understand then they understand the price you are asking is a bargain and they should just pay it and be done. If they do not just accept this, you probably will need to meet with them face to face, which means key people from [Client company] need to go to China very soon to meet with the [Chinese company] players face to face. In that setting, you should understand that the Chinese company will likely be expecting you to give them a substantial price concession and so whoever travels to China on your behalf should have authority to agree on pricing; the people in China will want to negotiate with a decision maker, not a functionary.

Successful negotiations of company sales with Chinese entities typically work only if the company they are looking to buy both act like and truly do operate from a position of strength. This though means you must be willing to take the risk that [Chinese company] will walk away. The idea of a deal that is fair to both parties is for the most part foreign to Chinese companies. One side has to be on top. You need to be the side that is on top, even if that means [Chinese company] walks away. If you really believe you are giving [Chinese company] a rare market opportunity — and everything seems to align with this view — you have to believe you are “on top” and you do not need to sell to [Chinese company].

If you want, you can confirm immediately that your intent is to sell 100%. However, your offer document says just that. If they cannot read, then that is also a problem.

I note we had a similar situation here in Washington state for the sale of a company to a Spanish buyer. We took a hard line and the buyer walked away. Four months later, they returned and our client was sold at a very good price. The key was that our client did in fact own very valuable IP assets the Spanish company needed, so they came back. And when they came back we were able to say: now you understand we are not going to tolerate a low-ball price or any other nonsense; let’s just do the deal and be done with it. We did the deal in two weeks and we told all the investment banker vultures to get lost. But, the client had to take the risk that the Spanish company would never return. You may end up having to show similar patience here.

China Cybersecurity law
China’s new Cybersecurity Law becomes effective on June 1
China’s new Cybersecurity Law will become effective on June 1, 2017. In addition to focusing on cybersecurity, the law also details how companies are to handle personal information and data. In determining what is allowed and not allowed for handling personal information in China, it is important to examine The Decision on Strengthening Information Protection on Networks (2012), The Guidelines for Personal Information Protection Within Public and Commercial Services Information Systems (2013), and The Provisions on Protecting the Personal Information of Telecommunications and InternetUsers (2013). There are also many industry-specific rules, including such rules for banking and credit information services. China’s new Cybersecurity Law adopts and modifies existing regulations and codifies them.

Under the new Cybersecurity Law, collecting any user’s personal information requires the user’s consent and network operators must keep collected information strictly confidential. Personal information is defined as information that can be used on its own or with other information to determine the identity of a natural person, including the person’s name, date of birth, ID card number, biological identification information (e.g. fingerprints and irises), address, and telephone number. Once such information has been de-identified, it is no longer subject to the requirement for personal information under the law.

According to the new Cybersecurity Law, network operators are subject to the following requirements when collecting and using personal information:

  • Collection and use of personal information must be legal, proper and necessary.
  • Network operators must clearly state the purpose, method, and scope of collection and use, and obtain consent from the person whose personal information is to be collected; personal information irrelevant to the service provided shall not be collected.
  • Network operators shall not disclose, alter, or destroy collected personal information; without the consent of the person from whom the information was gathered, such information shall not be provided to others.
  • In the event of a data breach or a likely data breach, network operators must take remedial actions, promptly inform users, and report to the competent government agencies according to relevant regulations.
  • In case of an illegal or unauthorized collection and use of personal information, a person is entitled to ask a network operator to delete such personal information; when information collected is wrong, an individual can request correction.

Who are the network operators to which the new law will apply? Owners of networks, administrators of networks, and network service providers. Telecom and Internet service providers, clearly, but “network” is broad enough to go well beyond that.

Networks are systems consisting of computers or other data terminal equipment and relevant devices that collect, store, transmit, exchange, and process information according to certain rules and procedures (Article 76 of the new Cybersecurity Law). If you have a couple of computers at home that can share files, and perhaps a printer connected to them, you technically have a network. The law is not likely to go that far, but the generic definitions of network and network operators leave a lot of room for interpretation, which is exactly how the Chinese government wants it.

The new Cybersecurity Law also requires critical information infrastructure operators (CIIOs) store within China personal information and important data gathered and generated within China and conduct annual security risk assessments regarding their data. Though the definition of CIIO is yet to be clarified, we already know China’s yet to be finalized Measures for Security Assessment of Personal Information and Important Data Leaving the Country will likely require foreign companies doing business in China make big changes in how they handle data. The Cyberspace Administration of China (CAC) published a draft of Measures for Security Assessment of Personal Information and Important Data Leaving the Country back in April, raising many concerns for foreign businesses operating in China.

These Measures for Security Assessment would expand the data localization requirement to all network operators. This would mean that pretty much all personal information and important data collected by network operators within the PRC must be stored within China and not leave China, other than for “genuine business need” and after a security assessment. And if you think you may be a network operator, you probably are.

Since the new Cybersecurity Law does not differentiate between internal and external networks, it is broad enough to include any company that owns an internal network. Will your China WFOE be able to transmit employee information back to its overseas headquarters? In China’s Cybersecurity Law and Employee Personal Information, we set out best practices for doing this, but that was written before publication of the Draft Measures. Should the Draft Measures become effective — as expected — our views on data transfers will almost certainly toughen. Foreign companies are already setting up data centers in China so as to be able to keep data local and many of our clients are looking at doing the same.

We have been reluctant to write much about data and privacy protection in China because existing laws are both unclear and in a massive state of flux. But because this is so important and because this reluctance cannot extend to a client who needs to know what it must do now with specific data, we plan to write more often about these topics in the weeks and months ahead.

Please stay tuned.

