China Law Blog - China Law for Business

By: Steve Dickinson

Preserving its track record of major defeats before the WTO, China recently lost its appeal of the WTO panel decision in the minerals export case. The appeal decision was issued on January 30 and can be found here. Briefly stated, the original panel report held that Chinese export duties and export quotas for certain industrial minerals violate WTO requirements. China was ordered to reduce its duties and dismantle its export quota system. China appealed and lost on all important issues.

This decision has important implications. As most observers have noted, the real issue is export quotas and the real target is China’s export quota system for rare earths. Under the terms of this decision, China’s rare earths quota system is in clear violation of the WTO. The U.S. and others expect China to now act on its own and terminate the rare earths quota system. If this is not done voluntarily, the U.S. and the European Union have threatened to bring a follow-up action in the WTO, targeting rare earths. After this victory in the metals case, such an action against China would almost certainly succeed.

More important, China has an extensive export quota system covering over 600 products. These are all basic materials considered by China to be vital to its internal security: energy, raw materials and food. Under the terms of the panel decision and appeal, it is now clear that China's entire export quota system is in violation of the WTO. This recent decision on minerals therefore goes far beyond rare earths. It is a challenge to a vast and complicated system that the Chinese see as essential to national survival.

Ron Kirk, the U.S. Trade Representative, described the success of the appeal as as a “tremendous victory” for the United States.  In reality, the decision is bad for both the United States and China and for the members of the WTO as a whole.

This case is a very hot issue in China. After the decision, assessments have appeared from the Chinese government, the Xinhua News Service (the Chinese government's propaganda arm) and from general business commentators. The universal conclusion of the Chinese is that China has no intent whatsoever to comply with the terms of this decision or any other decision relating to its export quota program or to any other regulatory regime China deems in its national interest (such as China's restrictions on importing print and audio-visual materials).

The basic position set forth in the Chinese press has been as follows:

• Control of domestically produced raw materials, energy and food are vital to China’s national interest. China will not allow a trade law like the WTO to impact its pursuit of policies such as export quotas that are vital to its national interests. The attempt by the developed countries to use the WTO as a way to attack China’s national interest is unfair and shows bad intent. Such attempts will be rejected.

• China still intends to remain within the WTO so as to be able to obtain certain trade benefits. Rather than openly disregard the minerals decision, China will resort to “procedural games” (游戏规则) to render any response against China ineffective as a practical matter. China is proud of how it has  used “procedural games” to avoid its responsibilities to respond to adverse WTO decisions and it openly states that it will continue to use this approach in these "national interest" cases. In fact, the term “procedural game” has become a standard feature of the China's trade policy vocabulary.

This result is bad for supporters of the WTO trade system and it is bad for China. It is bad for the supporters because it exposes the weakness of the WTO dispute resolution process for resolving serious trade conflicts. China’s recent series of losses in the WTO justifies the US and other countries imposing major tariff and related trade sanctions against China, but no such sanctions have been imposed and China has concluded that no such sanctions will ever be imposed. China correctly believes that it can afford to ignore adverse WTO decisions because the complaining countries have no interest in actually imposing sanctions. We can thus expect China to continue ignoring most (all?) adverse WTO decisions against it. This will serve to progressively weaken the WTO trade system.

The odd thing about the export quota case, however, is that China itself is likely to be the biggest loser. China is the major importer in the world of raw materials, energy and food products. China therefore absolutely requires an open and fair export system for such products. By acting to support mercantilist export quotas and other restrictions on the export of critical raw materials, China is acting directly against its own economic and national security interest. China's control of the rare earths export market has convinced it that it can become a rare earths version of OPEC, giving them power to finally dictate terms to the developed world. This dream has blinded China to the real risks of its plan.

Both China and the U.S. are acting recklessly in a way that serves to undermine the WTO trade system. The damage has been done. The WTO minerals ruling is just another nail in the coffin. The WTO has been murdered. China pulled the trigger and the U.S. and Europe supplied the gun.

What do you think?

For more on China and the WTO, check out the following:

• The WTO, China's Media, Copyrights And Other IP. It's A Control Thing.
• WTO China Piracy Ruling: It Ain't Worth A Thing....
• Is China Having Regrets About WTO Accession (China Hearsay)

For more on China's rare earths, check out the following:

• China Rare Earths Quotas -- The Facts And The Law
• China's Rare Earths. The Video.
• Rare Earths And Polysilicon. Does China Control Our Green Future?
• China's Rare Earths. We Called This One.
• China U.S. Dispute Over Raw Materials. Rare Earths Are Key.

This is part II of Dr. Clarisse von Wunschheim's series of guest posts on China arbitration. I asked Dr. von Wunschheim to write this series because arbitration is of such crucial importance to so many China transactions and she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China.

More from Dr. Von Wunschheim:

PART 2:         Pros & Cons of Arbitration Inside and Outside China

In my previous post, I tried to establish that though the question of whether to arbitrate in or outside China may seem to be primarily relevant for so-called ‘foreign-related’ contracts, it actually concerns all kinds of China-related contracts.  Today’s post aims to determine the main pros and cons of each option, as well as the current trends which they give rise to.

Referring to the arguments most often invoked by the supporters of each option, the main pros and cons can be summarized as follows:

Though the above lists give a good overview of the most common ‘selling points’ of each option, they do not distinguish:

(i)            the weight of each individual pro or con compared to the others;

(ii)          what makes the difference at the end of the day, the pros of the chosen option or the cons of the opposite option.

With regard to the individual weight of each pro or con, this can be quite different if looking at the problem from the perspective of a Chinese company/lawyer or from the perspective of the foreign company/lawyer.

• With regard to the position of Chinese lawyers/companies, most of them seem to favor arbitration in China for the following main reasons:
  • They believe arbitration outside China is too expensive, takes too much time and is too complicated;
  • They believe Western arbitrators and arbitration institutions are biased against Chinese companies;
  • The Chinese arbitration system works just fine.

While there is merit in some of these arguments, I also think that they are partly misplaced:

-            Regarding the costs: There is no doubt that arbitration according to international standards and with the involvement of international specialists is generally more expensive than arbitration in China under a local arbitration commission and with local experts. However, there is a reason why, and the list of pros and cons listed above already gives a hint of these reasons. In addition, many companies and especially Chinese companies, misperceive the real cost items and ignore that there are ways to control and limit these costs. They often believe that the main cost item are the fees of the arbitrators and arbitration institution, while it is actually the lawyers’ fees (which are estimated to represent over 80% of the total costs related to an arbitration). They will also often tell you that prices in Geneva, London or Stockholm are far too expensive and they can’t afford to travel there. This argument ignores that the place of hearings does not need to be at the place of arbitration (actually a lot of lawyers ignore that too…). The place of arbitration is a virtual place determining the applicable legal framework to the arbitration, and while they may need to hire lawyers from that region, parties do not need to go there. Hearings can be held in Hong Kong, or even somewhere in China, while the place of arbitration can be anywhere outside China. 

-            Regarding the time: It is also true that the deadlines provided in Chinese arbitration rules are usually shorter than in international arbitration rules, and that arbitration proceedings in China usually take less time than in international arbitration proceedings. However, firstly, while speed is good, it is rarely a virtue per se. If it is at the expense of quality it is useless, and even detrimental given the final and binding character of the award. Secondly, let’s not forget that in international arbitrations the parties are the masters of the proceedings, and therefore also of the timeline. In many cases, the problem does not lie with the arbitrators or the rules, but with the parties and their counsel. As busy as famous arbitrators may be, the same is true for high profile arbitration counsel… Here again, there are ways to control this issue, by choosing appropriate arbitrators and counsel. Many arbitration institutions now also provide for fast-track arbitration proceedings.

-            Regarding the argument of ‘complicated’ proceedings, I believe this argument confuses ‘complication’ and flexibility. Chinese arbitration does not provide lawyers and parties with a lot of autonomy, and most things are decided by the arbitrators in a fairly expedited manner. Thus, when Chinese companies and lawyers are involved in international arbitrations, they do not know how to deal with the autonomy given to them and they see that as being ‘complicated’. Due to their lack of exposure to arbitration abroad, many Chinese companies and lawyers do not feel confident in their ability to efficiently conduct such proceedings. And, let’s be honest, no one likes to have to get external help…

-            Regarding the argument of bias against Chinese companies, I believe it is closely linked to the previous argument. It is normal that Chinese parties feel safer at home, the same is true for any party from anywhere. However, this concern has recently been alimented by a survey from CIETAC according to which Chinese companies involved in arbitrations abroad lost in 9 out of 10 cases. Unfortunately, only the result of this survey was published without any information on the reasons for the loss or the methodology or scope of the survey. Thus, while some believe that this survey confirms Western arbitration is tainted by a general bias against China, others (myself included) prefer to explain the figure of 9/10 losses (if at all representative - I am still skeptical about this figure) with the lack of experience and familiarity of Chinese lawyers and companies with international arbitration, which leads them to make the wrong choices. Also, let’s remember that splitting the world into the West vs. China does not really reflect the current world map, be it in terms of geography, economic interests, culture or political power…

In summary, I believe most concerns of Chinese companies and lawyers arise from misperceptions concerning the real functioning of international arbitration. This is understandable to the extent that, except for a handful of mostly big Chinese law firms and their clients, most Chinese lawyers and companies have not yet been exposed to international arbitration.

However, I should also stress that I have noticed in recent years an increased willingness of Chinese companies and lawyers to arbitrate their dispute outside of China, though they often insist on places such as Singapore or Hong Kong. Chinese parties choose these venues because they feel culturally close to them and believe that the risk of a bias against them is limited. From an outsider’s perspective, since these regions having both adopted the UNCITRAL Model Law on International Commercial Arbitration, they are attractive options compared to arbitration in China. However, what the parties often do not realize is that these jurisdictions have common law legal systems, which means that the way that lawyers work and the manner in which the case will be pleaded may be very unfamiliar to them and different from the spirit in which their contracts were drafted. I am thus not sure that this is necessarily the best way to go for Chinese parties, and in particular I am not sure it will help them feel more confident with international arbitration.

• With regard to the position of foreign lawyers/companies, there is no unanimity and the two schools of thought find supporters. With regard to each of these options, the most common arguments I hear are the following:
  • From supporters of ‘Arbitration outside China’: Arbitration in China is unpredictable. Arbitrators have too much power and the risk of lack of independence and impartiality reduces the chances of fair proceedings;
  • From supporters of ‘Arbitration in China’: Arbitration outside China is not always efficient. After all, winning the arbitration is only half the battle, and enforcing foreign awards in China is more difficult than enforcing Chinese awards.

Again, I remain partly unconvinced by most of these arguments for the following reasons:

-       Regarding the argument of unpredictability of arbitration in China: I agree that arbitration in China is often unpredictable. However I am not sure whether this is really due to the alleged lack of independence and impartiality of the arbitrators or the arbitration institution, as opposed to the general unpredictability of the Chinese legal system. In addition, one cannot deny that international arbitration always shows a certain degree of unpredictability, in particular when the case involves arbitrators from different backgrounds, lawyers and parties from different backgrounds and legal cultures, various laws applicable to various aspects of the dispute, etc.  Who can honestly pretend to be able to predict the outcome?  What must be predictable is the process; arbitration must provide the guarantee of a fair process according to pre-determined rules, and this brings me to the argument of lack of independence or impartiality of the stakeholders.

-       Regarding the argument of lack of independence and impartiality of arbitrators: I have no doubt that this argument is justified in some cases. But this is also true on the international arbitration scene. Let’s not forget that the maxim: ‘the arbitration is only as good as the arbitrator’. In other words, your arbitrator can kill your arbitration, and this is true everywhere, not just in China. While it is true that the choice of arbitrators is more limited in China due to the system of panels of arbitrators, this limitation has been widely relaxed in recent years: Firstly, the current panels of some arbitration commissions, such as BAC or CIETAC, now list many foreign candidates, and secondly, these arbitration commissions now allow the parties to choose arbitrators outside the official panels (with regard to party-appointed arbitrators). In other words, when drafting their arbitration clause, parties have sufficient room to limit risks relating to the background and personality of potential arbitrators.

-        Regarding the argument of enforcement: This is the argument that convinces me the least.

Firstly, why should enforcement of a Chinese arbitration award be easier than enforcement of a foreign award?  While it is true that a Chinese award does not need to be first recognized before being enforced, this recognition phase consists in the review of the existence of grounds for non-recognition/enforcement. Such a review is also applicable to Chinese awards and they are subject to a similar system, though it is not called ‘recognition’.  In addition, I am not sure that the end result of enforcement is more optimistic for Chinese awards than it is for foreign awards.  Most of the difficulties encountered in enforcement proceedings are of a practical nature (finding the defendant, locating the assets, etc.) and apply generally to both types of awards. As to local protectionism or lack of independence of the courts, it can just as easily affect a Chinese award (rendered in favor of a foreign company) as a foreign award. In addition, numbers do not seem to support the theory that Chinese awards are easier to enforce (see a survey conducted by WunschARB).

Secondly, even if one was to assume that it is easier to enforce Chinese awards (which I do not believe), this can only be deemed an advantage if the award is the result of a fair process, which meets and corresponds to the parties’ expectations. And in this regard, in view of the cons listed above, many would say that the chances of getting a fair process is more difficult in a Chinese arbitration...

I draw two main conclusions from the above:

• It seems to me that what makes the difference at the end of the day is often not the pros of the option eventually selected, but rather the cons of the other option.

• This, together with the lack of persuasiveness of many of the cons, in turn indicates that the way parties choose between arbitration inside or outside China is still largely directed by their fear and ignorance of the other system and is not made in due regard of the specific needs and possibilities of the case at hand. And this will be the topic of my next post.

By: Steve Dickinson

In my previous post in this series on the end of cheap China, I noted that the risks relating to purchases from Chinese manufacturers are rising in the export sector in China's Eastern provinces. Given the risks, it surprises me that I still see many buyers who continue to use the worst payment system possible in their dealings with Chinese manufacturers. The standard (terrible) system for payment in most of the export sector is: 30% down payment on signing of contract with the remaining 70% payable prior to shipment.

Why is this a terrible system for the Buyer? Let's consider the deposit system first. It is common for a Buyer to learn that the manufacturer is not able to make the product, makes the product with excessive defects or substantially delays in delivering the product. If the Buyer has paid a 30% deposit, the Buyer is basically "stuck" with the manufacturer and is not able to go elsewhere even after these problems are discovered. I have seen many Buyers who find themselves trapped in this way.

More important, the need for deposits reveals weakness of the manufacturing sector. Many foreign buyers naively believe the deposit is retained in a special account or is at least reserved for their own project. This is not the case. The 30% deposit is not used as any sort of security. Rather, the deposit is used as a financing tool for the manufacturer. Most raw materials for production are purchased with these deposits without regard to the specific project or buyer. Other costs are paid from the same general deposit fund.

As a result, when there is a problem, the deposit is almost never returned. There are two reasons for this. First, the manufacturer has already spent the money on costs and simply does not have the funds available to pay a refund. Second, the manufacturer knows that the amount of the deposit is so small that there is little risk of the foreign buyer filing suit for a refund. Indeed, normally there is not contract so the basis for requiring a refund is not clear. Thus the Buyer is forced to negotiate a price reduction or an extension or some other make-do remedy with a manufacturer that has already revealed ts clear weaknesses.

Now consider payment of the 70% upon shipment and prior to delivery. Under this approach, if the Buyer does not inspect in China, the Buyer only discovers what has actually been shipped after the payment and after the product has been delivered to the buyer. To consider the risks, consider these stories that have come into my law firm over the years:

• Buyer purchases carrying cases for its notebook computer. Computer is 8 inches wide. The cases arrive. They are beautiful, except for one "minor" problem: they are all seven inches wide.

• Buyer purchases jewelry bracelets with clasps that are to be mounted on the left side. The bracelets arrive. They are beautiful, except for one minor problem: the clasps are all mounted on the right side.

• Buyer purchases hand blown glass Christmas tree ornaments. The ornaments arrive just in time for holiday sales. The are beautiful except for one minor problem: the ornaments do not include a ring on top for mounting on the tree.

• Buyer purchases candle lamps. Lamp must be made from inflammable safety materials. Buyer pays extra for use of this material. The lamps arrive. They are beautiful except for one minor problem: they are made from normal, flammable paper and plastic and explode into flames at the touch of a match.

In each case, the Buyer received a full container of 100% defective product. The defect was so obvious that it would have been discovered by even the most rudimentary inspection prior to shipment. By failing to inspect, the buyer suffered a total loss. So much for the China price.

Of course, the more common thing is finding a smaller number of defects that result in damages ranging from 10% to 30% of the delivered product. Since the money has been paid, if these defects are discovered only after delivery to the buyer, then the buyer is entirely at the mercy of the manufacturer and is virtually without an effective remedy. The manufacturer knows that the amount at issue is too low to justify a lawsuit on the part of the buyer. If the manufacturer is looking for repeat business, the most common result is that the manufacturer will admit there are defects, refuse to pay a refund or damages and will instead offer a "credit" (typically 5% to 10%) against future purchases.

As with advance deposits, the "credit for defects" system is also a terrible system for the buyer that virtually always ends in failure. Let's take a look at how this works. In order to obtain the credit, the buyer must purchase from a manufacturer who has already shown that it will make a defective product and not give a refund for having done so. Buyers then get locked in a downward spiral. Each shipment has defects, and the amount of the credit grows. The manufacturer knows that the price for the subsequent shipments will be discounted, so the manufacturer gets even sloppier. So defects increase and delays become common. Finally, the buyer just gives up and writes the whole thing off or simply goes out of business due to the lack of adequate product.

Some buyers have finally understood that making payment prior to inspection is an invitation to disaster. Many buyers now perform inspections in China prior to shipment. This is an excellent trend and is basically required for protection of the buyer. However, this approach is still not as safe as inspection after delivery in the home country of the buyer. The basic reason is that we are aware of many times where Chinese manufacturers deceived inspectors and shipped non-conforming product.

As I mentioned in my previous post, some really bold manufacturers will substitute an entire container of non-conforming product by replacing a sealed container with an alternative. More often, manufacturers will rig the container so that conforming product is easy to find, with non-conforming product hidden deep in the container or in alternative locations on the loading dock. The only way to avoid these deceptive practices is to inspect at the place of delivery in the home country of the buyer and to make payment after that inspection is complete. Most Chinese manufacturers will strenuously resist payment only after inspection upon delivery. Buyers should therefore at a minimum inspect in China prior to shipment and then take into account the inherent risk in this practice. The price the buyer pays is actually substantially higher than its face value since this inherent risk is built into the price.

In part V of this series, I will discuss payment options that can reduce your risks.

The following is a guest post by Jonathan Poston. Jonathan is the Editor-in-Chief of the Learn Chinese Business Blog and Chinese Carolinas. Though learning Chinese well is obviously helpful for doing business in or with China, actually accomplishing can be so difficult that many a learner has given up or just pondered whether it is worth it. I asked Jonathan to write a post on the pros and cons of learning Chinese for business because his Learn Chinese Business blog so often delves into issues relating to China's business culture. Here's Jonathan's post:

If you Google “When will Chinese economy overtake US,” you will notice how many of the top results spit back a year that is closer than five years away: 2016. Though no one can predict the future, consider that China is already the second greatest economic power in the world, which begs the question as to when learning Mandarin-Chinese will be mandatory for aspiring international business people worth their mettle. Let’s take a look at the pros (beyond China’s massive economy) and cons to determine whether it pays to learn Mandarin-Chinese for business.

Pros

Government Subsidies for Mandarin Language Training.  The Chinese government is making it easier for foreigners to learn Mandarin, as part of a highly organized campaign to strengthen their “soft power” abroad. U.S. high schools and universities are already recipients of Chinese government subsidized Mandarin learning initiatives, which usually operate under the sometimes controversial Confucius Institute marquee. 

Mandarin is the Most Popular Language on Earth. Mandarin is the official language of the most populous country on Earth: China. That means Mandarin easily ranks as the most widely used language among native speakers. There are also millions of other native Chinese speakers living in Taiwan and around the world, who use the language to conduct their regular business affairs.  

Stronger Relations. Developing a strong relationship with Chinese business partners usually precedes meeting at the official negotiating table, and is in many ways paramount to the deal itself. Learning to speak with Chinese business partners in their native tongue always imparts a special advantage to anyone willing to learn a language for the sake of business. It shows respect, and who wouldn’t appreciate that? Furthermore, foreigners who end up doing business with the Chinese may have a partner or translator who speaks the language, but relying on them too much can undermine crucial “bonding” experiences with important Chinese decision makers.

Catching Bad Translations. Knowing a bit of Mandarin in most cases won’t mean there isn’t going to be need for a translator, but it can help non-native speakers catch some mistakes during negotiations.

Getting Around Easier.  American businessmen often make the mistake of believing that everyone in China learns English and that everything comes with an English translation. This might be somewhat true in tier 1 cities like Beijing and Shanghai, but more business opportunities are becoming available in tier 3 and 4 cities, where English is more of a rarity. Even with a translator, what business thought-leaders want someone to order everything for them, or even escort them to the public bathrooms at a tradeshow?

Cons

Takes Forever to Learn. The argument has been made over and over again that Mandarin-Chinese is too difficult for foreigners to learn, when weighed against the “business” benefits the learner stands to gain. Many who seriously tackle Mandarin with the gusto that it takes to become truly fluent do so for personal reasons, rather than strictly for business. Though it’s relatively easy to take high school Spanish coursework abroad and actually make some use of it for business purposes, it’s almost impossible to expect a similar use-outcome from the same amount of time spent learning Mandarin.  It takes many years of study and practice to begin to peel back and process through the layers of complexity of a four tone, fifty-plus thousand character language.

You’ll Never Be “Chinese.” When you do business in China, you are, for all intents and purposes, an outsider (There’s even a term you’ll probably hear yourself referred to as: Wai Guo Ren -外国人). No matter how much Mandarin you know, you’ll still never be seen as Chinese. That means you may be missing out on inside talks and preferential treatment the Chinese government has been known to reserve for Chinese-owned companies. So, while knowing Mandarin can give international business people some advantages, it can only take you so far.

Regional Dialect Differences. “Standard Mandarin” is what most Chinese language learners study. It’s what’s officially spoken in Beijing, and supposedly in the rest of China as well. But the further you travel from the capital city, the less likely your standard Mandarin will “work.” So what might pass for good Mandarin in Beijing might not be intelligible in Shanghai, much less in some of the more rural areas where Mandarin is amalgamated with the local dialect (which might not even be Mandarin-based at all). This author saw where tour bus drivers from one region had trouble asking for directions in another.

Unlikely to be the Next English. Though many extol the virtues of learning Chinese to prepare for the new global economic reality of China's dominance, because Mandarin is currently primarily used only by native Chinese speakers (because it is so difficult to effectively learn and standardize), it is unlikely to supersede “English” as the preferred language for global business communications.

With the above “pros and cons” in mind, readers might still be left wondering what to do. Do you learn Chinese for business or not? For businesspeople currently living in China or those planning to spend a considerable amount of time working with the Chinese, it’s definitely worth it. For those planning to do a deal or three over a lifetime, it’s just not feasible. For personal purposes of tourism, ex-pat retirement escape plans, making international friends, or just expanding your world view (imagine how much Chinese you would know if you spent the same time learning the language as you do reading the Economist), learning Mandarin is just as rewarding as mastering any other skill, and well worth the time spent.  It all just depends on your goals.

I think (and hope) this is the first time we have used an exclamation point in a blog post title and I assure you that this will not become common. I just am so impressed by the idea and the ingenuity and the hard work and the sheer helpfullness of the AllSet Chinese Grammar Wiki. I first learned of the Wiki from Ryan over at Lost Laowai, who in his post, "Chinese Grammar Wiki: Learning Chinese grammar just got easier," had this to say about it:

AllSet Learning, the Shanghai-based language learning consultancy founded by long-time China blogger John Pasden, has just released what is surely a boon for mandarin learners who aspire to achieve better Chinese grammar — the Chinese Grammar Wiki....

As an on-again, off-again Chinese learner, I’m pretty excited for the resource. Few people I’ve met have spent as much time as John thinking about language learning, particularly as to how it relates to Chinese. His blog and various resources at Sinosplice have been extremely helpful over the years, and I have to imagine that with his ambition and love for the language behind the wiki, it’s sure to be fantastic.

I second that emotion.  What do you think?

UPDATE:  A reader sent me an email regarding a "wiki-ish" site he likes called Wordbuddy:

It is wiki-ish because it is a dictionary that anybody can add to (slang, etc). Other sites can do this, but this one is interesting because people can also add 'memory tricks' for learning words which everybody can share. For example:

书 (shū): The librarian will 'shoot' you if the <book> is not returned on time.

东西 (dōng xi): In old times, a "donkey" was one of a person's most basic <things>.

讨 (tao3): The purpose of a <discussion>(讠) is to slowly inch(寸) toward an agreement.

独 (du2): A dog(犭) with flees(虫) will be shunned by humans and other dogs. He'll become a <lonely> "dude".

These are just off the cuff examples that users have entered. The site also integrates flashcards, radicals, translation, study lists, forums, etc, and makes a very good training tool for learning vocabulary.

Having spent part of last night helping my youngest daughter memorize Latin American capitals, I can vouch for the value of using memory tricks. Does anyone have a good way to remember that the capital of Uraguay is Montevideo, the capital of Paraguay is Asuncion, and the capital of Ecuador is Quito?

The Foreign Entrepreneurs in China blog is in the midst of a very worthwhile three part series, entitled, "A China Joint Venture Survival Guide. 22 Facts and 22 Practical Tips." The series is now at tips 9 through 15 and I like all of them. Not only are they good tips for those contemplating doing a China Joint Venture, most are are good tips for those contemplating or doing business in or with China as well.

Here is a summary of each tip, followed by my own analysis of it in italic font.

9. Your Potential Partner is Well Connected … Maybe Good, Maybe Bad. "Do not be dazzled by your partner’s connections …They will not necessarily be used for your benefit. The fact that your partner is well connected is good (you obviously don’t want to end up with a nobody), but it is also a fact that at times those connections are only used for their own benefit."  Absolutely true. Whatever "power" your China joint venture partner has to help the joint venture, it likely has equal power to shut you out and keep you out should the tide turn. And trust me when i say that I have seen that happen far too many times.

10. Financial Reports: “I can’t live with or without you.” "Be aware that reports can easily be falsified, and a lot of relevant information may be missing." Absolutely true. Check out "Buying A Chinese Company? Why China Deals DON'T Get Done," for more on this.

11. Tax Planning: “Tax Breaks. Do not believe all you hear.” "Tax breaks are a common tool to lure you into a location that needs to be developed....We were promised tax exemptions on all those tools and parts required for our product manufacturing. It did not happen. Not even once....Your investment should make sense regardless of the tax exemptions or other promised benefits."  Again, absolutely true. Unlike even five years ago, legitimate tax breaks in China are actually few and far between. You will be promised tax breaks that do not exist. You will be promised tax breaks that are not legal. You will be promised long term tax breaks that disappear. If the deal does not make economic sense without the tax breaks, do not do the deal. It really is that simple. 

12. Let me guess: your Chinese partner wants to contribute the land to the joint venture. 
"The Chinese partner always wants to contribute his own properties to the joint venture." But it will usually be worth a lot less than claimed. it not only may end up being worth a lot less than claimed, it may not even be owned by your potential JV partner. Verify, verify, verify. 

13. Does your land have a license to have a factory built on it? "You need to watch out for this one. Chinese companies often ignore this step. You may find sizeable companies operating (100 employees, tax bureau number, social security …) without the license to legally operate a factory/company on their land. So true. For more on this, check out "Cracking Down On Illegal Land Use In China. Do You Really Still Feel Lucky, Foreign Punk?" and "Eight Big Mistakes To Avoid In China."

14. Building the Factory- Oh Nightmare. This is another potential source of conflict. You will probably trust your partner to lead the factory construction works. You will need to monitor this closely and have good contracts in place. Indeed. 

15. Check Company Operational Manuals. Very often there is nothing written on how operations should function. When you land there and try to organise things you do not even know where to start. And what is worse, your Chinese partner is not interested in changing anything as he feels it has been working for him for years before you arrived.  Just assume you are going to have to start over on this front.

I urge all of you to read the full post here.

The Boston Consulting Group came out with an excellent piece last year, entitled, "Made in America, Again: Why Manufacturing Will Return to the United States." An excellent summary of that article can be found here, from which I pull the following:

Within the next five years, the United States is expected to experience a manufacturing renaissance as the wage gap with China shrinks and certain U.S. states become some of the cheapest locations for manufacturing in the developed world, according to a new analysis by The Boston Consulting Group (BCG).

With Chinese wages rising at about 17 percent per year and the value of the yuan continuing to increase, the gap between U.S. and Chinese wages is narrowing rapidly. Meanwhile, flexible work rules and a host of government incentives are making many states—including Mississippi, South Carolina, and Alabama—increasingly competitive as low-cost bases for supplying the U.S. market.

“All over China, wages are climbing at 15 to 20 percent a year because of the supply-and-demand imbalance for skilled labor,” said Harold L. Sirkin, a BCG senior partner. “We expect net labor costs for manufacturing in China and the U.S. to converge by around 2015. As a result of the changing economics, you’re going to see a lot more products ‘Made in the USA’ in the next five years.”

After adjustments are made to account for American workers’ relatively higher productivity, wage rates in Chinese cities such as Shanghai and Tianjin are expected to be about only 30 percent cheaper than rates in low-cost U.S. states. And since wage rates account for 20 to 30 percent of a product’s total cost, manufacturing in China will be only 10 to 15 percent cheaper than in the U.S.—even before inventory and shipping costs are considered. After those costs are factored in, the total cost advantage will drop to single digits or be erased entirely, Sirkin said.

All well and good, but what does all of this mean now for YOUR manufacturing and what will it mean five years from now and what should you do about it?

I have always been fascinated by economics and the differences between the macro and micro sides of it. When we read that sales of cars are expected to increase 3% next year, I think our first cursory presumption is that this likely will mean that VW, Honda, GM and Ford will all likely see their sales increase about 3% next year. But of course, nothing could be further from the truth.

I remember during the Asian crisis of 1997 hearing a news report of how exports from the United States to Korea were down about 20% (I admit I am guessing on this number) but that exports of quinces (I think it was quinces) had fallen from $20 million a year to zero. In other words, Korea's tough economic situation had completely ended their buying of quinces.

I am seeing the same sort of disparate impact when it comes to manufacturing costs. It is all well and good to say that China's wage increases are reducing or eliminating its cost advantage as compared to the United States, but that means almost nothing for each individual business. I am always asking our clients about their costs and about their decisions on where to manufacture and here is some of what I have been hearing:

• Company that makes a high end but fairly simple wood pet product wanted to manufacture in the US, but the cost to do so was four times higher than in China. His explanation was that the manufacturing was very labor intensive and so China had a clear edge.
• Company that makes a very complicated, very large, and very expensive piece of equipment told me that its costs to make this equipment are "about the same in the US as in China." The reason is that so many American engineers need to be in China to oversee things and to check quality. The company wants to retain its dual-country manufacturing capacity but unless it can raise productivity in China it expects to shut it down within the next five years.
• Company that makes environmental equipment is moving "some" of its manufacturing to China. It expects production costs to be "a lot" higher there during the first few years but is doing it anyway because of the "psychological and political importance of being able to say they manufacture in China." They believe that their manufacturing in China will greatly increase their sales in China.
• Clothing company that was making 100% of its items in China is in the process of moving about half of its production to Vietnam and to Cambodia. It is doing so because its labor costs will be considerably less in those two countries, even accounting for any productivity differences.

I could go on and on, but the point here is that the macro numbers are just the starting point for an individual business.

What are you seeing/hearing/doing out there by way of manufacturing? Is this really the end of cheap China?

For more on the end of cheap China and where else to go for manufacturing, check out the following:

• Made in America: Trend against outsourcing brings jobs back from China
• China Manufacturing: "We're Bringing It Back Home
• China Too Expensive? Who You Gonna Call? I Say Vietnam.
• Vietnam and China. Labor Shortages Or Not?
• China's New Labor Law And Why Vietnam Is No Big Thing
• On The Demise Of China Manufacturing....Kidding. Part II
• Vietnam Is The Next China. Only If You Completely Ignore Logistics.
• Vietnam Is The Next China, Part II. Only If You Completely Ignore Political Stability

Much has been written about Chinese students coming to American colleges. An article out today, entitled, "Chinese applications to U.S. schools skyrocket," starts out quoting a Chinese high schooler who is contemplating attending the University of Washington:

I know this [ambition] is pretty high,” said the 17-year old Beijing native.  “But I think I can give it a shot.” 

To prepare, Duan wants to study international relations at an American college – someplace like the University of Washington. “I hear [it] is good at social science," she said.

The University of Washington is one of approximately 10 U.S. universities Duan plans to apply to in the coming year with the help of an education consultant she hired last summer.

That got me to thinking about the complaints (yes, it has been nothing but complaints) I have heard from college students (about half of whom are at the University of Washington -- but I certainly have heard the very same thing from sons and daughters of friends who attend other schools and from their parents as well, who in turn have heard it from their kids) about their fellow students from China. I am not going to editorialize at all here, beyond noting that I find these comments troubling. Instead, I am just going to set out the sort of things I have heard and let people discuss them in the comments.

I want to be very careful to note that these comments are about students from China, not about students of Chinese ethnicity. I also want to note that pretty much without exception, the students who conveyed these comments are sophisticated, intelligent, and well-traveled. They are not red-necks, by any means. In many instances, they would temper their comments by noting how the Chinese students who come from Hong Kong or Singapore or even Vietnam "are not like this."

I have heard the following, mostly more than just once and virtually always with other students present, who always seem to join in. There is a lot of anger out there. Though i have put quote marks around the comments below, in most cases, I do not remember exactly what was said.

• "They don't come here to learn. They just come here for the grades." I have heard this one at least a half dozen times. 
• "I am convinced that if our teacher asked the class what 2+2 equals, and nobody spoke up who is not from China, not a single student from China would answer." I have heard some form of this one at least a dozen times. 
• "They are killing class discussion. They never contribute." One student told me of how all the students not from China agreed not to speak one day to see what would happen. There was no class discussion and the teacher asked them not to do it again.
• "I cannot even stand having to listen to them give presentations. Their English is terrible and they don't even try. Somebody else must have taken the tests for them."
• "The school is going to regret having admitted them. They will never donate money to the school as alumni. It will be like they were never here at all."
• "You will never see any of them at any school function. Never ever ever. Unless it can help them with a grade." I am constantly hearing this one.
• "They never make any effort to talk with anyone other than those who are also from China."
• "They cheat all the time. It is pretty unbelievable how often I have seen them cheating. I am always complaining to my professors about this, but they usually just act like they are too important to deign to deal with something like this. Just come watch a test being adminstered and it will be obvious. They are allowed to get away with it because they pay the foreign tuition rate. It isn't fair." I hear this one constantly as well and, needless to say, it is the one that causes the most anger.
• "My friend with a 3.8 GPA and 650 SATs didn't get in and had to go to ______. I know he/she would have contributed far more to the school than these students from China."
• "I've heard that most of them cheated to get in."
• "The school claims they contribute to diversity. That's a complete lie. How can someone who never says anything contribute to anything? Everyone knows they are here only because they pay the foreign tuition rate. 
• "I tried to speak with some of them, but they clearly had no interest."
• "This is a great way to ruin relations between China and us."
• "Why do they even bother? They come here to study, but since they never interact with anyone who is not from China, I don't even see why they come."

And again, what's so interesting is how often the complaining students were careful to note that they had no issues with Chinese students from Hong Kong or Taiwan or Singapore or Malaysia or the Philipines or the United States, "who are not this way at all." The above views really do seem to apply to just students from China.

I know we are going to get comments from people criticizing the students who made the above comments (and me for publishing them), but I think the more fruitful comments will address what can be done to help bridge this massive fissure. I would also love to see people address what this university-level tension portens for future China-US relations. I will note that I have heard Australia and the UK are dealing with the same sorts of issues.

What, if anything, needs to change? 

For more on these issues, check out the following:

• New York Times, "The China Conundrum"
• Chicago Sun Times, "Chinese students enrolling in U.S. colleges in record numbers"
• Chronicle of Higher Education, "How American Colleges Can Better Serve Chinese Applicants" and "The China Conundrum: American colleges find the Chinese-student boom a tricky fit"
• American Public Media, "Chinese students, too qualifed to be true?
• Danwei, "Opening the door to American Universities with lies"
• China Beat, "Passport to the World: Chinese Students at the University of Kentucky"

UPDATE: Seeing a comment below reminded me of something I should have put in this post. A few months ago, I spoke at my alma mater, Grinnell College. Grinnell is a small, liberal arts college in the middle of Iowa. Here is a New York Times article on Chinese students at Grinnell. It talks of how Grinnell's admission is need blind and of how a dozen full scholarships are set aside for foreign students. It says Grinnell usually accepts around 15 of 200 applicants, out of total student body of about 1600 students. When I went to Grinnell, I led a discussion group of maybe ten students who were interested in international law. Two of those students were from China and neither of them were the least bit reticent. In fact, one of them asked if she could go with me and my career services minder to the student union to talk some more. I have also met a number of law students from China who do not match the complaints above. So my thinking is that maybe the problem is in the numbers. If 500 students from China go to one university as undergrads, it is just too easy for them to act as set out above. But if 40 students go to a small college that reviews the application intensely for more than just the numbers (test scores and dollars) and absolutely will not tolerate its students not participating in class discussions and the life of the college, it can work out just fine. Your thoughts people...

As regular readers know, there is nothing I like more than being able to create a post straight from what goes into my email box. I am able to do that today by way of having been cc'ed on a long email discussion between our Beijing-based attorney, Mathew Alderson (who does quite a bit of China film law) and Rob Buckham, of Oceana Films China. The discussion started when Mr. Buckham wrote Mathew regarding foreign companies sharing in China movie box office receipts.

Buckham:  Quick question.  In one of your blog posts, you say that "Insufficient attention is given to the issue of garnering a share of the box office." We naturally assume we will be "ripped off" for any box office receipts in China . . . .

Alderson:  That is a sound assumption.

Buckham:  … and therefore would normally structure the deals so that we would get any dollars we actually expect from China (ever) to be cash up front from the Chinese participants.

Alderson:   That is the best way to structure your deals. I must add, however, that I see a disturbing trend even among those who structure deals this way. What frequently happens is that the Chinese party promises to pay cash on account of production costs but what they really do is arrange locations, props, equipment or services at substantial mark-ups, through deals with related parties or through deals which are not done at arms length. In such cases the Chinese side is not actually putting in hard cash and it is obtaining a disproportionate share of the production. This is not a good way to structure a deal.

Buckham:  Then if we get anything on the back-end it would be more or less in the category of a windfall.

Alderson:  Precisely.

Buckham:  It's probably one of the main reasons why the big studios aren't trying harder here yet -- they're waiting for the collection process to open up and begin to look like it makes sense.

Alderson:  Yes, you may be right about that. The major studios are curiously quiet about their China box office. We constantly hear about this or that US production, or US-Sino co-production, doing ‘well’ at the box office in China but what we don’t hear is whether the American party is getting its full share paid through in the US with all of the tax dealt with. I imagine that whatever problems they are encountering are being kept quiet. I could be wrong about this – I am just basing this on what I hear or see reported and on what I have seen from some of the botched film deals that have come to us. I would be pleased if we were wrong.

Buckham: So the question is this: Do you think there's a way to get a fair count of the box office from Chinese exhibitors and distributors and actually collect a significant portion of the proceeds due the western producers of a film distributed in China?

Alderson: Probably not yet. For that to happen, we need an independent collection agent endorsed by the Chinese authorities and run along Western lines. As I said in one of my recent posts, one of my cinema clients (whom we are advising on entering the cinema market here) confirms ticket sales by getting a photo taken of each session’s movie audience before the lights go down. I suppose you could require your Chinese partner to jointly undertake such an exercise with you. That would not mean that you would be paid, but it would mean that you would know precisely how much you were owed.

Buckham: Not asking for legal advice here - just your thoughts as an informed participant - if someone could figure out a reliable method of accomplishing this they could become quite successful.

Alderson:  You are right about that, too.

Just read a very interesting post, entitled, "Will India Challenge China? Not yet." The post is by GE Anderson over at the ChinaBizGov blog. I know GE Anderson to be one very smart guy (with a Ph.d and an upcoming book to prove it) and one damn fine analyst of things China, particularly those things relating to China's auto industry.

He wrote his post on India after having spent a couple of weeks there. 

Now before anyone points out the shortcomings of views based on a two week visit, let me stop you by saying I both agree and disagree with you (only we lawyers can say things like that). I disagree because one can get a "sense" of a country in two weeks and then use that sense, coupled with previous readings, to glean and then convey one's impressions. I buy into the idea that first impressions are far more accurate than often credited and I am a huge fan of the book, Blink.

Before I agree with you, I would like to note that I have never been to India and I do not purport to know terribly much about the country. When I was a freshman in college, my freshman tutorial was on India, but since I read only 4 of the 17 books assigned (who the hell assigns 17 books in a freshman tutorial anyway?), I can hardly claim much expertise from that. I should also note that my father served in India during World War II (who the hell serves in India, anyway?) and he absolutely hated the place from the moment he got there to the moment he left. He spent most of his time in New Delhi, which, as I understand it, is a tough place to love. Anyway, his views of the place have always (rightly or wrongly) overly influenced mine. There is one image that has never escaped him (nor me) and that was his arrival into New Delhi by train, where he saw hundreds/thousands of people squatting by the tracks and defecating. He told me this but once and I have never forgotten it.

When I was vacationing in HoiAn, Vietnam, last year, I met a couple of sisters from England who were there doing charity work. One of the sisters lives in London, the other in Goa, India. The one from London had talked of going to India for the charity work, but the one from Goa had dissuaded her by saying that the "entire country smells of human feces from the moment you get there until the moment you leave." Since hearing that comment I have asked about a dozen people who have been to India whether that is true or not and about half said "yes" and about half said "no."I am concerned that Dr. Anderson too has been overly influenced in his assessment of India by what I will call the "feces factor," for lack of a better term.

Dr. Anderson's post is absolutely excellent, but as an assessment of India's ability to compete with China, I worry that it leans too much towards describing filth and chaos. Though you can absolutely count me among those who will go a long way to avoid filth and chaos, I am just not sure how relevant that is in assessing a country's economic future.

india has its problems but it is moving forward economically. China has its problems (some the same as India, some different), but it is moving forward economically.