Editor’s Note: Sara Xia is an experienced lawyer with law degrees from Shanghai University of Finance and Economics and the University of Washington. Sara practiced law in China from 2010 to 2013 and then in 2015 she became licensed to practice law in California and 2016 in Washington. Sara recently joined Harris Bricken to assist our clients with their cyberlaw and corporate matters, mostly while working out of Seattle, Beijing and San Francisco.

Chinese companies in America

We are constantly writing about American and European companies that do business in China or with China without sufficiently recognizing that China isn’t Frankfurt and Chinese law is not British law and Chinese courts are not American courts. In other words, they may give lip service to the idea that they must operate differently in China than in the West, but they are not truly drinking that Kool-Aid yet.

But compared to Chinese companies coming to America, Western companies in China are the gold standard. The way many (most?) Chinese companies operate overseas give lawyers the shivers and ought to give everyone pause.

The following are just some of what our international lawyers have seen:

  1. Chinese company wanted to retain our lawyers to conduct due diligence on a quite expensive commercial building it was buying in California, but refused to pay our rates or any other law firm’s rates and ended up buying the building without a lawyer. We subsequently learned that the  amount they paid for the building nearly dollar for dollar matched the amount they would need to pay to clean up the environmental problems they apparently unknowingly bought along with the building, which pretty much any first year lawyer would have detected.
  2. We are getting countless American (mostly) employees (from CEOs to COOs to Sales Managers to in-house lawyers) at Chinese companies in the United States contacting us, almost pleading for us to “convince the head office back in China” to hire us. We don’t do that because it pretty much never works and even if it were to work, unwilling clients are not exactly what we want. In many of these cases the American (and sometimes European companies that contact our Barcelona office) employees are being told to use translations of Chinese language contracts for things as varied as employment contracts and sale agreements. Trust me when I tell you that using a Chinese contract in the United States makes about as much sense as using an American contract in China, which is none at all.
  3. The head of HR for the American operations of a Chinese company came to us to have us draft an employee termination/settlement agreement with one of its California employees, but the Beijing home office insisted the HR head (who had lived in the United States for only about five years) draft this without any lawyer help and she did. Two months later, the California employee sued the company alleging (100% rightfully) that the settlement agreement was invalid and seeking the full amount already paid to him to get him to sign the first settlement agreement, and more. The thing is this exact same thing has happened twice.
  4. We were involved in a fairly large lawsuit against a Chinese company’s foreign subsidiary and in an apparent effort to cut costs, one of the higher ups at the American subsidiary started emailing our client and in those emails saying things he never should have been saying. I have never seen an American or a European company go so rogue during litigation and I am convinced that the emails from this employee hurt the other side’s case and enabled our client to achieve a better settlement than we ordinarily would have.

I have plenty more stories, but only the above are old enough and common enough and can be told vaguely enough so as not to reveal anything the least bit secret.

But what spurred me to write this is the following paragraph I recently received from a very experienced and very international executive at a Chinese company’s U.S. subsidiary in response to my telling him that I keep planning to write something about Chinese companies overseas but that I really do not know what to say beyond talking about how they mostly seem to refuse to adapt.

When the Japanese companies came into the U.S. in the 80s, they started off with the same mistakes as we are seeing with Chinese companies. They tried to operate in the U.S. based on Japanese models. It did not work. So what did they do? They organized research teams, figured out the right way to operate, and on the second wave they did very well. The Chinese companies are completely different. When things don’t work for them they blame the foreigners within their own company. They do no research or thinking. They just double down on their failed strategy. So it is not clear what your post would say, other than to say that these Chinese companies are doomed to fail.

What are you seeing out there? Are Chinese companies adapting better to the United States and to Europe outside the legal arena? Are they really any worse than companies from other countries, or is it just a matter of time?

 

China IP lawyerClients often ask us which of their entities should own their IP (patents, trademarks and copyrights) in China. The basic answer is usually simple: whichever entity will be using the IP in China.

There are some perfectly legitimate reasons for wanting to separate the ownership and exploitation of IP rights – reasons related to tax, liability, or corporate structure. But in the vast majority of situations, the only time IP ownership matters in China is when you are trying to enforce your IP rights. Chinese lawyers are expert at creating delay, and they know exactly how to exploit evidentiary gaps. And if you are attempting to bring an enforcement action in China but the plaintiff is not the registered owner of the IP, expect your dispute to take much longer than usual.

The Chinese lawyer on the other side will likely argue that someone who is not the registered owner of the IP cannot bring an action to enforce the IP rights and the mere fact the companies are under common control won’t be sufficient. A properly drafted license agreement might be sufficient – so long as the agreement is written in Chinese, registered with the appropriate authorities in China, enforceable under Chinese law, notarized, and authenticated by the Chinese Embassy, and so long as you do not run into any use issues. See China Trademarks: When (and How) to Prove Use of a Mark in Commerce. You can probably guess how often all of these things are done and done right by American and European companies. Most of the IP license agreements we are asked to review – no matter whether the company that comes to us is a two-person startup or a Fortune 100 company – are in English and governed by the laws of whatever country the plaintiff is in.

You better believe the Chinese lawyer for the Chinese company you sue in China for infringing on your China IP will be questioning each link in the evidentiary chain of your IP and pointing out each potential problem. If you’re lucky, you’ll have the chance to fix each of these problems in time before you sue, but doing so could add weeks or months or years to the process. And meanwhile, the infringing party will be going about their business using “your” IP. It’s death by a thousand (paper) cuts, and it’s a losing game.

Unless you have a really good reason to split ownership and use of your China IP into different entities, just keep it simple and use one company.