But let's get to the core of this. Can India compete with China? Is that a stupid question in that India already competes (and beats) China in many things, including IT and pharma?  Why must we compare the two? And why India and not Indonesia or Vietnam or Brazil or ....? What is it with the whole India versus China thing anyway?

I'm "opening up the "microphones" here so have at it. But please nobody comment without first reading Dr. Anderson's post.

I am of the view that I can understand about 50% of a country by going into five of its grocery stores and by watching five basketball games of its best players. I have a friend who is a dancer and she says she can understand a country by watching its people dance. I know basketball and I know food, but I do not know soccer, but if I did, I am sure that watching soccer games would help me better understand a country as well.

I mention this because a reader just sent me an Economist article, entitled, "Why China Fails at Football," along with a note saying the following:

China is never going to get its act together in football and for the same reasons, it's never going to get its act together in the big picture either.  They play football like they do everything else. Selfishly and by rote.  That works fine for factory work, but when it comes to innovation, it's worthless.

The Economist also does not shy away from using soccer as a metaphor for China as a whole:

Solving the riddle of why Chinese football is so awful becomes, then, a subversive inquiry. It involves unravelling much of what might be wrong with China and its politics. Every Chinese citizen who cares about football participates in this subversion, each with some theory—blaming the schools, the scarcity of pitches, the state’s emphasis on individual over team sport, its ruthless treatment of athletes, the one-child policy, bribery and the corrosive influence of gambling. Most lead back to the same conclusion: the root cause is the system.

It sees the soccer problem as stemming from a top-down system that is good for individual sports, but not team sports:

So whatever ails Chinese football, it is not a lack of passion from the country’s leaders. If anything, the opposite may be the problem. China’s Party-controlled, top-down approach to sport has yielded some magnificent results in individual sports, helping China win more Olympic gold medals in Beijing in 2008 than any other country. But this “Soviet model” has proven catastrophically unsuitable for assembling a team of 11 football players, much less a nation of them.

I do not know enough about either soccer or Chinese soccer to engage in any real analysis here, but it certainly does seem like a good area for discussion.

What do you think?

Interesting (and blisffully short and to the point) PowerPoint on luxury goods over at the The China Observer Blog, entitled, "Eight Trends to Watch in China's Luxury Sector."  What I found most interesting about the eight trends is that none of them came as much of a surprise to me, and it is not as though I now much at all about luxury goods in China. The eight trends did not come as a surprise because they seem to show that China's luxury goods consumers are not all that different from luxury goods consumers in most of the rest of the world.

A year or so ago I read an article (wish I could find and link to it) that posited that the elites in most countries around the world have a lot in common with each other and more than they do with the non-elites in their home countries. I buy that and this eight trends PowerPoint seems to be further proof of that. UPDATE: In Feng's comment below, the "missing" article was provided to us and it can be found here. It is entitled, "The Rise of the New Global Elite."

Do you agree?

I am in the process of writing an article for a leading publication on the things I am seeing that tell me China's economy is cooling. The statistics from China seem to be saying everything is just fine, but man, all I can tell you is that my firm has been absolutely inundated with matters that tell me we are in the throes of a crash.

The email I just received has become unbelievably typical over the last few months:

Hi. I am an avid reader of China Law Blog. I run a small _________ company in Shanghai and have come upon my own situation in which I would like to ask for a legal opinion. It's not a very big issue and maybe not even worth pursuing it but since we are a very small company with limited funds it's still of relevance for us.

A part of our business is renting out _________ machines to customers such as restaurants. One of these restaurants has just gone out of business. Since several months of rent are due to the landlord, the landlord has locked the shop down with all equipment (our _______ machine, the restaurant's employees' personal things, etc.) all still inside. The landlord is saying that they will release everything inside the restaurant only after discussing with the restaurant operators, all significant employees of which have now left town.

I am not exactly sure what will happen, the situation is vague as many things are here, but we would like to get our machine back (wholesale cost of about 20k RMB).

My questions now are if the landlord has the right to keep our property (e.g. the machine) and if not, if there is anything worthwhile that we can do about it?

Thank you.

Here is my response:

Without reviewing your contract with this restaurant, I have no way of knowing what you can and should do. If you have a really good contract (preferably in Chinese) that makes clear that the ______ machines belong to you unless and until they are fully paid-for, then you should show that to the landlord and odds are good he will let you walk off with your machines. If you don't have such a contract, I wish you good luck because at that point it is not likely to be very clear who owns what.

We have lately been getting a ton of these sorts of requests and I am going to do a blog post on it, stripping your email of any identifiers. 

This is China's new reality, brought about by the fact that businesses are failing and foreigners are now much more intwined in China's economy than ever before.  We are right now working on the following matters, all of which I am being intentionally vague about for obvious reasons:

• Chinese manufacturer gets shut down because it has fallen behind on its loan(s) from the government/private company/private individual. Foreign company has X dollars worth of product sitting in this factory. In some cases, the foreign company has paid for the product, but lacks a good contract to prove that it has paid in full for it and the lender is seeking more before it will release it. In other cases, the foreign company has yet to pay anything for the product but it needs it really badly because it has already sold much of it on to others, with an incoming delivery date. 

• Chinese manufacturer gets shut down because it has fallen behind on its loan(s) from the government/private company/private individual. Foreign companies molds/tooling are in the factory and it wants those back so it can quickly and cheaply move on to having some other Chinese manufacturer make its product. The lender is saying that the molds/toolings now belong to them. We have previously written on what you can do to protect your molds in China and that advice holds doubly true for the situation when someone else has come in and taken over the factory of your Chinese supplier. For those How Not To Lose Your Molds In China.   Want Your China-Based Molds? You're Probably Too Late For That How To Protect Your Molds And Tooling In China.

The contract really is the key. In most cases, there typically will be some negotiating with the landlord or lender, with the key to that negotiation being your leverage and your leverage will depend on the quality of your contract. If your contract makes clear that the asset belongs to you, the lender/landlord typically will choose to give you your asset. If your contract is less than clear on this point or if you have no contract at all, it typically becomes a negotiation between you and the landlord/lender and you will need to pay about as much for the assets as the landlord/lender thinks it can get by selling the assets to someone else.

By:  Steve Dickinson

I have been engaged in a friendly debate with a number of economists about the date when the Chinese real estate market "bubble" will finally burst. The opinions of the economists vary. Some believe the bubble will never burst. Some project that the bubble will burst "sometime" in the future. The future date is usually something vague like 2013. The argument being that the Chinese government will not allow the bubble to burst until after its 2012 power transition.

For the last year, I have been arguing that all of these projections are far too optimistic and since June I have been contending that the bubble has already burst. The serious work that needs to be done is not to project when it will happen, but rather to consider the impact on China of the fact that the collapse in the real estate market has already occurred.

Recent events here in Qingdao (where I live) illustrate my point. Since June of this year, officially advertised prices for new residential real estate projects in Qingdao have fallen an average of 30%. In a market that has seen nothing but price increases for many years, this has been a shock to the local real estate purchasers. As is typical in China, most of the new projects have not been completed. In a typical project, buyers purchased in June for a project that will not be completed until sometime at the end of next year. Now they are seeing units in that very same complex being sold at 30% or more less than the amount that they paid in June. Since the price is in free fall, they have no idea how bad it will be.

Owners in these projects have formed groups on QQ and Weibo to discuss their fate and to share rumors. On many projects, these unfortunate buyers have demanded that the developer reduce its price to reflect the recent discounts. In the alternative, they have demanded that their purchase contracts be cancelled. Most of these buyers have paid substantial down payments, so the reduction in price or the cancellation would require the developer to pay refunds to the buyers. Of course, none of these remedies are contemplated in the purchase agreements. Developers have therefore consistently refused to cancel purchase contracts. As a result, many buyer groups have organized formal protests, picketing at the sales offices of the distressed projects. These protests have had some impact and there are reports that some developers have offered at least partial price discounts. No developers have offered refunds.

The impact of the price decline has been considerable. Since the prices are widely advertised in the local newspapers and other media, the decline and the amount of the decline is well known in the local community. Most local residents have real estate fever, and they will freely tell you that prices have declined a minimum of 30%. This has had an immediate impact in three important ways. First, the sale of existing units has fallen dramatically. The only sales occurring are for drastically discounted units, with 30% to 50% discounts becoming normal. Second, work on uncompleted projects has slowed or stopped. Thus, all those buyers who paid deposits risk being trapped in permanently uncompleted projects. Third, purchase of undeveloped land has virtually stopped. Even though the local government has offered substantial discounts, with so many dead or dying projects littering the local landscape, developers are in no mood to take on new land at any price. This is particularly true in the light of Chinese law which prohibits land banking and requires land to be developed within two years after purchase. The lack of land sales then means the primary source of income for the local government has dried up.

In response to this, the Qingdao government has announced a number of new measures that are intended to loosen many of the restrictions on purchasing residential real estate that have been imposed over the
past several years. This includes a reduction in interest rates, a reduction in the amount of down payment required, and a relaxation on restrictions on purchases of residential real estate for purely investment purchases. The government is confident that these relaxations will bring the real estate market back to a "normal" level, with normal being defined as approximately the price level of June of this year with no major increase or decrease. The local newspapers carry articles virtually every day explaining how 2012 will mark a return to the formerly strong real estate market of the recent past.

However, these policies appear to be in conflict with the most recent decision of the central government to leave the recent restrictions in place without any major restriction. The center apparently believes that the bubble has not burst but rather that the real estate market is returning to a normal, healthy condition. Whether any of the locals believe the above is "healthy" and "normal" is not known to me because I do not care. To state it bluntly, I am certain that the Chinese real estate market cannot be guided be back to a healthy, vibrant state in 2012.

Once a real estate bubble bursts there is no government powerful enough to stop the resulting collapse in prices and subsequent effects. The real estate bubble has burst in China, and now the government must work to contain the effects. The task is huge because of the wide ranging impact on the banking sector, local government finance and general social stability. Though governments cannot stop the bubble from bursting, governments can play an important role in dealing with the impact. Some governments push the economy to recover quickly. Others take counteractive measures that make matters worse. We will have to wait and see which approach China takes. So far, the signs are not encouraging.

What are you seeing out there?

Update: A number of readers have written to point out a very good article by Patrick Chovanec in Foreign Policy Magazine, entitled "China's Real Estate Bubble May Have Just Popped." To put it mildly, Chovanec too seems very worried by what he is seeing with China's real estate market.

About a year ago, veteran China journalist Chris Myrick wrote a very thoughtful and well-researched article on China internet competition for knowledge@Wharton. The article is entitled "Land-grab Mentality: The Cutthroat Competition on China’s Internet" and it discusses the increasingly hostile and legalistic competition between China's leading internet companies. I was quoted in that article and a friend of mine just wrote me today to say that he had seen it.

His email caused me to read the article again and doing so caused me to have the following initial thoughts:

• It is, not surprisingly, an excellent article. I say, not surprisingly, because I have known Chris Myrick since his days as AFX's Beijing Bureau Chief and I think very highly of him.
• The article, written in December of last year, already seems woefully out of date, for reasons I will explain at the end of this post.  

The article begins by describing the mano-a-mano competition that is China's Internet:

The gloves are off. Tensions over recent weeks between China's major Internet players have been rising precariously. As interactive entertainment provider Shanda accused search engine giant Baidu of copyright infringement, Tencent's instant-messaging provider QQ and anti-virus company Qihoo 360 blocked each other's online products and services amid allegations of users’ privacy being violated. But as attention grabbing as these run-ins might be because of the sheer size of the firms involved, they are pedestrian in a sector in which intellectual property (IP) and copyright infringements and other underhandedness are commonplace.

Myrick then analogizes China's internet of today with California's Gold Rush in the 1800s with "Internet entrepreneurs ... [as] the modern-day prospectors staking claims in a vast and wild frontier, where sheriffs are few and far between.“ Mark Natkin of Marbridge Consulting provides a good explanation as to why this is the case:

China is an extremely rapidly developing economy that has undergone tremendous change in the past 20 years, you could almost say that there hasn’t been time to establish universally accepted ethics or business practices," says Mark Natkin, managing director of Marbridge Consulting in Beijing. "There is a certain Gold Rush or ‘land grab’ mentality in China.”

The mentality, he argues, is partly driven by an uncertain regulatory environment. Online video, blogging or social media businesses can change overnight from being unregulated opportunities to services subjected to rigid regulation. “Some people have seen rule changes where there may have been an opportunity yesterday, but it is gone today because the government changed a regulation overnight," he says. "This fosters a very short-term outlook to making profits, and because it’s short term, people are looking for short cuts.”

Natkin is right and what he says extends beyond the Internet. In fact, his description of what is happening in China jibes with what I wrote in an article many years ago for why short term thinking so often predominates in emerging market countries:

For example, many emerging market countries have a history where "bad business" meant "thinking long-term." A year or two after the fall of Soviet communism, I was involved in a matter where an investor put $250,000 into a Russian joint venture. The business very quickly was making good money and all indicators pointed towards steadily increasing profitability. But, quite quickly, the Russian company stole the $250,000. Was it so irrational for the company owner to think so short term in a country where the government and tax systems had such a history of unpredictability?

Way back in 2006, in a post entitled, "Is There A Chinese Mindset, And So What If There Is?" I too analogized China capitalism with the Wild West (and I certainly was NOT the first to do so), when I compared what I was seeing in China to what I was seeing on the TV Western, Deadwood:

I think the duration of a country's capitalist system, its economy, and its legal system greatly influence business behavior. I think American business behavior is based at least as much on the belief that a breach of contract will lead to an expensive and detrimental lawsuit as on our mindset. I am in the middle of renting all episodes of the HBO series, Deadwood. I defy anyone to watch that show and still claim America's business morality is inherent in our culture, rather than something that has evolved over time, mostly for business, rather than moral reasons. 

China is new to capitalism. China is learning how to conduct business according to international best practices. Some there have already learned and more will learn. I do not believe there is anything immutable in the "Chinese mindset" that should make me believe otherwise. 

The number of Internet users in China has already overtaken that of the U.S. and revenue from Internet businesses in China is exploding. With growing take-home pay and a steadily increasing Internet user base, China is a gold mine where businesses aggressively fight to gain turf and defend it.

The article quotes Tim Smith, an IP lawyer with Rouse as saying that “[w]hat principally motivates companies in China is a ‘land grab.’ It’s a brutal commercial environment and they will do whatever they need to gain commercial territory. He goes on to say that "[t]hey [Chinese Internet companies] will seek to -- as any company would if faced with the same situation -- filibuster, slow down, defend as vigorously as they can any proceedings that suggest that their business model is infringing on anybody [else’s] rights.”

The article goes on to note how badly foreign companies have fared when trying to break into China's Internet market:

For foreign companies trying to break into China's market, this creates rough and unforgiving terrain. Big Western names such as eBay, Amazon and Yahoo have failed. Others -- including Google and MSN -- struggle against local competitors and YouTube, Twitter and Facebook are among those that have been shut out by domestic restrictions and China’s "Great Firewall." While some may have grievances about the operating environment, they also might be partly to blame for their struggles if they're inflexible and incapable of adapting their business to China.

Despite all this, "there is no shortage of investors willing to join the Gold Rush....[t]he potential rewards are just too high. They can’t bear not to participate:”

William Bao Bean, managing director of SingTel Innov8, a Singapore Telecommunications-backed venture capital fund, notes that investors see China as a big pool of profitability, even though innovation may be lacking. “China is the place where the services are being created, perhaps not the high-level tech, but the services,” says Bean. “Talking about regulation and lack of enforcement probably made sense five years ago … but these days the real focus is on where the value is. For us, we’re looking for game-changing technologies out of the U.S., and we are looking for money-making services out of China.”

The article then talks about the role of China's lack of IP enforcement and there is general agreement that companies really have no choice but to persevere despite that: 

A major complaint – and perhaps excuse – among Western firms is the country’s weak or underdeveloped regulatory system, particularly in areas such as IP and copyright protection. Analysys’s Yu notes that while China’s Internet sector lacks solid regulations, "enforcement is a bigger issue…. In some cases, everyone knows something is in violation of a law, but from a legal point of view, it is very hard to prove an infringement or copying of an innovation … and to do so, may take months or years.”

While that may be true, Dan Harris, founding partner of Harris & Moure, a boutique law firm specializing in U.S. investments in China, says the entire system needs to be put into context. “Americans are always complaining about the lack of enforcement in China," he says. "But what they really mean by that is, 'The government is not doing enough to stop someone from manufacturing fake Adidas.' Well, in the U.S. the government is not that active either.”

Other experts agree. Harris says the Chinese legal system – while generally good at dealing with complaints in a fair manner -- is not as effective at penalizing bad behavior. “The reality is that Chinese courts do not have the same power to enforce judgments as courts in the U.S. do. In the U.S., if you get a judgment for US$5,000 against a U.S. company and they don’t pay, you can bring in the sheriff and start seizing furniture and bank accounts,” says Harris. “You can do that in China too, but it’s a lot more difficult and the court just isn’t as strong a body.”

In spite of imperfections, Smith notes that the legal system is increasingly used for conflict resolution in China and proving capable of handling an increased caseload. “There were 30,000 intellectual property claims filed last year in China. It’s the most litigious IP jurisdiction in the world … but the system is quick. You expect to get a decision in the first instance within six months and on appeal within a year,” he says.

All of the above is true, but it now seems almost quaint because when it comes to China's Internet, the big issue is no longer IP, it is whether foreign companies will be allowed to compete at all. Right now the answer to that is pretty much no. Moving on...

What do you think?

I love it when a blog post just lands in my lap, and one just did. It is a couple of emails from two of my firm's lawyers to two different clients, both of whom recently retained us to draft OEM Agreements for production of product by factories in China. Both clients are in the process of changing their Chinese manufacturers and this time around they want a strong and enforceable supplier agreement with their new Chinese manufacturer.

I am doing this post to give an idea of some of what should go into a Chinese manufacturing agreement.

Since we have a fairly standard initial questionnaire we send to our clients when we being working on China OEM manufacturing agreements, I have combined the two emails into one, further camouflaging the companies involved. Here are the questions posed by the emails:

• What is the name and contact information of the Chinese manufacturer?

• What sort of products will the Chinese manufacturer be making? Do you anticipate that these products will change over time? Will the volume change over time?

• Where do you anticipate selling your products In particular, will you be selling it in China?

• What are you expecting regarding shipping terms?

• Will you be using this OEM agreement only with this specific Chinese manufacturer, or will you be wanting to re-use it with others?

• What arrangements will be made for packaging prior to shipment?

• Are you concerned about your manufacturer going around you by directly selling a competing product your customers?

• Exactly what will you want to be  done with any defective product?

• Do you have an existing purchase order (PO) that you intend to use for your product orders from this manufacturer? If so, please provide us with a copy.

• How are you anticipating pricing and other terms will be negotiated? On a purchase order basis? On an annual basis? Some other way?  If you submit a purchase order and is not accepted by the Chinese side, what happens? In other words, is the Chinese side bound for some period to make a certain amount of product at a certain price, or is the Chinese side only obligated to make product for you after it accepts your purchase order?

• How many of the deal terms have been negotiated at this point? From the documents you have sent us, it appears that only the very basics have been negotiated: 40% down, 60% before delivery/shipping, plus certain quantity discounts. These are not great terms from your standpoint, but fairly typical for deals with manufacturers in Southern China (i.e., Shenzhen, Guangdong, etc.).

• What sort of arrangements have you made for inspection and quality control, and what sort of warranty terms have you negotiated? This question is particularly important in that many manufacturers in the south of China insist on a no-warranty provision.

• What are your main concerns in this deal? I ask this both so I can focus on the provisions that matter to you, and because it can help determine the choice of law and the choice of venue. From what I know so far, your main concerns seem to be twofold: (1) getting a high quality product and (2) protecting your intellectual property (i.e., ensuring that the Chinese manufacturer does not sell your product behind your back and/or steal your tooling).

• What exactly is the tooling for this product? Does the Chinese manufacturer already have all of the tooling in question?

• Has the Chinese manufacturer already signed an sort of agreement/memorandum of understanding (MOU) with you, even if only in English?

• Are there any unresolved issues involving your previous manufacturer ? For instance: have you gotten all of the tooling back from the previous factory? Are there any outstanding invoices or payments due?

After we get answers to the above questions, we virtually always write back with a whole slew of follow-ups.

For more on what it takes to have/create a good OEM Agreement, please check out the following:

• China Supplier Agreements. With Apologies To Kansas.
• China OEM Agreements. Why Ours Are In Chinese. Flat Out.
• China Manufacturing Agreements. Make Liquidated Damages Your Friend.
• The Six (Not Five) Keys To China Quality
• How To Protect Your Molds And Tooling In China

One of the things we have learned in representing companies involved in China's film industry is that it is the theater owners who seem to make the most money from films shown in China.

But Just last week China's government film agency mandated that the share of film ticket sales be lowered for theater owners. In a post entitled, Beijing’s (Bloodless) Boxoffice Battle, Rob Cain (whom I had the pleasure to meet last month at the 2011 US-China Film Co-Production Summit), writes of this change and how it came about.

Producer Zhang Weiping had demanded that China's theater owners raise their minimum ticket price from 35 y to 40 yuan and lower their after-tax share of ticket sales from 57 percent to 55. Cain described Zhang's reasoning as follows:

Zhang was looking to protect the nearly $100 million that’s been invested in The Flowers of War, his latest collaboration with his mega-director partner Zhang Yimou. The film, which stars Christian Bale, is the costliest in Chinese history, and is set to open wide next week. Under the existing structure distributors receive only 39 percent of each dollar, or yuan, of ticket sales, and after the distributors’ cut producers get substantially less than that.

As Zhang Weiping put it, “For producers in China, the only way to get a return on investment is through ticket sales. Ancillary products do not sell well. Raising ticket rates could help keep movies from being fast food and junk food.”

China’s State Administration of Radio Film and Television (SARFT) quickly stepped in and issued a document “On Promoting the Coordinated Development of Movie Making, Publishing and Releasing,” mandating that "cinemas can get no more than 50% of the box-office revenues from a first run movie. Cain rightly describes this new mandate as "a major victory for film producers and distributors" and sees this "7 point bump in their share" as having the potential to "spell the difference between profit and loss for many Chinese films." 

If you are interested in China's film industry, I strongly recommend you check out Chinafilmbiz.

Spoke with a client the other day, who for reasons that will soon become apparent, I am not going to name. This company makes a mid-line consumer product that sells for approximately $150 in both the United States and in China. Its sales in China had been okay, but nothing inspiring. Then he hired a marketing guru who told him that the company needed to vault its product into the luxury category and it should do so by changing the colors of the product (from mostly silver and blue to mostly black and gold) and double the price and give it a new name "made up to sound prestigious and old-line."

The company did this and within months, its China sales had doubled and its profit margins had shot through the proverbial roof.

Is this a one shot lucky thing, or is this going to be true of lots of other products as well? Let me just say that there is no way in hell that I would pay $300 for this product and I would not have even believed there would be a luxury market for it.  What is going on with the China consumer?

Christopher Jackson has written this guest post. Chris co-owns and runs Jackson Rosenberg, a boutique China aviation consultancy that provides consultancy and advisory services on China aviation matters. Before that, Chris worked at AVIC, China's state owned aviation conglomerate. Chris is fluent in Mandarin and he currently lives in Beijing.

I asked Chris to write this post because my firm has a number of companies in the aviation business (mostly involving Eastern Europe) and pretty much all of them are very interested in China. During my last trip to China, I had the opportunity to speak for a long time with Chris and with one of Chris's aviation clients (with a well-known airplane manufacturer) about aviation in China and I was riveted. One of the things I learned is that the Chinese aviation authorities virtually always err on the side of safety as opposed to the side of moving more passengers quickly. I view aviation as one of China's great opportunities and I have been bugging Chris for months to write a series of guest posts for us and he now has written the first one and so without any further ado, here we have it:

By: Christoper Jackson

Almost exactly five years ago, for reasons unknown at the time, Shanghai’s Pudong Airport was unexpectedly shut down, with all flights in and out cancelled. Many airport staffers were quoted as explaining that “Air Force exercises” were responsible for the sudden closure. As events unfolded over the next few days, it became clear that the Central Military Commission had ordered the shutting down of one of China’s busiest international airports, with no prior notice. An airport staffer confirmed this, when he stated that the shutdown “was not because of the weather.” Though the airspace was quickly re-opened, many questions still remained.

Airspace in China is heavily regulated and controlled, and the PLA Air Force is vested with the ultimate authority over it. This is, of course, vastly different from the system in Western countries, where civil aviation authorities set guidelines and manage airspace operations. Typically in the West, these civil authorities operate autonomously from the military, and instead, work closely with the aviation industry to promote best practices for use of airspace and relevant procedures.

Imagine if in the United States the US Air Force decided to close Los Angeles’ LAX airport for an afternoon, without any explanation or apparent reason. Imagine being shrugged at by airport ground staff, and told that "military exercises" had caused your flight to be cancelled. This sort of thing has long been accepted as standard operating procedure in China.

Moving forward five years into 2011, right now marks the first time that real movement and energy has been directed towards changing China’s airspace status quo. China is slowly opening up its airspace to civil management and increasing the freedom of commercial planes to operate.  A new structure for reorganizing airspace was outlined in the Chinese government’s 2010 report, "Opinions of the State Council and the Central Military Commission on Deepening the Reform of China’s Low-altitude Airspace Management,” which was approved and integrated into the 12th Five Year Plan.  This document sets out new regulations, as explained in a recent article by the National Business Aviation Association (NBAA):

Current Chinese airspace plans call for a tri-part classification of low-altitude airspace, from the surface to 3,280 feet (1,000 meters). The three classifications are referred to as "reporting," for which no detailed flight plan would be required; "surveillance," for which a detailed flight plan would be required but prior government permission would not, and "controlling," for which a detailed flight plan and prior government permission would be required. From 3,280 feet to 13,123 feet (4,000 meters) within existing airline routes, a flight plan will be required but prior government permission would not. Above 13,123 feet, a flight plan and prior government permission would be required.

China is initiating these new deregulations via “test programs” in select cities, starting with Hainan and Guangzhou. Additional programs are planned to take place in 2012, with locations including Chengdu, Lanzhou, Shenyang, Jinan, and Nanjing, and eventual implementation of nationwide airspace management reform by the end of 2015.

Currently, China’s airspace management is a two-tiered system. Each regional authority of the General Administration of Civil Aviation (CAAC) must approve civilian flights but those flights also require a concurrent approval by the military before the CAAC issues flight plan approvals. Take the example of a Cessna 172 being flown from Beijing to Zhuhai for a display at last year’s 2010 Zhuhai Airshow. Approvals for the flight came from over two-dozen different bureaus, both civilian and military, which had to individually sign off and issue the permits. This is why flight plan approvals take substantially longer in China than any other country of which I am aware.

China has some of the highest airport landing fees in the world and for big commercial airplanes they can easily exceed tens of thousands of dollars. There are those who think the PLA Air Force’s shutdown of Pudong was its way of showing why it is entitled to its “fair” share. Others believe that the Air Force already has plenty of cash, but is just interested in maintaining power and influence. Either way, it is no coincidence that the cities selected to test the new regulations all host a PLA Military Regional Headquarters. 

Despite the military-civilian battle for China’s airspace (and all that comes with it), most of us involved with China's aviation industry see tremendous growth potential. The expectation is that success with the current reforms will lead to further, more meaningful reforms in the 13th Five Year Plan for 2016 to 2020. In the short term, most of the benefits from the currently planned reforms will be seen in the helicopter sector, which China has expressed an interest in developing. Just recently, China’s first medevac helicopter service was started in Beijing, and it is providing time-critical emergency services in the city. Helicopters are expected to account for most of the future operations under the 3,280-foot threshold, and with no need for flight plan filing or approval, helicopters will eventually (probably by December 2015) be able to operate freely throughout the country. Helicopter owners have already been skirting around the current set of rules, by not filing flight plans and by not waiting for approvals. These flights, dubbed “Hei Fei,” or black flights, have become increasingly common, both because helicopter owners have little choice if they want to make reasonable use of their helicopters and because the fines for such flights are roughly the same as the fees that would have been incurred had everything been done properly.

The mid-tier airspace sector, from 3,280 feet to 13,123 feet, will also offer opportunities to smaller general aviation operations, primarily propeller aircraft. Most propeller aircraft operate within this threshold and the opening up of airspace for these planes will boost the pilot training and “enthusiast” sector, as well as utility aircraft, which tend to operate mostly in rural areas where they are mostly used for agricultural, industry or recreational use.

The sector above 13,123 feet, which is the airspace designated for commercial flights and the flight levels where business jets operate at, will remain under the same regulations as before.

It happened again last week. Multiple calls from the same person, wanting to speak with me urgently, yet refusing to provide any information to our receptionist on the nature of his issue.

I eventually called this person back and here's pretty much what we discussed (which was essentially what I have heard from two other callers in the last 6-8 months or so):

Caller:  I've never done this before and I feel terrible.

Me:  Done what? Talk to a lawyer?

Caller:  Gotten that kind of massage.

Me:  Okay. But why are you calling me? Can we start at the beginning? 

Caller:  They took my passport and said that I would never be able to enter the country again unless I paid them USD$4000.  I didn't have that money so I went to an ATM over the next few days and kept paying them and I had the rest sent to me by Western Union.

Me:  Wait a second. Can we please start at the beginning. I am totally confused.

Caller:  I went to get a massage. I was tired and my back was hurting. I'm never going to do that again, I swear to you.

Me:  Okay. Look, what you do is really none of my business.

Caller:  I know but what I did was wrong and it led to a lot more than that and I have never done that before and I am really ashamed.

Me:  Okay.

Caller:  And right after it all happened, the owner and two others burst into the room and one of them looked like he was a police officer. They told me that what I had done was illegal and they demanded by passport and I gave it to them.

Me:  Okay.

Caller:  They then told me that they were going to hold my passport and press charges against me unless I paid the USD$4000 fine. I gave them all I had on me and told them that I would need more time to get the rest.

Me:  Did you pay them the rest? 

Caller:  Yes.

Me:  Did they return your passport?

Caller:  Yes.

Me:  Are you now back in the United States?

Caller:  Yes.

Me:  Then why are you calling me now? When did all of this even happen?

Caller:  Three months ago, but my company is sending me back to China and I am worried that I am going to get arrested for what I did. I swear I will never do anything like that again.

Me:  Yeah, that would be wise. But what do you want from me?

Caller:  Do you think I'm going to get arrested?

Me:  I have no idea. Those guys are probably just so delighted to have made USD$4000 off of you that they don't care about you anymore and who knows if the guy in the uniform was a police officer or not and since what they did was almost certainly illegal, I doubt if they ever reported you to anyone, much less border patrol, but I don't know. 

Caller:  But should I go to China?

Me:  That's your call. We could spend all kinds of effort trying to find out if you are on any police or border lists or not, but no matter what we do we'll almost certainly never know for sure. 

Caller:  I'm never going to do anything like that again. I really do feel so ashamed.

Me:  Okay. Well. Good-bye. 

Caller:  But should I go or not?

Me:  I really can't tell you one way or the other.  You are the one who is going to need to make that decision. But if you do go, I would stay away from the neighborhood in which that massage parlor is located. Good-bye.

Caller:  Good-bye. And I was being serious when I said I would never do anything like that again. I really have learned my lesson.

Me:  I understand. Good-bye.

It seems this scam is becoming fairly common. Were you aware of it?

Oh, and if you need another reason not to do what this guy did, check out this article.

A loyal reader just sent me an absolutely fascinating "case study" on a small Chinese manufacturing business. The case study is part of Emerald Emerging Market Case Studies, which dubs itself as providing a "library of teaching cases spotlighting the world's emerging economies." The case study on the Chinese business is called "The changing landscape for Chinese small business" and it highlights a company that started out making school uniforms for China's domestic market, and then shifted to making bags/purses/backpacks for export.

I hate to say this because I am not even close to being an expert on Chinese manufacturing businesses, but in reading the case study, just about everything in it sounded "typical" to me. This bag company sounded like most of the Chinese manufacturers my firm's non-Chinese clients have sought to buy, have bought, or have bought product from. In particular, the company's lack of rigorous accounting and pricing and its unbelievably low profit margins, rang totally true to me.

In 2010, the company had sales of 5,417,003.64 Yuan and profits of 983 Yuan (approximately $150 US dollars!). Even in its very best year (2006), the company's profits were only around USD$44,000. The case study attributed the low margins to one of the company owners oftentimes providing discounts without the knowledge or approval of the other owners.

We are always counselling our clients on how Chinese manufacturers tend to have incredibly thin margins. We do this for many reasons, including, just by way of example, the following:

• If you buy product from a Chinese manufacturer for too low a cost, you are increasing the risk of that manufacturer cutting costs by doing something bad to your product without telling you. Believe it or not, you may be better positioned to know your Chinese manufacturers costs than it is. 
• Because your Chinese manufacturer's margins may be so low, if you do get bad product, do not expect to just pick up the phone, tell the manufacturer what happened and wait for a refund of the USD$500,000 you just paid it for the product. Your Chinese manufacturer probably does not have $500,000 so you are going to have to come up with some other solution. You also should be thinking about this issue before you place your orders.
• With the margins being as thin as they are, think about what you ask for from your Chinese manufacturer. Should you require your Chinese manufacturer to provide product liability insurance or does doing so just invite the manufacturer to say it has done so but then never pay on the policy? Might it not be safer for you to buy the policy for yourself instead?  I am not saying one should always buy one's own product liabilty insurance, I am just using this as one example.  

As bad as things already are for this Chinese bag company, the case study predicts things are only going to worsen due to the following:

• The US Government is continuing to put pressure on the Chinese Government to strengthen the value of yuan and to do it fast;
• The continuing rise in oil prices; and
• The long-term decline of available migrant workers

If you buy product from China or are thinking of doing so, I urge you to read this case study (click through to the pdf). 

As regular readers of this blog know, I am not a fan of Chinese stocks. My usual reason for not liking them is that I rarely trust their numbers. I am even less likely to invest in Chinese stocks now.

I have two additional reasons for my increased pessimism regarding China stocks. The first is real estate and the second is loans.

The Sydney Morning Herald just did an article, entitled, "Bonds show 60% of Chinese companies dabble in property," describing how about 60% of Chinese companies that sold bonds in the past six months admit that they invest in the property market. Of course nobody knows what percent of the 40% invest in real estate but have not come clean about that.One should assume that the numbers for China's publicly traded companies (on all exchanges) are somewhat similar.

In addition to real estate investing, I have every reason to believe countless publicly traded Chinese companies are also in the business of engaging in grey market lending. Much grey market lending occurs when well funded/well connected companies borrow from China banks at low official interest rates and then, in turn, lend that money to mostly private Chinese companies at much higher interest rates. I strongly suspect that most publicly traded Chinese companies that have engaged in this practice did not list it on their books and/or that their shareholders have no idea the extent of this practice. What percent of Chinese public companies are lending money and how much are they lending? Who knows.

The problem with Chinese companies investing in real estate and in lending is two-fold. First off, both of these "industries" are volatile and not looking good for China right now. Second, how are you supposed to know in what you are investing? Is that low risk food company really so low risk if 30% of its business is tied up in real estate investing and lending? I truly hope that the extent of these "off book" businesses is low enough and stable enough not to crush a whole slew of Chinese companies' stock prices, but the more I know, the happier I am to have stayed away from Chinese stocks.

What do you think?

We are always preaching that if you 1) choose a good manufacturer, 2) use a good OEM contract, 3) engage in good quality control monitoring, and register your trademark, the odds are overwhelming that you will do just fine in outsourcing your product from China.

The odds just went down.

In 2009 and 2010 and the first half of 2011, I estimate that I would receive maybe two emails a month from someone who had sent money to a Chinese manufacturer and received no product. And of those emails, I estimate that pretty much all of them involved a relatively unsophisticated buyer who had done none of the three things listed out above.

In the last three months or so, I have received probably 4-5 emails from buyers who have been burned by Chinese manufacturers but have a very different story to tell. These buyers have been burned by Chinese manufacturers with whom they have been dealing successfully for many years. The following is a fairly typical example:

I did not receive my most recent order from ____________ Chinese manufacturer. I have been dealing with ______________ for six years and we have never had a problem like this. We have had issues with them in the past but we were always able to resolve them. Now they are not even answering their phone. They owe us around $30,000.  Can you help?

I also just received the following email:

On July 21st, you wrote an article entitled “Factory Closings in South China.  All Part of the Plan," in which rising costs for low value added factories was cited as part of the reason for factory closings.  Lately there has been another string of articles floating around several websites about Guangdong wages increasing another 20% this coming January.  While I do realize the government often puts out feelers to see how people will react, it does seem realistic and inevitable that wages will continue to rise.
 
Two things I would love to get your opinion on:
 
1)  As a director of a company that sources “promotional items” solely in China (assuming the quantity of goods is large enough), where else can we possibly be looking?  If we only did textiles I could set up in Vietnam or in Bangladesh; but we source plastic trinkets, low-end electronics, pens, lanyards, bags, and a variety of other LOW VALUE ADDED goods.  Is our only option to keep taking the price increase until someone finally starts making plastic toys and trinkets in another country?  From my experience these China manufacturers are NOT moving inland to cheaper places in China, but are either taking the increase or shutting down.  Keep in mind 95% of the factories I’m working with are not huge Foxconn-like factories but private owned 100 employee factories.  What have you seen?
 
2)  We work with over 100 factories a year in China. I’m trying to develop a plan on “How Not to Get Caught With Our Pants Down” where a manufacturer closes and takes our deposit.  If a factory goes bankrupt I think the chances of us getting any kind of money back on a deposit no matter how well our written contracts are is low (maybe this is wrong?).  Our current plan is ‘hoping and praying’ on deposits less than $10k that wouldn't really hurt our company, and making sure we send our QC team to visit the factory even if previously audited, for any deposits over $10k to ensure they have workers there, raw materials in storage, and are producing something. I don’t know that this plan is the most technical.
 
I would imagine many of your readers are facing similar situations.  It’s a scary time to be exporting from China.  I’m shifting my studies and free time to learning more about China consumerism these days because I believe that’s where the money is for the next decade and beyond.  I enjoyed your recommendation of Billions: Selling to the New Chinese.

I responded to this email by professing that I had no great solutions and that I would blog about it.

As for where to go, the answer is "that depends."

As for how to prevent yourself from getting caught holding a bag when your Chinese manufacturer disappears or what to do about it when that happens, I have the following advice, none of it great:

1. Redouble your due diligence in choosing a Chinese manufacturer. Check out the factory. Check out its company registration. Check out the rumors about it. Do whatever you can to try to gain a sense as to whether it is a company that is acting like it has a future.
2. Reduce the size of your orders to the extent that you can. This way whatever bag you end up holding will at least be a smaller one.
3. To the extent you can, try not to order anything in September, October or November. I have heard from a couple of clients that Chinese companies typically come up for renewal of various licenses in December and January and that they often try to hold on up until the point they are supposed to pay these. That being the case, they stop shipping a few months beforehand and then they are gone. It does seem to me that in prior years (2008 being a prime example), the number of disappearing Chinese companies increased during the end of one year and the beginning of another.
4. Increase your monitoring of the factory to make sure your product ships.
5. Do whatever you can to try to reduce the amount you pay upfront for your product. If you have been doing business with the same factory for five years and paying it 70% upfront, go to them and point out that you have always paid and then ask to be able to switch to a 30-70 or 50-50 payment plan.

Any other ideas out there?

This post was written by Matthew Dresden. Matthew handles China matters out of our U.S. office and this is his first post for the blog. Matthew speaks and reads Mandarin and has lived in both Beijing and in Shanghai (but is too politic to tell us which he prefers). 

Here's Matthew's post:

There has been a spate of recent stories in the media about the large numbers of Chinese students applying to U.S. colleges who have doctored their records. A paragraph from an article in the New York Times neatly sums up the issue: 

Colleges, eager to bolster their diversity and expand their international appeal, have rushed to recruit in China, where fierce competition for seats at Chinese universities and an aggressive admissions-agent industry feed a frenzy to land spots on American campuses. College officials and consultants say they are seeing widespread fabrication on applications, whether that means a personal essay written by an agent or an English proficiency score that doesn’t jibe with a student’s speaking ability. American colleges, new to the Chinese market, struggle to distinguish between good applicants and those who are too good to be true.

What's fascinating is how Americans who never deal with China are shocked by the extent of the cheating: more than 90 percent of applications contain some kind of fabrication, according to education consultancy Zinch China. Meanwhile, Americans who regularly do business with China simply say that the other 10 percent are merely the ones who haven't been caught.

How is this relevant to your business?

If you're starting a business relationship in China, you should assume that 90 percent of what your Chinese counter-party tells you is false. This is not to say that 90 percent of people in China are liars, or even that 90 percent of what your Chinese counter-party tells you is actually false, but rather that you should proceed as if that is the case. It's a simple matter of incentives. There is an extremely high probability that your Chinese partner will try to cheat you, because the chance they will get caught before you pay them is small, and even when you do find out, the chance you can do anything about it (legally or otherwise) is even smaller.

This is why we stress repeatedly on this blog that if you do business in China, you need a contract written in Chinese that is enforceable in a Chinese court. Ask yourself this: how many American companies would cheat, if there was a really, really good chance they could get away with it? A lot more than most of us might like to admit. Americans commonly use the Wild West as a metaphor for modern China; we might also do well to remember how many hucksters, swindlers, charlatans, and mountebanks roamed the American West. 

The director of the international division of Beijing's high-profile Peking University High School writes in the Chronicle of Higher Education about how U.S. colleges should interview Chinese high school students to accurately gauge their abilities:

[The interview] ought to be focused, detailed, and deliberate. Here are some examples of good interview questions that look for empathy, imagination, and resilience:

Pick a novel or a movie, and discuss the characters. Which character did you identify with? Why? Which part of the book or movie made you sad? Made you angry? Why? What experiences have you had that remind you of events in the book or movie?

Pick a memorable experience, and explain why it was so memorable. Tell the story. Explain your feelings during the experience. Why did you have these feelings? Do you know anyone either real or fictional who has had a similar experience? Did they behave the same as you did? Do you think their feelings were the same as yours?

When was the last time you were angry or sad?

What made you angry or sad? How did you get over your anger or sadness? What do you think will happen the next time you encounter the same situation?

Persist in asking "why?" Look for sincerity, for logic, and for clarity of thought.

What Jiang describes is due diligence, pure and simple and tailored to the specific situation, just as it should be. And it is precisely what many American universities have not done. As a recent report on American Public Media's Marketplace made clear, many American universities, desperate for students who will pay full tuition, have been contracting with Chinese placement agencies to deliver students. If a student gets admitted to an American school, the placement agencies get paid the equivalent of $6,000, usually by the students' parents; the American universities pocket the hefty tuition. Needless to say, the American universities have been shocked – shocked! – to discover that the Chinese agencies were falsifying students' applications on a massive scale.

Employers ought to be similarly skeptical when hiring employees from China. Don't take resumes or transcripts for granted; check references and confirm employment histories. This means contacting schools and employers in China. Most of all, it means conducting a meaningful interview.

Let's be clear: the truth about cheating in China is considerably more complex than anything captured by a single statistic. Some bloggers (either more cynical or more realistic, depending on your perspective) take these stories as an example that "lying" simply doesn't mean the same thing in China as it does in America, or that Chinese are amoral and have no common values. I like sweeping generalizations as much as the next guy, but this seems a bit harsh, to say the least. My personal view is that these stories have less to do with China and more to do with human nature. When the rewards are high and the consequences of getting caught are minimal, people will cheat. Heck, people will cheat even when the risks are high, as evidenced by recent front-page stories about cheating right here in America, both by students and by schools.

The admissions departments of American universities are learning a lesson that businesses dealing with China have already learned the hard way – or will soon enough. If a deal (or a person) sounds too good to be true, it (or he or she) probably is.

Excellent New York Times article (is it just me or has the NYTimes really picked up its China coverage both in terms of quality and quantity in the last six months or so?), entitled, Picking Brand Names in China Is a Business Itself. The article reaffirms what we are always telling our clients: get help from China branding specialists in choosing your brand name for China.

The article talks of how "China is a place where names are imbued with deep significance" and of how "an off-key name can have serious financial consequences." And, just as is true in the United States, choosing a "brand name that resonates" "has become a sort of science, with consultants, computer programs and linguistic analyses to ensure that what tickles a Mandarin ear does not grate on a Cantonese one."

The article goes on to discuss the following good branding of Western companies/products in China:

• Coca-Cola. Called Kekoukele in China, "which not only sounds like Coke’s English name, but conveys its essence of taste and fun in a way that the original name could not hope to match."
• Tide detergent. Called Taizi, "whose Chinese characters literally mean 'gets rid of dirt.'”
• Reebok. Called Rui bu, which means "quick steps.”
• Colgate. Called Gao lu jie, which means “revealing superior cleanliness.”
• Lay’s snack foods. Called, Le shi, which means “happy things.”

The article goes on to note that some brands use foreign-sounding names in China that have no meaning, but lend "a cachet that a true Chinese name would lack, such as Cadillac (Ka di la ke) and Hilton (Xi er dun), which "employ phonetic translations that mean nothing in Chinese."

In its funniest part, it also discusses the harm that can result from choosing the wrong name for China:

Peugeot (Biao zhi) sounds enough like the Chinese slang for “prostitute” (biaozi) that in southern China, where the pronunciations are especially close, the brand has inspired dirty jokes. And in China, the popular Mr. Muscle line of cleaners has been renamed Mr. Powerful, (Weimeng Xiansheng). The product’s maker said in an e-mail that it had forgotten why.

But it could be that when it is spoken, the name Mr. Muscle has a second, less appealing meaning: Mr. Chicken Meat.

So what are the two things you must know when choosing a brand name for China? One, enlist specialised help. Two, once you have chosen your Chinese brand name (and spent time and money in doing so), you are going to need to protect it. For that, you must trademark it in China.

What do you think?

Though we often talk generally about what it takes to form a company in China, a reader recently pointed out to me that we have never set out the basic steps one must take to do so. The following sets out the basic steps a foreigner usually must take to form a Wholly Foreign Owned Entity (WFOE) in China. For more information on what is required to form a company in China, check out How To Start A Business In China -- WFOE and How To Start A Business In China -- The Minimum Capital Requirements For A WFOE.

 Forming a WFOE in China typically requires the following:

1. Make Sure Your Business is Legal For Foreigners. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. For example, until recently, China prohibited private entities from engaging in export trade. Be sure your business will be legal.

2. Provide The Proper Documentation. The investor in the WFOE must provide the documentation from its home country proving it is a duly formed and validly existing corporation or Limited Liability company, along with evidence showing who from the investor is authorized to execute documents on behalf of the investor. The investor also often must provide documentation demonstrating its financial adequacy in its home country. 

3. Investor Documents Needed. The Chinese government normally requires the following documents from the investing business entity:

• Articles of Incorporation or equivalent (copy)
• Business license, both national and local (if any) (copies)
• Certificate of Status (original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)
• Bank Letter attesting to the account status of the investor company (original).
• Description of the investor's business activities, together with added materials such as an annual report, brochures, website, etc. The first four of these must be in Chinese. The last one may be submitted in English, with a Chinese summary.

4. Consider Forming a Special Purpose Company to Own the WFOE. Many investors create special purpose companies to serve as the investor in China. China's company regulators have become accustomed to this process. However, the Chinese regulators will often still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. It is common to form a Hong Kong company for this purpose and there are often tax benefits in doing so. 

5. Secure Chinese Government Approval. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the company registration process. If the project is not approved, the company will not be registered. 

6. Compile and Provide These Documents for Chinese Government Approval. The following documents must usually be prepared and then submitted to the Chinese government:

• Articles of Association. This document will set out all the details of management and capitalization of the company. All basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.
• Feasibility Study. The project will not be approved unless the local authorities are convinced it is feasible.This usually requires a basic first year business plan and budget. We typically use a client produced business plan and budget to draft up the feasibility study (in Chinese).
• A Lease. An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into into account in planning a budget because the governmental authorities will be expecting this.

7. Compile and Provide These Additional Documents for Chinese Government Approval. You will also usually be required to provide the following documents:

• Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from around 30% to 40% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these benefit amounts. The required initial investment includes an amount sufficient to pay salaries for a reasonable period of time (usually one year or more) during the start up phase of the Chinese company. These documents must be in Chinese.
• Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.

8. The Approval Process. It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. Large cities like Shanghai tend to be slower than smaller cities. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital. On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory may have serious land use or environmental issues. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset.

if you comply fully with the above, your chance of getting your WFOE approved is nearly 100%.

I must get some form of the following at least twice a week:

"I just received a shipment of bad product from China and the Chinese company is ignoring my requests for a refund. What do I do?"

Needless to say, my initial answer is always, "that depends" -- after all, I am a lawyer.  It depends on the following:

1. How much is at stake.
2. The history of the relationship with the Chinese company.
3. The city in which the Chinese company is located.
4. The legitimacy of the Chinese manufacturer.
5. The nature of the defects in the product.
6. Whether there is a written contract and, if so, whether that contract clearly addresses the defect.
7. What the contract says about dispute resolution.

Nine times out of ten, I pretty much instantly tell the caller/e-mailer that it makes no sense to involve my law firm, usually either because the amount at stake is too little or because there is no contract on which to base a legal claim. They then ask what they should do and I tell them to try to find a China licensed lawyer who will take the case on a contingency fee basis or just keep trying on their own. If they ask about involving "the Chinese government" or the US Embassy/Consulate, I tell them that if they want to try either or both of those things, they should, but that I am not aware of a single example where doing so has helped anyone. 

I have learned that my advice is not terribly different from Mike Bellamy's, who wrote an article entitled, "Is It Too Late to Do anything if I receive bad quality products?"

Mike sets out five "essential check points," which he says if you cannot "check off," the best advise for you is probably just "to learn from your mistakes and do things right on your next order.

Mike writes that foreign buyers of Chinese product who have the following five items in place, "have a decent chance of negotiating a resolution that is acceptable":

a signed / chopped contract that clearly defines what is the acceptable level of quality

a clear paper trailing showing proof of payment

the seller named on the contract matches the receiver of the payments. (With so many trading companies out there it is a common mistake to have a contract with a supplier but pay a trading company!)

your supplier has physical and financial assets (small “one-man-bands” disappear as soon as they feel a lawsuit is on the way)

the jurisdiction on the contract matches the location of the supplier’s assets at a city, province or country level.

He then adds that "it is always nice to have future orders you can leverage as well."

Good advice.

What do you think?

It's been years since I've written about the etiquette at Chinese banquets, but just saw a really good post (with really good comments) on the subject, so i cannot resist. The post is at Seeing Red in China and it is entitled, "Banquet etiquette for gaining face." Nothing new or unusual there, but very nicely lays out how to act at a Chinese banquet so as to make a good impression.

Before I talk about Seeing Red's post, however, let me set out the two key things you have to know about these events, beyond which, all the rest is commentary:

1. Don't sweat the small stuff. Nobody is going to expect the laowai to know every aspect of Chinese banquet etiquette. Read Seeing Red's post, be respectful, have fun, and try your best, and you will do just fine.
2. You have to go and you have to partake, at least a bit. Acting as though you can and should do business in China just the same as you do business in Kalamazoo.  I am not telling you to discard your values. Not at all. But I am saying that you should be flexible. When in Rome....

Seeing Red's post discusses the following aspects of a Chinese banquet:

• The Seating. I have found that the key here is to hang back and wait for the host/leader to instruct you where to seat. It matters!
• "Saying No" on food. I do not eat meat so I have to say "no" more than most, but I have never found this to be a problem. I do not think it right for my eating habits to influence a table of 6-12 so I typically do not mention my not eating meat until the food has come, at which point if anyone asks me why I am not eating a meat dish or looks askance at that, I explain that I do not eat meat. This usually leads to a long discussion as to why I do not eat meat and then that's it. I always play up the fact that I love Chinese food and that I love the tofu, the noodles, the fish and the green beans (all true) and nobody seems to care at all. Seeing Red would say it is because my not eating particular dishes reflects solely on me and not on the host's choice and so the host has lost no face. Again though, I do make it a point to gush over the best dishes, but since I love food, that is no problem.
• Toasting/alcohol. I love toasting but I am, admittedly, a wimp when it comes to drinking. Let's face it, most Americans are. So what I do is what one of the commenters suggested. I talk up the beer and joke about the baiju. If you can avoid the baiju, you have a better than 50-50 chance of making it out alive.

I also should note that most of my big meals in China are with Chinese law firms with whom my firm has had long term relationships. Virtually none of these lawyers smoke and they are generally more worldy/civilized (I am betting) than factory owners in Handan. This means that the pressure they exert is probably far less than at a typical China banquet and so I would love to hear more from those who attend these in their more basic form. China banquets. What say you?

Interesting post over at the All Roads Lead to China Blog. The post is called "Developing Trust in China by Building Trustworthy Systems," and it starts out talking of a client who "just want[ed] to get our Chinese suppliers to the point where I can trust them. That they will do the work without constant supervision." I know that lament, having heard it dozens of times from my clients.

All Roads gives a good answer on how firms should "operate" in this sort of market. His answer is not an analysis of how to determine what Chinese companies can be trusted or how to find such companies. Instead, it advocates you, the foreign company, set up systems for monitoring your Chinese supplier that you can trust:

Systems that can, regardless of human ignorance, greed, inaction, confusion or incompetence, remove the downside risks that comes with the human element of any process. Systems that at the heart of it, are established to minimize human impact, alert system operators (buyers/ clients) of a failure, and provide the data necessary to make changes to the system (human or mechanical). For me this is a system, as basic as it is, that allows for the most protection for a firm who is engaging with any external party, and in a way where “trust” isn’t an issue.

All Roads then gives a great example of a that set up such a system for building a "simple construction tool," the goal of which was "to catch problems before they went to market." All Roads then describes, in necessarily painful detail, this client's system. Then he notes this was a system that worked "because it removed the 'trust' factor with a process that had numerous checks along the way and was fair to all involved."

All Roads has it right. Once you have picked your Chinese supplier, you really have no choice but to trust them to some extent and there really is no point in debating how much you can do so because you probably cannot afford to be wrong. You need to set up systems so that trust is pretty much taken out of the equation. A couple years ago, I wrote a post, entitled, "Manufacturing Product in China. Trust Yet Verify." I'm thinking I should have called it "Manufacturing Product in China. Trust Yet Systematize."

What do you think?

China Media Monitor Intelligence (CMM-I), based in Beijing, is the leading independent business to business intelligence resource for the Chinese media industries. CMM-I analyzes China’s media industry, with a strong focus on content across film, TV and New Media platforms. CMM-I recently interviewed our own Mathew Alderson for CMM-I’s  sector report, "Feature Film Co-production in China," which is scheduled for publication next month. With CMM-I’s permission, I have asked Mathew to do a series of blog posts based on the interview. Here is the first post in that series: 

CMM-I:  Can you explain the main legal challenges that Chinese and foreign producers face when they decide to co-produce feature films?

Alderson:  The most common law-related mistake I see is the failure to bring on experienced China-based film lawyers early enough. Projects are generally in post or initial theatrical release before producers give proper consideration to legal issues in China and by this time it is usually too late. Insufficient attention is given to the issue of garnering a share of the box office, remitted from China and received in the foreigner’s home jurisdiction. Producers also often fail to pay sufficient attention to the approvals needed for filming or to the fact that taxes must be paid in China before their share of box office can be remitted to their home jurisdiction. 

On the flip side, Chinese companies that are engaged in co-productions with foreigners too often fail to account for how foreign rules and regulations can impact their foreign partners and therefore the film itself.

CMM-I:  Can you give an example of a planned co-production that ran into legal problems that eventually caused the termination of the project? Which legal issues were responsible for that?

Alderson:  The legal problems I have seen have tended to arise only after production has been completed. 

CMM-I:  Can you name instances where not complying with China's rules resulted in any kind of punishment like monetary fines or even jail time? 

Alderson:  Chinese film-maker Lou Ye’s first feature film, Weekend Lover (1995) (周末情人), was banned for two years before being released and his second major film, Suzhou River (2005) (苏州河), is still banned in China. The latter movie caused Lou to be banned from film-making in China for two years after he showed it at the International Film Festival Rotterdam without approval. After premiering his movie, Summer Palace (2006), (颐和园) at the Cannes Film Festival in 2006 Mr Lou was again banned from film-making for five years. Summer Palace was entered into Cannes without SARFT (State Administration of Radio, Film and Television) approval.

CMM-I:  What can smaller producers do that are just interested in co-producing once in China and won’t achieve big box office revenue in China anyway? Is a joint or assisted co-production a desirable vehicle or are the bureaucratic barriers too high to make getting an official permit desirable? 

Alderson:  All forms of foreign production require compliance with Chinese law and smaller producers are not exempt from this. I have seen several cases recently where low-budget features were shot in China without the necessary approvals. The films made it out of China, but the producers then had trouble with the assurances they needed to give to distributors and exhibitors about the absence of illegality or claims in relation to the films.  I am always saying that producers need to remember that they give these sorts of assurances to their investors and completion guarantors as well and their failure to comply with them could lead to claims for repayment of funds invested or a refusal to pay a tranche of investment when due.

CMM-I:  Does a “triangular” co-production between Mainland China, a foreign country and Hong Kong reduce or increase the complexity of the legal framework for co-productions compared to co-productions between Mainland China and third countries that don’t include Hong Kong? 

Alderson:  The level of complexity is more or less the same and there can often be tax advantages by involving Hong Kong in the deal. However, it is important to remember that China’s film authorities treat Hong Kong investors and producers as foreigners. 

CMM-I:  The Chinese government currently tries to promote Chinese culture throughout the world to create a positive image of China. Does this result in any government support for co-productions as a vehicle to achieve that goal?

Alderson:  Yes. The Chinese government encourages its producers and media companies to conduct at least a portion of their business outside China. One challenge Chinese media companies have faced (and very likely will continue to face) is that foreign audiences are not necessarily interested in the Chinese historical dramas or period pieces popular with the Chinese government and with many Chinese viewers. Additionally, the Chinese construct and tell stories in a very different way than the West.

If you want to read more about the legal issues related to flims in China, check out the following:

• Sino-Foreign Film Co-Productions in China
• Making Films in China. You Talkin' To Me?
• China's Sino-Foreign Film Co-Productions. Show Me The Money.
• Protecting Hollywood Films in China Makes Sense For China

Topics to be covered in further posts in this series will include film finance and the Chinese regulatory environment.

The following is a guest post from one of our readers in Iceland, Neil Holdsworth. Neil has been updating me via email regarding a Chinese investor who is seeking to purchase a massive amount of land in Iceland and the controversies that have been attendant to that. When he asked me why I don't write a post about it, I asked him the same question and the below is the result. 

As has been reported extensively elsewhere, China has taken an interest in Iceland as a potential location for a deep sea port on arctic shipping routes and as a future source of fresh water. Though China has not shown signs of embarking on an Africa-style resource grab in Iceland, it obviously has a long term strategic interest in the country. It is proposing to develop what will be by far the biggest embassy in Reykjavik, raising eyebrows among the country's 320,000 inhabitants.
 
Despite Iceland's being part of the European Economic Area, investment opportunities for outsiders here are limited. However, the tourism industry is open to foreign investment and a number of successful tourism related businesses are seeking finance for expansion. Financing is nearly impossible to obtain in Iceland because of its banking problems (there are mostly no new loans, only old loans being renegotiated and written off). For this reason and others, the government is keen to attract foreign investors in this sector.

Instead of buying into relatively safe and established companies, this China group is trying to do something much more symbolic and grand. China wants to come to Iceland's rescue, but on China's own terms and in its own way -- buying no less than 0.3% of the land mass of the country and unveiling a vision of a new Chinese sponsored tourism in the country. China-based investors are proposing two huge hotels, a new airline, golf courses to be built in the mountains, horse riding, and hot air balloon rides. And all of this is going to happen year round.
 
This vision for Iceland makes little commercial sense and is very unlikely to work, mainly because for about 80% of the time in Iceland, the weather is so miserable you can't go outside for more than a few minutes at a time. What probably started as a genuine and good natured attempt to invest in an area of the economy in which Icelanders are desperate for investors, has descended into a fiasco. Everyone wants to know why the Chinese investors need 300 square kilometers of land for a hotel, and Mr. Nubo, who is heading up the investment from the China side, has no convincing answer.

Mr. Nubo is saying the controversy is making him think about taking his money elsewhere. Iceland's  interior minister (from whom approval of the deal is necessary) has responded to the effect that he is more interested in looking at speeding up the approval times for residency permits, than in dealing with Mr Nubo, who can wait in line with everyone else.

Though buying up 300 square kilometres of overgrazed wilderness does not confer rights to build a Chinese military base in the Icelandic countryside, there are some people here [in Iceland] who seem to believe that. Even if Mr. Nubo and his group buy the land, Iceland will still require they secure planning permission and pass Environmental Impact tests, for whatever it is they want to do with it. Whatever Mr Nubo's motivations for his project, this episode does demonstrate how suspicious people are of China, and of how little soft power China actually has, particularly in the West.

Indeed, the most believable analysis I have heard of the project itself is that China wanted to help Iceland out and so it sent over a property developer/poet/cat lover/arctic explorer with connections to the Icelandic Social Democratic party to invest in the one area of Iceland's economy where foreign investment is tolerated. Despite this, it has all backfired spectacularly. As someone who lives part-time in Iceland and who is cautiously optimistic about China's role in the world, I'd suggest that if China wants to use FDI as a way of building up good will among Icelanders, it consider building a brewery in my town of Flateyri would achieve a lot more (and cost much less) than golf courses and five star hotels. 

11-26-2011 Update.  Iceland has rejected Mr. Nubo Huang's purchase of this land, saying that it is incompatible with Icelandic laws. An article on this can be found here.

Yesterday, co-blogger Steve Dickinson wrote a post essentially excoriating VIEs. That post went live early this morning. A few hours before our post went live, Bill Bishop (who knows as much about China's tech industry as any human being alive) wrote a post essentially saying that those who are trashing VIEs are engaging in scare tactics and that there is little cause for worry.

Bishop makes his very powerful counter-argument on his Digi-Cha blog, in a post entitled, "Bloomberg Keeps VIE Fears Alive: China Companies Evading Rule With U.S. Listings Stump Regulators." Bishop contends that "so many powerful interests have financial stakes in VIEs that it would be career suicide or worse for a Chinese bureaucrat to destroy this structure on a wholesale basis." We do not disagree with this statement, but we do not think it deals with the two main issues. One, the government has come out with regulations making very clear that such structures are illegal. On top of that, and as we have said all along, these regulations probably should not have even been necessary because VIEs were almost certainly already illegal under a proper reading of the various applicable laws. Having said this, however, we fully recognize that the Chinese government has in the past come out and said something was illegal and then done nothing about it. See, for instance, "China Rules Skype Illegal. Tell Me Something New," where we predicted that the government's making Skype "illegal" would have no real impact.

But with VIEs it is different and Bishop does not address our main point (note again that his post came before ours).

Whether or not existing VIEs are shut down (and at this stage we tend to agree with Bishop that they generally very likely will not be), the reality is that they have now been deemed illegal and that cannot help but have a major and game-changing impact on them. As mentioned above, VIEs are a structure that allows foreign companies to control the Chinese entity via various contracts. Now that those various contracts have been declared illegal, it will be difficult/impossible to enforce those contracts in Chinese courts. In this VIE structures, many of the contracts involve foreign countries and foreign country enforcement so their illegality in China may be minimized to that extent. However, even outside China, the party seeking to avoid enforcement of a contract will, in many cases, still be able to argue against enforcement based on China's having made the structure illegal. 

In many ways, what is happening to VIEs is no different from what we have called "fake Joint Ventures" and on which we wrote in the post, "Fake China Joint Ventures: Why You Calling Me, I'm Not The Guy:"

In that post, I very loosely transcribed into one conversation a number of conversations I had been having with people wanting to set up contractual arrangements to avoid China's expensive and difficult joint venture laws:

Caller: I've got this great website and it is exactly what China wants/needs. And I've been working on developing it with some Chinese tech friends of mine and we want to take it legal so we can start getting VC (venture capital) funding for it. Here's our plan. Now I know that the old/truly legal/expected/usual way to do this is for me to form my own company and then form a joint venture with my Chinese partners, but I also know that will cost a lot of money. So our plan is for the Chinese company to own the website and then we will have an oral agreement (or a written agreement) that I really own half of it.

Me: Listen, my firm has been contacted at least twenty times after these situations have gone bad and I am aware of at least another twenty times where the same thing has happened, and let me tell you, these arrangements (it is NOT proper to call these joint ventures) virtually always end the same way. They end with the Chinese company booting you out completely and leaving you with no recourse. Protecting foreign companies in legitimate joint ventures is difficult enough, but it is pretty much impossible under the scenario you are describing. We had a guy who paid us a lot of money once for us to do everything we could to try to get "his" multi-million dollar business back. Guess what, we could not even come close to getting it back. Every Chinese lawyer we talked to about suing to get it back told us we had no chance of winning at all. I mean, just listen to the argument we would need to make to the judge:

Your honor, my client knew that China's laws are very clear on what foreign companies must do to operate legally in China, but he thought these very clear laws should not apply to him because, well because he is an American tech company and he was just too smart/too poor to bother to comply with the very clear laws. So instead, he had this great method for completely circumventing China's very clear laws. His idea was to not form a company, but rather, have his Chinese friends form the company and he would have a little side deal with that company. Well, that side deal has now gone bad and my client wants you to go against China's very clear public policy on how foreign business is to be done in China and enforce this unwritten side deal.

What do you think of that argument?

Caller: (long pause) I understand things could go wrong with that kind of arrangement, but would you be willing to draft the contract between me and the Chinese company?

Me: No. I can't do that. I can't draft a contract that I know will never work. I just can't. Give me a call if you ever want to do this legally, in a way where you actually have a chance of profiting from your work down the road.

For more on this, check out "China SMEs, Own If You Want To Own." To get a feel for how difficult it can be even with a fully legal joint venture, check out this article by Steve Dickinson in China Brief, entitled, "Avoiding Mistakes in Chinese Joint Ventures." and this Wall Street Journal article I wrote, entitled, "Joint Venture Jeopardy."

Update: In, "Private Equity, Venture Capital and ‘Fake’ China Joint Ventures," China Hearsay very nicely maps out the way these deals are typically done (using an offshore holding company) and notes that you might have legal recourse in the rare instances where your Chinese partner has "huge assets offshore" in a country in which you can sue and win:

You can tie up the Chinese founders in 100 different contractual knots, but unless those founders have huge assets offshore (real assets, not equity in the holding company) that you can go after in a dispute, they can always tell you to piss off and kick your ass out of the business.

All I can say is that I have never and I will never invest in a company based on so thin a reed.

FULL DISCLOSURE: Our firm long ago made the decision to work with those companies and individuals with claims based on the arrangements set forth above, as opposed to representing those wanting to enter into such arrangments.

THIS JUST IN: Stan Abrams over at China Hearsay is out with a post, entitled, "A Post-Holiday Update on VIE Chatter," that essentially says what this post says, which is that the dividing line between Bishop and us is that Bishop is analyzing what the government is likely to do with existing VIES while we are analyzing the risks involved in having a corporate structure based on unenforceable contracts. Stan completely nails it when he says he thinks the differences between us and Bishop stem largely from the angle from which we are looking at the VIE issues:

Anyway, I have nothing new to say, but I did want to point out a couple of new things for you VIE groupies to read. First is a lengthy Bloomberg overview of the issue. It’s generic, and therefore a decent place to start if you’re looking for a jumping-off point to the topic. Second and third are two opinion pieces, by Bill Bishop (DigiCha) and Steve Dickinson (China Law Blog), who sort of set themselves up on opposing sides of the issue.

It was interesting reading these two blog posts, since both authors are wicked smart, experts in their respective fields, and very opinionated (not that there’s anything wrong with that).

Stan then describes Bishop's post as putting forth “The sky is not falling” position and Steve's post as "VIEs are complete rubbish and should be avoided like the plague." Stan then notes how the positions appear very different, but maybe not so:

So, at first glance, two very different views, and I bet they would get into a serious argument if the opportunity arose. But I actually think that their fundamental conclusions are both right but are merely coming at the issue from two very different perspectives. Bill is a Internet and finance guy, and is looking at the market, firms’ access to capital, and what the government is likely to do.

Steve, on the other hand, is a corporate lawyer. He is looking at potential risk, at what might go wrong, and what is/is not a technical violation of the law.

When Bill says that we shouldn’t worry about the government going after Chinese listed firms in the U.S. that use the VIE structure, I think he’s right. All the inside chatter on that issue seems to indicate that the government will grandfather in those companies even if it adopts a new enforcement strategy.

And when Steve says that VIEs are rubbish, he’s of course right. These things are illegal in that their purpose is to deliberately skirt foreign investment restrictions. I don’t actually agree with him on what the M&A rules mean (I think it’s too early to tell), but I definitely agree with his overall legal opinion.

Stan then goes on to say essentially what I say above, which is that the story is not the shutting down of VIEs, it is the inherent risks they present by being based on illegal contracts:

All this being said, if I have one bone to pick with recent commentary on this subject it’s that it emphasizes the latest regulatory goings-on without paying attention to the real risk story with respect to VIEs. The most likely source of problems with these companies has nothing to do with the government, but rather with unenforceable contracts and unstable shareholding structures. Perhaps this is one of those things to which Bill was referring when he said that there are other reasons to be cautious about investing in China. (I should also point out that Steve regularly writes about these sorts of legal issues as well.)

I completely agree.

UPDATE: Fredrik Öqvist over at the China Finance Blog did an excellent post today, entitled, Consolidating Recent Opinions on VIEs, in which he seeks to synthesize all the posts that have been written on VIEs in the last few days by me, by Steve Dickinson, by Stan Abrams, and by Bill Bishop. Fredrik concludes his post with his own take on VIEs:

Here’s where I think the real issue lies, but I don’t think it’s entirely confined to future deals and PE/VC investors. This could for all intents and purposes have a deeply negative impact for listed companies as well.

In order to consolidate VIEs one has to show that the listed company not only receives the economic benefits and takes the economic risks of the venture, a second condition is to show that the VIE is in fact controlled by the listed company. If the contracts, which are put in place to establish this control, are indeed deemed illegal and unenforceable, fulfilling the second part of the consolidation requirement becomes decidedly more difficult.

I agree.

Just watched a video on Shanghaiist, entitled, Everything You Need to Know About China in Ten Minutes.  I love stuff like this and before anyone leaves a comment pointing out the shortcomings of this video, let me state that I realize it is not an encyclopedia. But if you are about to get on a plane to China or about to start doing business with China, there are definitely worse and less enjoyable ways to learn about China than watching this video. Or as Shanghaiist so nicely put it:

Okay, probably not everything you need to know, but this video certainly makes the best attempt we've seen so far. They cover everything from economics and regional development to eating habits and even how the concepts of face and guanxi can influence corruption. Despite a few weird mistakes made by the narrator (like China's "five million year history") the entire film is very well made with lots of aesthetically pleasing infographics. Seems like the perfect primer for anybody looking to absorb China 101 over their lunch break.

So I say, watch it and enjoy. What do you say?

The other day we wrote about how to shut down a China WFOE. One of the solutions I suggested was to just let the company slowly wither on the vine, without formally shutting it down. The advantages of this solution are that there is no large cost for getting squared away with the government and there is still an existing WFOE, available should it make sense to revive it at some later date.

In response to this suggestion, we received the following comment/question:

Btw, do you think there will be a secondary market for such 'dormant' shells?

My answer is no. The benefit of buying such a shell is that it would give its buyers are WFOE fast and probably fairly cheaply. However, the disadvantages will almost always outweigh the advantages. The biggest disadvantage is that it is very unlikely that the scope of the dormant WFOE will line up exactly with the scope desired by the potential buyer. 

In a post entitled, "How To Form a China WFOE. Scope Really Really Matters." we discussed the importance of a WFOE having a proper scope:

BUT -- and this is why I am writing this post now -- if you under or overreach on the description of your business scope, you might find yourselves in big trouble.  We are getting an increasing number of calls from American companies in trouble with the Chinese government for doing things in their business that were not mentioned in the business scope section of their initial WFOE.

In some cases, the companies have admitted to us that they were never "really comfortable" with the business scope mentioned in their applications, but that the company they had used to form their WFOE had "pushed" them into it as it would "make things much easier." In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the company probably would never have been approved at all had it been upfront and honest in its application. In nearly all instances, the companies had managed to secure local approval but were now in trouble with Beijing, which constantly is auditing these applications. In one instance, the local government went back and changed its mind, probably after conducting an audit of its own.

I cannot go into any more detail on these matters, but I can give this advice: applying for a WFOE in China involves a heck of a lot more than just filling out a form and getting approval. It does matter for what you get approved and you (or whomever you are using for your WFOE application) need to know China's foreign investment catalog inside and out before applying. You then must tailor your application to meet both the requirements of the foreign investment catalog AND the reality of what you will be doing in China. A failure to comply on both fronts will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.

The odds a dormant WFOE seller's scope lining up perfectly with that of the WFOE buyer are just too slim. On top of that, the cost of conducting the due diligence on the dormant WFOE, coupled with the risk of missing some latent liability, are likely to be greater than any cost savings that might be realized by not having to pay to go through a WFOE formation from scratch. The biggest benefit in buying a WFOE would be speed, but it is going to be the rare instance where saving a few months will warrant the extra risk.

I have not participated in the buying or selling of a dormant WFOE nor am I aware of anyone else who has. I just ain't seeing it.

Have you?

Whenever I am asked about what I get out of this blog, I never fail to mention something along the lines of "information from our readers." Both co-blogger Steve Dickinson and I are always talking about how we are the rare lawyers who love our jobs and we both list "learning something new every day" as one of the reasons for that.

When I had been practicing law for around three years, I was offered a prestigious in-house position with THE company in my hometown. I almost took the job, but something someone said from the company made me decide against it. One of the in-house lawyers talked about how much he liked feeling that he had "mastered the company and mastered his work." I interpreted him to say that his work had become routine and easy and I did not like that comment then and I like it even less now.

My work is not routine and I doubt that it ever will be. Chinese laws are forever changing as is China's enforcement of them. This means that my firm is constantly having to adjust in terms of the advice we give our clients. On top of that, every client's situation is going to be at least a little bit different than the others. In other words, we as lawyers cannot get cocky, cannot get tranquil, and cannot remain static and expect to remain at the top of our games. We need to keep on keeping our ears open, keep on learning, and keep on developing our craft. That is what I love about my work and that is what I love about having this blog.

This blog is a great source for our own learning and the comments left by our readers are at the heart of that. We first posed the question, "What do you think?" back in early 2006 and we have posed it thousands of times since then. We do it because we sincerly want your comments. 

When we were just thinking of doing a blog, we drafted a mission statement to help guide us. That statement has barely changed and the following paragraphs imploring comments have not changed at all

It has become a blog cliché to implore readers for their input, but it is so important we must join the crowd on this. We do not purport to know everything about Chinese law. That is impossible. Our strengths are forming companies in China, drafting international contracts with Chinese companies (in English and in Chinese), intellectual property protection and international litigation and arbitration. We welcome your comments, suggestions and ideas on any area of law relating to conducting business in China. China is anything but monolithic and we will be relying in large part on you, our readers, to round out this site with your own stories.

In plain language, we ask that you write us early and often. We will review your comments before we post them, but that does NOT mean you should not criticize us or disagree with us. Our review will be to filter out comments that are without substance and/or personally abusive. We want to encourage a high level of discussion, but we will not ban or delete your comments just because you come after us.

Interestingly but unfortunately, though our readership seems to grow pretty much every month (we are now allegedly the third most read English language law blog and the fifth most influential), the numbers of comments has declined a bit, due in large part (I believe) to the fact that a much greater percentage of our readers view us from their blog readers without ever actually alighting on our site.  Both we and our readers benefit from your comments so please keep 'em coming.

What do you think?

I am often asked by my clients what they can do to minimize the risks of getting stuck holding the bag when the product they import from China either injures consumers and/or needs to be recalled. My first answer is usually “not a whole lot” and then I talk about how they need to inspect the product as best they can and “get a really good insurance policy.” I then talk about how difficult it can be to sue and collect a full award from a Chinese product manufacturer.

It is possible to require your Chinese manufacturer to secure product liability insurance, but this comes with its own problems. First, many Chinese manufacturers will simply refuse to get this sort of insurance. Second, many will say they will get it and then never will. Others will say they will get it and then show you a fake policy and unless you are well versed in such things (and few are), you will never know the difference until you seek to collect on it. 

As for suing your Chinese manufacturer, that is possible, but it is usually fraught with difficulty. If you have a properly drafted written contract between you and your manufacturer, it will contain an appropriate choice of venue provision that will allow you to sue the manufacturer in a jurisdiction (probably China) where it has assets against which you can collect any judgment you receive. The problem is that it is unlikely both that the Chinese court will reward you the full extent of your damages and it is even more unlikely that your Chinese manufacturer will have the cash on hand to pay it in any event. 

Provided you have properly drafted your manufacturing contract, arbitration is another option. There are essentially two main ways you can go in terms of drafting your arbitration provision. The first is to call for arbitration outside Mainland China, either in your own country using your own country's laws or in a neutral country using that country's laws. If you wish, you can arbitrate in one country under some other country's laws, but that usually does not make sense. Both China and the United States are parties to the New York Convention on the Recognition and Enforcement of Foreign Arbitration Awards, which means that China has signed on to enforcing United States arbitration awards.

We see two problems with this sort of arbitration provision. First, Chinese manufacturers almost never agree to them. Second, though China is required by the New York Convention to enforce U.S. arbitration awards, it may refuse to do so on “public policy" grounds and this exception can be a big enough loophole to drive a truck through. 

We have become fans of Hong Kong and Singapore and Canadian (particularly Vancouver) arbitration both because Chinese companies are much more willing to agree to arbitration in these jurisdictions and because we have the strong sense that China's courts are more willing to enforce arbitration awards from these countries. Not surprisingly, Hong Kong is typically the best for this, with Singapore second, and Canada third. Hong Kong is a great place for arbitration, but it is very expensive. 

Your second option is to arbitrate in China. The China International Economic and Trade Arbitration Committee ("CIETAC") is the best known arbitration center for foreign related arbitrations, but there are some others that are pretty good as well. Around 25% of CIETAC arbitrators come from outside China.  

CIETAC arbitration is well priced and fairly reliable and its awards have a very good chance of being enforced in China's courts. You should be extremely careful when drafting a CIETAC arbitration clause as they can easily contain pitfalls for the unwary foreigner. Just by way of example, I have had to tell many an American company that their failure to specify English as the language of the arbitration means that it will be in Chinese.

There are all sorts of issues that can arise in trying to protect your company from bad or harmful product coming from your Chinese manufacturer. Unfortunately, there is no one best solution and certainly no fool-proof one. In the end, the best solution will likely be some combination of a good and well-heeled manufacturer, a good contract, and a good insurance policy (certainly for you and for your Chinese manufacturer as well, if possible).

What do you think? 

I spent my junior year in high school in Istanbul, Turkey. Before I left Istanbul, I sold all of my English language t-shirts for around three times what I had paid for them new. I remember getting $30 for my  "Harris County Community College" t-shirt, which should have had no value to anyone other than me (or anyone else with the last name "Harris") or to those who attended that school.

What has always bothered/puzzled me is how in so many countries the only t-shirts you can buy are either of horrible quality or they say something on them like "Abercrimbie." This is generally true in China, where I gave up long ago on buying a really cool, Chinese language t-shirt for my kids.

I gave up too soon.

My law firm recently did some legal work for a company called Unlimited Delicious that just recently got into the business of selling really cool Chinese language t-shirts geared mostly toward a Western aesthetic (or at least one that my kids like).

There are two collections of t-shirts. One of the lines is Travel Hotspots and there you can get t-shirts with drawings of Beijing, Datong, Chongqing, Guilin, Guangzhou, Innner Mongolia, and Tongzhimen. The other line is called "Speak Up" and those shirts consist of drawings of pop culture references. 

If you want a great Chinese language t-shirt online, Unlimited Delicious is your place. I have even managed to snare a 20% discount for our readers who type in "CLB" right after checkout.

What do you think?

A few months ago I was talking with a Korean lawyer friend of mine about where Korean companies are locating in China. He talked of how Qingdao and Dalian were still really popular with his Korean clients, but that some of them were looking at Chengdu and a few other places "more inland." They were looking to cut costs. I told him of how very few of our clients were seriously looking to inland China.

Boy was I wrong.

Within about a week of that conversation, we were hit with a flurry of companies looking to move out from places like Suzhou and Shenzhen and Dongguan to places like Yantai, Chengdu and Datong. Two of these companies have already begun the process. Note though that I intentionally used the ambiguous term "move out from" as opposed to "leave" because in none of the cases is the company going to shut down any operations. At least not yet. Their plans are to open ancillary facilities elsewhere, see how those go, and then, based on that, decide what to do with their existing facility or facilities.  

These companies are reluctant to shut down their existing operations entirely, in part out of a concern about how the local government at their existing locations will respond. Though the local government is not legally entitled to prevent these companies from leaving, it is "entitled" to make things difficult on them by making very sure that they are caught up on all of their obligations to the government (i.e. taxes, etc.) and to their employees.

So in both instances, rather than moving the WFOE (Wholly Foreign Owned Entity) from one place to another or shutting down the WFOE in one place and opening a new WFOE in another place (or even trying to open in the new place as a branch of the old WFOE), both companies have chosen to keep their old WFOEs and form new ones in their new locales. Both are of the view that if they reach a point where moving their operations fully to the new locale makes sense, they can at that time consider whether to close down their old WFOEs or merge the old and new into one WFOE.

What do you think?

I am fascinated by China as a consumer market. I am fascinated by it for the same reasons companies have been fascinated by it for hundreds of years. 1.3+ billion people and it is not yet clear what they will be buying.

I just read the book As China Goes, So Goes the World: How Chinese Consumers Are Changing Everything and it has provided me a somewhat better sense of what China's consumers want now and will be wanting in the future. The book is written by Karl Gerth, who in 2004 wrote the book China Made: Consumer Culture and the Creation of the Nation.  Gerth is a professor of Modern History and Chinese Studies at Oxford University and in his Oxford bio he accurately describes his most recent book as follows:

Written for the general public, As China Goes explores the wide-ranging ramifications of China’s shift toward a market economy over the past thirty years, showing how China’s rapid development of a consumer culture is revolutionizing the lives of hundreds of millions of Chinese and is re-shaping the world. The book reveals why we should all care about the everyday choices made by ordinary Chinese and the deeper consequences of their seemingly small changes in lifestyles. Kirkus Reviews describes the book as “Nuanced, balanced and accessible — essential reading for anyone trying to make sense of China today.”

Gerth is an historian at heart and his book does a consistently excellent job of contrasting China today with China past. I also like how Gerth talks of the harm China's rising consumerism is causing both to China and to the world, but also writes of how this harm differs only in scope, not kind, from the harm caused by the rampant consumerism found in so many other countries around the world.

What I most liked about the book, however, is that it helped me understand just a little bit better the thinking of Chinese consumers. I say "just a little" not to detract in any way from the book, but to emphasize the vastness and complexity of the issues.

This book is very well written and very well researched. Most importantly, it makes for a very enjoyable read. I am always touting the book Chocolate Fortunes: The Battle for the Hearts, Minds, and Wallets of China's Consumers (see here and here) for those wanting to learn about China's consumers.

From now on I am going to tout As China Goes, So Goes The World as well.

A US based client of ours recently had me conduct a talk on how its people should conduct their business in China, from a legal perspective. I am not going to go through most of what I talked about because it is too legalistic and too tailored for this particular client and we have covered much of the rest on this blog already.

But I do want to relay what I talked about in terms of the general attitude i advised this company to have towards the law in China and towards the government which enforces the laws. 

I started off by talking about how Western companies often unwittingly find themselves under a spotlight in China and how the likelihood of that happening has seemed to increase. The Chinese media loves to be able to write about a Western company that is involved in a labor/wage issue or an environmental issue or a bribery issue or, best of all, a food safety issue. China's vibrant blogging and micro-blogging communities love writing about these issues as well. Since the client before whom I was speaking has a fairly recognizable name, I talked of how this made it an even "juicier" target.  

I was asked what the company might do to make itself a less "juicy" target and I said that I thought the best things it could do would be to try not to stick out for anything other than the quality of its products and to make sure that the local government knew it was there and providing China jobs and to do so now, rather than when it first needs government help.

I also talked about how this company needs to realize that abiding by Chinese standards is not going to be enough. Instead, wherever possible, it should strive to abide by the same standards in China as it does in the United States. 

Way back in early 2006, I did a post where I talked about the need to avoid giving the Chinese press/public an opportunity to accuse you of lack of concern for China:

We are aware of a large Fortune 500 retail company that is opening units in China that meet or exceed the toughest United States environmental laws.  I estimate this company's environmental sensitivity will cost them at least an additional $25,000 per unit, yet I am firmly convinced this company is doing the right thing.  This company's actions make sense because the odds are good that China's environmental laws and enforcement will get tougher over time, and building environmentally sound units now will almost certainly cost less than having to retrofit existing units a few years from now.  On top of this, people often get very emotional about the environment and I can see Chinese citizens getting very angry at a foreign company whose units in China are less environmentally sound than their units in the United States or elsewhere.  This is obviously even more likely to be the case if there were to be some sort of environmental disaster.

This is even more true today than then. 

What do you think?

If you want a watered-down, not horribly written, somewhat sanitized, quasi-westernized version of what the Chinese government is thinking (and get some decent photos to boot), there is probably nothing better than the Global Times.

The Global Times just came out with an article that says pretty much nothing new, but its coming out and saying it and its doing so in the way that it did is at least somewhat significant. The article is entitled, "Political system now China's core interest" and it essentially says that "China's political system and ensuring sustainable economic and social development" will be China's primary drivers:

The Chinese government released the White Paper on China's Peaceful Development Tuesday, redefining the scope of China's core interests.

For the first time, China's political system and ensuring sustainable economic and social development have been officially declared as being among China's core interests.

This redefinition is timely. Other items included in the core interests are state sovereignty, national security, territorial integrity and national reunification, which remain the same as before. China has been familiar with foreign challenges aimed at the four latter interests and has experience in dealing with them. However, the country lacks knowledge in how to protect these newly defined core interests in the process of reform and opening-up. 

People hold different opinions on the influence of reform on China's political system at home and abroad. There are also questions over whether reform should come at the cost of social stability, but defining these controversial topics as being among the nation's core interests shows China's decisive attitude.    

Implementing reform is difficult, and so is controlling its direction. It is as risky to make a breakthrough as restricting the areas in which reform can operate. China needs to learn lessons from those socially unstable cases to enhance its awareness of social stability. China must continue to advance its political reform, as its goal is not to subvert the country's basic political system, but to make the system more effective.

Blindly advocating change within China's political system is irresponsible. Social unrest is inevitable if a political system is rapidly replaced or abolished in a big power like China. It is unknown whether there is a political system more suitable for China. Several generations have taken over six decades to change the country's fate. China cannot pursue an illusory "political paradise" at the cost of their efforts and broader peace.

As China has increasingly become a competitor to Western countries, weakening China by disrupting its reform has become an open policy in the West. China is facing a worsening reform environment as compared to the 1980s, but it should accelerate the pace of reform according to its own needs and prevent the West from making the country deviate from this path.

Chinese society should reach a consensus on the direction of China's reform and core interests. However, China is confronted with many obstacles in reaching a consensus. Newly emerging communication platforms seemingly provide more opportunities to divide opinion.

The new expression of core interests Tuesday provided political support for society to find agreement. Such a clear official statement is helpful in eliminating some social confusion. The cohesion of Chinese society direly needs the help of the government.

Why is this important and what does it mean? It means what we here at China Law Blog have always said. That Beijing's core interest is the Chinese system and to the extent business or the economy (and certainly foreign business) conflict with that, they will be subordinated. Nothing really new here, just nice to see it articulated so bluntly and so clearly. 

What do you think?

Got an email from a client/friend yesterday with a link to an Industry Week Article and a note saying that i needed to give this "CLB's dumbest article of the month award." We do not actually have such an award (should we?) so for that reason alone, it is not in contention. Bad articles on China abound, but this one stands out because it is in a very influential magazine and because much of what it is wrong on has been repeated so often I fear it is beginning to pass for truth.

The article is in IndustryWeek Magazine and it is entitled, "Why Is China Cheaper?" It is written by Michele Nash-Hoff, President of ElectroFab Sales. She is also the author of the book, Can American Manufacturing Be Saved?  

The main point of her article is that China manufacturing is cheaper than US manufacturing for reasons that go far beyond wage disparities. I do not dispute that point, but I do dispute much of what she says in support of that claim.

Her article starts out well by describing the costing differences between manufacturing a stuffed teddy bear and a Frisbee. Ms. Nash-Hoff points out that about 70% of the cost of manufacturing the teddy bear goes to labor, whereas the labor costs make up only around 20% of the cost of manufacturing the Frisbee. She then notes how because China deals in such massive quantities of the plastic resins that go into the Frisbee, its material costs for the Frisbee will be "as low as it could be." I am not sure whether Ms Nash-Hoff is saying that the plastic resins will cost less in China than in the United States and I am not sure whether that is true or not.

Ms. Nash-Hof then tells us that labor is cheap in China because China has "one billion people living at the poverty level." This is by far the highest number I have seen listed for those living at or below the poverty level in China but so be it.

As a result, wages have finally been rising by about 15% per year over the past four years. It took suicides by workers in the summer of 2010 to achieve additional improvement in wages and working conditions at plants that were more like prison camps with dormitories for workers to live on site and fences around the buildings so workers couldn't leave the premises.

Okay.

This argument contains its own flaw. Wages in China have increased (fairly briskly) every year since the late 1980s and the average wage for workers in urban areas was four times higher in 2006 than in 1995. As Ms. Nash-Hof herself points out, wages have been rising "by about 15% per year" since 2006. With these statistics, is it really fair to claim that it took "suicides by workers in the summer of 2010" to achieve additional improvements in wages? Also, is she implictly saying that it is not fair to the United States that China has so many poor people and that those people should not be employed? Or is she saying something else?

Ms. Nash-Hof's third reason for China being cheaper is that China's workers receive "nothing" when they are injured on the job:

Third, there are the costs of compliance to health and safety regulation and environmental regulations. These costs are less expensive in China than in the United States because the Chinese government imposes few health and safety or environmental regulations. China doesn't provide workman's compensation insurance for their workers so workers hurt on the job don't receive any compensation when they are injured to the point that they are disabled.

Ms. Nash-Hof is both right and seriously wrong in this argument. Of course the cost to comply with health and safety and environmental regulations is way less in China than in the United States. I say "of course," because even if China's regulations were exactly the same as those in the United States and even if the enforcement of those regulations were exactly the same in China as in the United States, compliance would still be considerably cheaper in China. Compliance would be considerably cheaper in China because medical care and wages (and pretty much everything else) are considerably cheaper in China than in the United States.

But beyond that, Ms. Nash-Hof is right to claim that China does not enforce health and safety and environmental regulations nearly as rigorously as the United States, but she is flat out wrong to claim that China does not have workers compensation when it does and she is also flat out wrong to claim that "workers hurt on the job don't receive any compensation when they are injured to the point that they are disabled" because they almost invariably do. Again though, a worker who loses a finger in China might get $500 while a worker who loses a finger in the United States might get $50,000. I wonder if Ms. Nash-Hof is seeking an increase in workers compensation in China or a decrease of it in the United States?

Ms. Nash-Hof then argues that China's VAT law works in its favor as against U.S. manufacturing:

Next, there is the cost of taxes and duties. China is one of over 150 countries that utilize a Value Added Tax (VAT) system. It is a tax only on the "value added" to a product, material, or service at every state of its manufacture or distribution. The VAT rate is generally 17%, or 13% for some goods. Chinese companies receive a VAT refund from the government for materials of products produced for export. American imports to China are charged a VAT, but the U. S. doesn't have a VAT to charge Chinese imports.

Help me out here readers because I am just not seeing it. Maybe I am missing something here, but I do not see how China's VAT has anything to do with its manufacturers being able to produce for less. I just do not understand how charging the VAT for domestic sales, but refunding it for exports reduces Chinese manufacturing costs. Could I not argue that the VAT actually increases manufacturing costs by reducing domestic sales and thereby making it tougher to achieve economies of scale? Is not this exactly what pretty much every country does with its VAT and exactly what U.S. states do with their sales tax?

Ms. Nash-Hof then makes a completely off-base factual argument that I am seeing and hearing much more frequently of late, which is that foreign companies cannot go into China without a Chinese partner:

In addition, the Chinese government requires foreign firms to have a Chinese "partner" company, who maintains the majority interest, takes most of the profits, and has the real control of the company.

This is just false. Completely 100% false. When I wrote a Wall Street Journal article on China Joint Ventures back in 2007, "only 27% of new foreign-invested businesses used this legal mechanism [Joint Ventures] in 2006, compared to well over 50% in 2001." I would guess that percentage is less than 20% today. China allows foreign companies to go into China alone in just about all industries other than media, military and mining.

Ms. Nash-Hof also gets it wrong when it comes to China R&D and technology sharing:

More seriously, China now requires U. S. companies to share their technology and relocate their R&D centers to China if they want to have access to Chinese markets.

This statement is just so wrong I hardly even know how to attack it. First off, there are hundreds of thousands of U.S. companies that have "access to Chinese markets" without having any presence in China at all. Every U.S. company that sells a product or a service to China has "access to Chinese markets" and many (most?) of those companies are not even in China, much less sharing their technology and relocating their R&D centers there. Then there are the foreign companies in China that do no R&D there and zealously protect their technology. China does not require U.S. companies set up an R&D facility in China or share their technology with China to have access to China's markets. Apple Computer, KFC, The Gap, McDonalds, Price Waterhouse, and an endless list of other American companies that are thriving in China give lie to this bizarre claim. There have been instances of what Ms. Nash-Hof describes (see the Chevy Volt), but fortunately, that it is not the norm.

Unsurprisingly, Ms. Nash-Hof also attributes the China Price to China's undervalued currency:

Above all, there is the ever-present currency manipulation, where China undervalues their currency by an estimated 30%-40%, which simply makes every product that China ships out 30-40% cheaper than those of a potential American competitor.

I am not going to dispute that the Yuan is undervalued, but 30-40% seems high to me. Is it?

Lastly, Ms. Nash-Hof talks about dumping and I am not going to fight her on that. 

What do you think? Am I being too harsh on Ms. Nash-Hof? Is she right?

I just think that with election season upon us, it is more important than ever that we get our facts right.

The Economist has a very interesting article on "privatization in China." The article is entitled, "Capitalism Confined" and its subtitle is that "Chinese companies, like companies everywhere, do best when they are privately run. In China, however, the state is never far away."

The article does an excellent job explaining the role the Government(s) play in various sorts of Chinese companies and I recommend this article for anyone who has ever been confused about the relationship between China's government and its companies. This article is not going to clear up everything for you, but it will help.

I received the following email today (modified slightly to take out any possible identifiers):

My name's William and I am a Chinese. I am also an avid reader of China Law Blog. So when Frank, my American friend who owns a translation services company in America, asked me about how to set up a limited partnership in China, I turned to your blog for info. I made a search using the keyword "partnership" and found a number of great articles on how to establish a business in China. And it appears that three ways repeat constantly: a WFOE, a JV and a representative office, with the WFOE seemingly highly recommended. I also noted that as early as back 2009, a new partnership law had begun to be talked about. I did a little homework and found that partnership law had been passed and come into force since Dec 2009 and Mar 2010 respectively. However, I didn't find any articles talking about it (good chances are that I missed them). So I was wondering if you could kindly recommend articles comparing pros and cons of a WFOE and a partnership. I'd really appreciate it.

I responded as follows:

I am not aware of any such articles nor am I aware of anyone who has set up such a partnership or been in one. The problem is that these partnerships seem only to exist in theory. There are not nearly enough laws/regulations/statutes on the books to tell us how they should work or how the governement will treat them.  Because of this, they probably don't make sense for anyone. And if they do, I do not know anyone with any experience with them. That is why you will see so much on WFOEs, Joint Ventures and even Representative Offices, yet virtually nothing on Partnerships.

Hope this helps.

What do you know?

The Rhodium Group (an economics consultancy) has come out with a really cool interactive map showing  "Chinese investment in the United States by industry, year and more." On the same page as the map are a number of articles playing up the increased investment by Chinese companies into the United States.

The funny thing is that I look at the map, particularly when filtered to just show Chinese investments in 2011, and all I can think is how few there have been. In thinking about my law firm's own experiences with Chinese investment in U.S. companies, the thing that stands out for me is how many times we have been called in on potential deals that from their inception looked as though they would never happen.

Whenever my law firm is called in to work on a deal that involves a Chinese company paying a large sum of money, we like to predict whether the deal will go through or not. We usually agree. If the deal makes no sense for the Chinese side or if we do not believe the Chinese company has the political or economic wherewithal to make it happen, we both predict the deal will never happen and in those situations it virtually never does. Probably around 75% of the deals that look good end up happening and we usually both predict those will.

Where we have disagreed is on those that look bad, but in which the Chinese company has put down a large and non-refundable deposit. We have had two of those and I have to concede that Steve ended up being right on both of those, with me being wrong. Steve predicted the deals made no sense at all and would not go through. I said that nobody would put down $500,000 in the one case and $300,000 in the other without having already figured out how everything would work. Strangely enough, in both cases the Chinese companies pulled out (and rather early) and forfeited their deposits without even a whimper. In hindsight, I concluded that these companies had plenty of money and desire, but were severely lacking in international knowledge.

What are you seeing out there. China FDI into the United States, today, tomorrow, five years from now or not ever?

I have certain articles I send clients and potential clients in response to their questions. One of my favorites (and the one I send when anyone asks a question relating to what it is like dealing with a Chinese factory) is Ok, so it doesn’t meet your standards….so what? This post is by David Dayton of the Silk Road International Blog and I like it because it is just so dead-on in describing the aggravations of dealing with Chinese factories.

Fortunately, we as lawyers rarely deal directly with factories over QC problems, but I hear these same sorts of things just about every week from companies that contact us wanting to sue their Chinese suppliers. I always politiely hear the foreign company out and then explain that my firm long ago decided that we have zero interest in pursuing such claims unless there is Chinese-language manufacturing contract that clearly and specifically sets out the quality standards for the product and that has the Chinese company's seal on it. Though as pointed out in the JLMade post, "Sampling Strife," if you list out 9,999 points of control, there is still a decent chance the Chinese factory will do something completely weird and unexpected with one you never even deemed possible:

The sticky thing about controlling orders in China is that you can give the factory a list of 9,999 things to do and not to do, but they will still find something that’s NOT ON THE LIST! 
You’ll see factories make decisions that, in a million years,  you would not have considered they would make.  Something random, such as change the color when no color change was ever discussed, mentioned or needed. 

Their response:  “Well if you didn’t want it that way, then you should have told us.  You should have given us 10,000 points of control instead of 9,999!” 

Dayton's article starts out by quoting the response of the three Chinese factories when confronted about  their quality control problems:

• “Sorry it is not the same as the sample. We hope that you’ll accept it anyway.”
• “Your QC is too strict. No one can expect to be 100%.”
• “This is still within tolerance levels.” (No tolerance levels were ever given.)

Dayton then notes how all three factories then "moved to the dreaded show-down level of negotiations: “We won’t make it again. You can accept this standard or cancel (part of) your order.”

In one case, the Chinese factory completely backed down when Dayton refused to do so. The factory blamed the QC problems on a manager who Dayton had never met but who had supposedly been in charge of the project and fired him. As Dayton puts it, the Chinese factory "saved face, we got our product (re)done correctly and the exchange was relatively pleasant and not too confrontational, all things considered. Of course they ended this round of negotiations with 'OK, but next time the price has to go up'"

If you have never dealt with a Chinese factory, you no doubt are having a tough time believing this sort of thing goes on. But if you regularly deal with Chinese factories, this same sort of thing has no doubt happened to you countless times. I am not sure if I can remember a quality control problem that was not blamed on a non-existent person who was just fired or on an unidentified subcontractor that allegedly made the product. But as Dayton points out, the goal is to remedy the problem, not to make sure the Chinese company loses face. 

Dayton then discusses how he oh so logically handles the “we didn’t really believe you when you said you were going to be this strict” line: 

Whenever we hear this our questions are always the same, 1. If you can’t meet this standard in production, why did you sign a contract saying you could (and why did you repeatedly tell us you could)? 2. How come you can do it for a sample but not for production (and if it is a different process, why did you bid on one process but plan on using another).

Dayton concludes his post by noting how "few and far between are the factories that admit that they over-estimated their abilities and give you your money back"

What have you experienced? 

I feel like one of the most important things I do on this blog is to steer people to other good writings on China. I recently learned of a very good blog on China manufacturing and so steer I will.

The blog is called JLMade. 

JL Made mostly focuses on the basics of buying product from China, oftentimes in small quantities. I have been reading the blog for a few weeks and i am convinced its writer, Jacob Yount, knows whereof he speaks. The blog consistently conveys helpful information, such as in the following posts:

• Finding a Factory
• Smaller Order Pitfalls
• Back to the Basics: Air Shipping
• Back to the Basics: Sea Shipping

In other words, JLMade writes on the exact things every buyer of product from China must know but so often does not. If you are are buying product from China or thinking of buying product from China, you should be reading JLMade.

We recommend it.

What do you think?

I recently read an email from co-blogger Steve to one of our existing clients. Our client was seeking legal advice regarding a potential China joint venture investment. Steve responded with a very long email, some of which I can reveal here and some of which I cannot. I am running an excerpt from that email because it nicely highlights some of the basic issues that typically and initially arise when dealing with a China joint venture investment.

Here's Steve's email:

If you plan to invest in China, you will need to do so via a joint venture company. If the existing company in which you are interested in investing is already a joint venture, you will be able to come in as a new joint venture owner. If the existing company is not a joint venture, it will need to be converted into a joint venture. In general, we will need to cover the following:

• Due diligence to ensure that the Chinese entity is legitimate. Many China companies with Taiwanese investment were NOT properly formed in China.

• You will need a very careful joint venture agreement that sets out the rights of all the various investors.

• You will need sales/distribution and related agreements to cover the purchase rights of your side of the deal. Many people forget to do this and this can be a big mistake. We have handled a number of matters for American companies who went into a joint venture just assuming they would get the joint venture product at a discount and that ended up not being the case. In fact, in some cases, the joint venture has refused to sell to them at all.

• If you are transferring any technology, you will need agreements to protect your technology.

• Normally, it will be best for your investor group to establish a company in Hong Kong first and then have this Hong Kong company be the investor in China. This almost always provides substantial tax benefits. It also provides flexibility, since you can deal with the investor group issues in Hong Kong as opposed to in China. This can be quite important if you will have changing investors over time. Changing ownership in Hong Kong will nearly always be considerably faster, cheaper and easier than doing so in China. 

In any event, the first step is to do due diligence on the Chinese side and to design the basic structure of the deal. Also note that the business you are looking at is in a very hot indsutry and so you should take extra care to make sure you are dealing with people who can perform. There are many, many fraudulent companies operating in this industry in China.

What do you think?

Growing up, I used to occasionally play basketball with a guy by the name of Eddie Stokes. Eddie was a few inches shorter than me, but a heck of a lot stronger and quicker and he used to give me fits. What particularly irritated me about him was that every single time he would score against me (or anyone else), he would point at me and say "money....so money"  Though Eddie was a nice guy, every time he did that, I wanted to punch him.  But seeing as how he was a golden gloves boxer (and apparently 1-0 as a professional), I was smart enough never to do that.  

I thought of Eddie for some strange reason today when viewing the "China Money Podcast" site for the first time. I was directed to this site by a China Hearsay link-over to a podcast by China Hearsay's Stan Abrams on Variable Interest Entities. The podcast is called "Variable Interest Equity is a Very Risky Structure" and it is excellent.

Stan knows VIEs and, even more importantly, he and I see pretty much eye to eye on them. To grossly summarize our positions, we are both wary of VIEs and particularly of the idea that they are risk-free. If you want to listen to Stan discuss VIEs and the risks (and rewards) inherent in them, I urge you to check out his podcast here, or go here for the iTunes version.

Stan has written extensively and well on VIEs, including the following:

• Reading the VIE Tea Leaves
• Buddha Steel, VIEs and Legal Ethics: Part I, the Internet Years
• Buddha Steel, VIEs and Legal Ethics: Part II, Man Discovers the WFOE

For even more on VIEs, check out the following CLB posts:

• Variable Interest Entities (VIE) In China. What Would The Buddha (Steel) Say?
• Gigamedia And The Perils Of VIEs. Dude, Where's My Chop?
• Crouching Tiger, Hidden Fraud. Clear Speaking On VIEs

How do you feel about VIEs?

I am a lawyer, not a policy wonk. This means I prefer dealing with the laws as written or at least as they exist, rather than how they might be. I also am not an HR Manager.  This means I find the whole social insurance for foreigners issue in China a colossal bore. Now I know that it really matters to foreign companies doing business there (I am constantly getting emails asking me about it), but it is in such a state of ever-changing flux (yes, I know that is at least somewhat redundant) that it is already driving me crazy.

If you want to know what is going on with social insurance for foreigners, I recommend you read Professor Stanley Lubman's post on China Real Time Report, entitled, "Chinese Social Insurance: Will Foreigners Be Able to Opt Out?" It does a great job in explaining the current situation surrounding China's plans to require foreigners contribute to China's social insurance.

This is the third in a series of posts by our Beijing based attorney, Mathew Alderson, on China's film industry. The first post was "Sino-Foreign Film Co-Productions in China." The second was "Making Films in China. You Talkin' To Me?"

Cinemas are being built in China at unprecedented rates and we are constantly hearing of explosive growth of Chinese box office takings. Needless to say, foreign producers frequently get seduced by these trends and their promise of enrichment and they have a tendency to assume that a slice of China's box office receipts will magically flow to investors outside of China.

Unfortunately, this usually does not happen even when the film pops in China.

Why is it so hard for foreign co-producers to get paid? There are three main reasons:

1. There are no trusted intermediaries for film in China. Collection agents, escrow account holders, trustees and the like simply do not exist here in China. The foundations of international film finance are not in place. In itself, that makes you wonder how completion guarantors can underwrite Sino-foreign co-productions.

2. You need to rely on your Chinese co-producer to collect the box office and pay your share to you outside of China. Good luck with that.

3. Even if you are lucky and your Chinese co-producer has some vague intention of paying you, they cannot pay you unless they can show the Chinese tax authorities that income tax has been paid on the gross receipts and that the withholding tax on their payment to you will be deducted. Even then, they will still need SAFE (State Administration of Foreign Exchange) approval before being able to send money overseas. The vast majority of Chinese businesses will not want to do business this way.

Even in the developed world, taxation of international films is one of the most difficult areas of taxation. For China, this situation is compounded by many orders of magnitude due to a new tax code, a non-convertible currency is not convertible and SAFE involvement from the time the money enters China to when it leaves.

In previous posts (here and here) we looked at the basic framework of rules governing foreign film production in China, as applied by the China Film Co-Production Corporation (CFCC).  As it is illegal for foreigners to independently produce films in China, a Sino-foreign co-production is required and the CFCC provides a standard co-production contract. 

The CFCC contract deals effectively with Chinese approval of the production process and content and censorship of the film, but it does not deal at all with the more important issues of taxation and distribution of proceeds. The regulations and the form contracts are silent on the role of distributors; they mention no role for distributors in financing. In fact, there is no explicit provision for the role of any parties other than the co-producers. There is no mention of banks, completion guarantors, distributors, sub-distributors, or collection agents. There also is no general treatment of overseas financing and rights. Participation in the project by such entities is not prohibited; it is simply ignored.

In the CFCC contract, it is assumed the foreigners have the money and that all will be paid for "up front," with no participation by the financing players and with little or no consideration to how and when payment will be made to the foreign financers. On the other hand, the documents and rules are extremely flexible and are not encumbered by many of the restrictive rules that apply to joint ventures and WFOEs.

The CFCC contract clearly provides that all proceeds are collected and processed by the co-production partners. There is a bank account controlled by both sides and careful accounting controls are put in place. The Chinese side is not put in complete control of things. In essence, the co-production partnership is its own collection agent manager. At least in theory, this can work because there are only two parties: the two producers.

The problem that we have seen with this arrangemetn is that there is no mechanism in China for the partial or primary funding of a film project by distributors. The assumption is that all of the advance funding comes from or through the foreign producer, with no direct involvement from third parties. The structure is therefore designed so that money and other benefits flow into China, but proceeds and other benefits will not escape from China. For producers not worried about Chinese box office, so long as the physical film escapes from China, the proceeds and other benefits issue is typically not of vital importance.

in our experience, foreign producers who want to get paid are usually better off allowing their Chinese co-producers to take China distribution rights in return for an up-front payment because the back-end off the receipts is usually just a mirage.

I received a somewhat ranting email the other day from a highly respected China academic in response to my having been interviewed in an article about IKEA's stores being copied in China.

Below is the heart of the email:

1. No one in the world thinks the Chinese "care" about intellectual property, in the sense that they voluntarily will comply with current Western notions of how IP law works or should work.

2. The Chinese do care about IP in the sense that they do recognize its value. That is why they will copy whatever they are legally or practically able to copy. For example, on the legal side, it is possible to trademark a color scheme. If IKEA did not trademark its color scheme, then it is perfectly legal for a Chinese company to use that color scheme in its own trade dress. On the practical side, if foreign companies do not pursue infringers in the courts, then there is no practical reason not to copy if you think it will give you an advantage in the China market.

3. If foreign companies are not willing to register and then defend their copyrights and trade dress in China, then they deserve what they get. As China gets more prosperous, the problem will get worse, not better.

There is a more interesting issue, however. The Chinese know this Kunming store is NOT IKEA. They know it is just a Chinese copy. They know it is a fake. So why do they shop there? There are two reasons: 1) the IKEA product is all made in China, so the store is actually selling exactly the same product (or it is at least believed that is the case), so in that sense it is not a fake, and 2) the fake product is cheaper than the IKEA trademarked product, and Chinese only care about price. They don't care about atmosphere and service and interior design. This leads to their only wanting the foreign brand at the cheap price. So it is mostly about what the Chinese want. They want cheap with no frills. The fake store gives them what they want.

This all leads to another question: China is full of fakes. The eggs are fake, the Baijiu is fake, the wine is fake, the clothing is fake, the phones are fake, the bags and shoes are fake, the antiques are fake. There is no other country in the world that is even close to China on this issue. Not India, not Russia, not Brazil, not Viettnam, not Indonesia: not anywhere.

Why?

The Chinese are supposed to love food, but they live in a world of low quality, fake and poisoned food. Why? What's wrong with China? Will this continue? Is it part of the internal design of Chinese culture, or is it a temporary response to the Leninist single party state? I used to think it was due to population pressure, but the different experience of India, Pakistan and Indonesia shows that population pressure is not the reason. There is actually greater overall population density in Holland than in China. So what is actually going on? I really do not understand the current situation in China.

Which leads to another issue: copying is not innovation. If China remains at the copy stage and never moves to the learning and creating stage, where will China be in the future? My view own view is that China will not change and that China in the future will be a poor, quaint country that will be a good place to visit and maybe a good place to retire. All this current interest in China as a future modern superpower is very temporary, I think.

Is this person right or has he gone to far? What do you think?

UPDATE:  China Debate recently did a post on innovation in China, entitled, "China’s Rail Disaster and the ‘Great Leap Forward’ Mentality," also questioning whether China will ever be an innovative country. 

We should have written on this years ago, but since it has never presented a real problem for my firm's clients, it just never really rose to a level that it occurred to me. My mistake. The it to which I am referring is the send out a bill scam to whomever has just registered a company or IP just about anywhere in the world.

But before I explain the scam in full, I will quote from the comment that finally spurred me to write this post:

Shortly after registering my WFOE, I got an early morning phone call from (a Beijing land line) someone who identified herself as being with the Tax Bureau in Beijing.  I'm a night owl who frequently works on US time so I missed most of the details due to still being asleep and her ignoring all of my "I'm asleep, please don't talk to me now" comments.

It wasn't until the next phone call (a Jiangxi cell phone number) identifying themselves as being in Hainan that I caught the gist of them saying they had a published copy of the tax code that all new enterprises were being required to purchase for 2000 rmb and change, that they would be mailing it to me whether I wanted it or not, that the bank details would be in the mailing, and if I didn't pay I'd be in big trouble.

All comments along the lines of "don't want," "don't need," and "can't use" were ignored and a couple days later the books arrive by courier.

My first hint that something was wrong was the package label.  It wasn't addressed to my company.  It wasn't addressed to the 22 letter English name that causes me all sorts of headaches with every single official bureau that must use the name on my ID.  It was addressed to my Chinese name.  Not only that, but they got the family name wrong.

Inside the box I find some very official looking books (on very flimsy paper) with a (still ridiculously huge) price tag that doesn't match the number they gave me on the phone.

I also find a fake fapiao.

The local police got involved and, at one point, were trying to set up a sting to get the scammers to come and meet me if they wanted to get paid but although they agreed a couple times, they'd never show up.

I continued to get early morning phone calls off and on for the next month.  In one phone call, the people on the other end threatened to have my visa revoked if I didn't pay up immediately.  In another, I got death threats.

A few months later, a company I'm involved with (but which isn't in my name) did a change of address.  The Chinese person whose name is on the documentation is the listed contact person but the number is mine.  When I got a phone call asking to speak to him so they could tell him about the important tax materials they would be mailing, I just hung up the phone.

Yup. This happens just about all the time, though usually not quite so aggressively (this is the first I have heard of death threats).

Here's the deal.

Just about every time my firm registers a trademark or a copyright or a corporate entity anywhere in the world -- be it a WFOE, a Rep Office, or a Joint Venture in China, or an LLC or a Corporation in the United States -- our client gets a fake invoice. The invoice purports to be from the trademark or copyright or company registration office of whatever country it is in which we just did the registration and it is usually for anywhere from USD$250 to $750. This happens so frequently that it is our firm's policy to warn our clients in advance of these.

The tax one of which the commenter wrote has become the scam du jour in China, which makes me think it is working. The fact that at least ten percent of our clients contact us about such invoices even though we have warned them about them in advance and assured them that we will cover ALL government filing fees and costs also indicates that these fake invoices do work, at least sometimes.

It is actually a pretty good scam in that it is not even clear to me that the scammer is violating the law. I say this because the invoices I have seen for this particular scam involving China WFOE formations usually say that they are offering a copy of the tax code along with tax consulting advice. So though the fees they are charging for this are absurd, they are at least offering something for the money. Where the illegality comes in though is that they are really just offering what you can get for free from the Chinese government and they are making it seem as though your registration is going to be held in limbo if you do not pay, which is, of course, completely untrue.

My law firm has overseen hundreds of company and IP registrations in China and not once have we or our clients ever been hit up for additional and unwarranted fees by the Chinese government. Not one time. Also (and unlike in some other countries), we have never been told to pay an extra fee for "expedited" service. So if something like this happens to you, the odds are overwhleming that it is not the government and it is not legitimate.

In any event, you have now been warned.

Have any of the above happened to you? What do you think?

Since the inception of this blog, one of our recurring themes has been the need for foreign companies to follow China's laws. We are always writing of how China does have laws, those laws apply more strictly to foreign companies than to domestic companies, and those laws apply whether or not some local governmental official assures you that they will not be enforced. We have also consistently extolled the virtues of setting up your business in a second tier city.

Phil Taylor, writing for the International Bar Association Journal, has just come out with an excellent article combining these two themes. Mr. Taylor is a law student at the University of London who freelance reports on the side. The article is entitled, "The Risks of the Middle Kingdom," but its real focus is on foreign businesses in China's second and third tier cities.The article talks of how China's smaller cities are usually cheaper and less competitive than the first tier cities, but riskier as well. 

It then zeroes in on the legal risks in these cities and how even though these cities are often less stringent on law enforcement, foreign companies should still comply with the law. Or as Ronan Diot, chair of the legal working group of the European Union Chamber of Commerce in China, so nicely puts it:

Too many foreign companies have run afoul of the local rules and it is a really bad idea to think that it’s OK because “most companies are doing it” or “there is no other way”. This is simply not true.

The article notes how "it can often be much easier to get away with [illegal] things in smaller cities that would be impossible in somewhere like Shanghai, and this can lead to a false sense of security." It then quotes me on why disobeying Chinese laws is a bad idea, even in second tier cities and even when it seems so easy to do so:

"Oftentimes, the smaller cities will allow foreign companies to bypass certain laws in an effort to get the foreign company into their town as quickly as possible," explains Harris, speaking by phone from Beijing. "The foreign company goes along with the shortcut, figuring it must be OK if the city itself is signing off on it. This can be a big mistake as it is exactly these sorts of cities that tend to be subject to audits at the provincial or maybe even the national level."

Harris mentions by way of example two foreign companies that were formed in very small cities, even though they had not satisfied all the requirements for forming a wholly foreign-owned enterprise (WFOE). They ended up being shut down within a year due to audits that came down from the central government."

"This is a very real risk that businesses are simply missing," says Harris

The article then does as good a job as I have ever seen at concisely explaining (and to a certain extent explaining away) guanxi. The article starts out by making clear "that creating and maintaining good relationships with regulators and local officials can be a very important element of business success" but then quotes Violet Ho of the Kroll company on how "people don’t pay enough attention to dissecting it. Not all guanxi is created equal." Ms. Ho then goes on to beautifully explain various types of guanxi and the particular risks and rewards each can engender:

She [Violet Ho] divides guanxi into several types. Inherited guanxi is exemplified by the influence of government officials’ offspring (known as princelings). This type is often very dangerous as it is susceptible to political volatility. Personal guanxi – where a company relies on one person for its success – can be very risky, particularly where little is known about that person. A foreign business that falsely believes a connection with a single influential political figure will keep it out of trouble can quickly find itself operating in a legal grey area.

A more positive type of guanxi is what Ho calls institutional guanxi – support from a particular government agency – which she says should be carefully developed. She also describes "a new generation of guanxi" whereby a company receives strong government support because it is considered a leading enterprise in the local area.

"An enterprise that has contributed to local development, paid a lot of taxes, and employed a lot of local people can find itself in a win-win situation where it is being recognised and supported by the government for its contribution," says Ho.

Ronan Diot then lays out how so-called guanxi can so easily backfire:

"Many people can tell you of their formerly rich and successful friend who is now serving 16 years for bribery and embezzling company property," says Diot. "Generally speaking, it is often a strategic mistake to rely on one well-connected individual for the development of one’s business in China."

A powerful local figure can also become a liability when they start to use their connections to override a contract or exert influence on a local judge. For these reasons, a foreign company may go too far in its attempts to nurture what it perceives as an important relationship. Lavish gifts or extra cash payments make a company easy prey for extraterritorial anti-corruption laws such as the US Foreign Corrupt Practices Act, the OECD Anti-bribery Convention, or the UK’s new Bribery Act.

"In addition to purely legal aspects, our advice to clients is to take their home jurisdiction as guidance: if you would not feel comfortable doing what you plan to do in China back home, then do not do it," says Diot.

Taylor then uses me to summarize:

Harris is more direct: "Making good connections makes sense but running afoul of anti-bribery legislation does not. Know what the laws are and do not violate them, no matter what."

The article moves on to discuss the differences in risks for businesses between China's first and second tier cities. Kent Kedl, Control Risks’ managing director for Greater China and North Asia, says that foreign companies are rushing into China's second and third tier cities and in doing so, they are ignoring many of the risks:

"[T]his mirrors what happened 20 years ago: then, American companies became very excited by the fact that Chinese factory workers were about 30 per cent cheaper than those in the US, and failed to take into account the efficiency and infrastructure issues that would also have to be overcome.

I think we’re in danger of making the same mistake this time; we didn’t learn the lessons, and people are just blindly looking West," he says.

Second and third tier cities present greater overall IP risks: 

Although the risk of IP theft itself may not be any higher in the provinces, the difficulty of dealing with the aftermath is usually greater. Take the case of a foreign company that agrees to license its IP to a Chinese company for a year. If the Chinese company keeps on using the IP, the chances of being able to stop the company will be greater in Shanghai than in a smaller city like Chengdu. A risk factor like this, although hard to quantify, should influence a foreign company’s decision regarding where to locate. Harris talks of a software company that wanted to set up in Chengdu and employ five people to write software there. It turned out that this would only have saved the company about US$25,000 a year.

‘If they were making widgets, then I wouldn’t have raised the issue with them, but is it worth it for the IP risk?’ asks Harris.

I love how the article then describes the difficulties in finding good lawyers in China's smaller cities:

The quality of advice and the depth of understanding of a foreign investor’s perspective can be variable in the provinces, to say the least. (Even the label ‘law firm’ can sometimes be misleading. A former journalist who spent time travelling around several smaller Chinese cities while carrying out research for a legal directory tells of her surprise when visiting some law firms. Although describing themselves as firms offering a range of services, at least one turned out to be nothing more than a one-man shop operating from a smoky room above a supermarket.)

The difficult question of guanxi appears again here. Some investors may be tempted to rely on a local Chinese lawyer who claims he or she has important connections. This may yield results in the short term but will not provide a stable, long-term base on which to build a business. Harris cites the example of a company that took advice from a local lawyer and rented a property in a small city from a landlord who was not legal. Things went well until the Beijing tax authorities said the company would not be able to claim its rent as a tax deduction because of its illegal landlord.

"I said [to the company], if you want to feel really bad, the tax authorities might tell MOFCOM [the Ministry of Commerce, which regulates foreign companies’ operations in China] that you’re not operating legally there and you may be shut down."

The article concludes with me extolling foreign companies not to abandon their common sense:

"First off, think. That’s right, think," writes Harris in one of his blog entries. "Secondly, do not do anything you would not do in any other country. Just because your Chinese partner and/or your Chinese partner’s lawyer tell you this is how things are in China does not mean you have to believe them and it certainly does not mean you have to abandon your common sense."

This really is a highly informative article with a whole slew of excellent advice and I urge you to go here to read it in full.

What do you think?

The Korea Law Blog did a post, entitled, "Enter the Korean Market -- Then Enter China and Japan," positing that companies use Korea as a test market for China:

The Secretary General [of the EU Chamber of Commerce in Korea, Jean–Jacques Grauhar] mentioned something that I think all global businesses should recognize.

He notes that:

While the world focuses on the Chinese market, company executives should also try to include Korea in their itinerary whenever they visit this part of the world, because a presence in South Korea is indispensable for truly global brands and could in fact constitute an excellent launching pad to reach the Chinese and Japanese market.

In most cases, Korea is a great test market before entry into China and Japan. Many of my clients have successfully succeed and also "successfully" failed in Korea and choose to enter or forgo the Chinese and Japanese markets based on these Korean experiences.

Korea is simply a much cheaper place to do business than Japan and is a much geographically small market than China, thus, lowering the cost of doing business.

Color me skeptical.

Why should a company go into Korea before going to China? What are the benefits of doing that, rather than perhaps using one Chinese city as a test market?

I am a huge fan of Korea and I absolutely am not saying companies should ignore Korea because they should not. But I do question the value of using Korea as a prelude for China. I am just not sure mastering Korea would help all that much in mastering China and even if it does, why not use Vietnam or Singapore or Taiwan as your prelude for China? 

Korea as China stepping stone?

What do you think?

I have a policy that if I receive five or more emails asking me to write on something, I will write on it.

I very intentionally have not written on China's recent train crash, but I have received well over five mails either suggesting I do so, or calling me out for not having done so.  Interestingly, I have been called out by both "sides" (as if there should be sides on something like this).  I pull the following two emails to summarize the two sides:

EMAIL 1:  I am not surprised you have remained noticeably silent regarding China's high speed train crash. I guess it just doesn't fit in with your constantly telling us how great China is and how much it is becoming just like us. Your failure to write on this just confirms for me that the only reason your blog exists is to make money for your law firm. 

EMAIL 2: I am surprised you have not done anything on the recent train crash. It fits in perfectly with your always thoughtful writings on how China is unsafe and overrated and is not going to be taking over the world any time soon. To me, this crash is great proof of what you are always saying.

I kid you not.

I am not going to write about the train crash.

I am instead going to explain why I have not written about it. My main reason for not having written about it is because (call me old fashioned), but I am appalled at the idea of instantly using a tragedy to advance any view. People died in that train crash. Real people.

I have nothing to contribute in terms of what caused the crash and one train crash, standing alone, in a massive country like China is not indicative of anything. I have not seen statistics regarding China's train system so I cannot comment.  Also, no matter what those statistics say, I have to believe that traveling by train in China is much safer than going by car or by bus.

More than anything though, I do not want to use this crash to prove a point. Any point. I find that distasteful. It is wrong to use the dead to market ideas to the living. Both deserve better.

Here are some pretty unbelievably insensitive and very recent examples of people using tragedy for their own ends:

1.  Some complete idiot (and ungrammatical) blogger used Amy Winehouse's death to let loose with a death threat against Israel. I quote directly from the post:

So Amy Winehouse, like so many others, is now dead and gone from over indulgence, a mentality that says nothing can hurt me, I am powerful, and I am invincible.

.....................not!

So, this brings me to the evil rogue state of israel, which, funnily enough, as it turns out, has quite a lot in common with Amy Winehouse, exept she had a great voice and didnt kill people constantly, they both suffered from the same affliction.

Once upon a time the mighty dinosaurs ruled the earth, and smaller life forms trembled at their feet, but nothing lasts forever, and just as the path chosen by Amy Winehouse caused her death, the path chosen by Israel will also cause it's ultimate destruction. 

But, guess what? Israel is not “God” and ultimately what killed Amy Winehouse will also kill off israel as well. All we have to do is wait, and just keep on chip, chip, chipping away at the out of control, over excessive, over indulgent, spoilt brat killer bully that we now know as Israel.

2. Stan Abrams of China Hearsay did a post, entitled, "The Most Insensitive Story on the Wenzhou Rail Crash." in which he awarded "the coveted insensitivity award" to Megan McArdle for her story in the The Atlantic, “The Significance of China’s First High-Speed Rail Disaster.” China Hearsay points out how Ms. McArdle used the train crash to tell "us that democracy is better than autocracy and that the United States should be thankful for the infrastructure system that it has."  Stan goes on to say that a "lot of people are talking about the Wenzhou crash and what it says about corruption, incompetence, the fast pace of infrastructure construction, and so on. Plenty of questions out there. But taking this one crash and using it to somehow vindicate the deplorable state of U.S. infrastructure is laughable."  I agree.

3.  Countless people have sought to use Norway's killings to make their points and many articles on the killings have been in poor taste. But at least there is some basis for getting political on that since the killer ascribed his actions to his political (loosely defined) beliefs. 

Before the above, we had Pat Robertson on Haiti and Sharon Stone on a China earthquake. I could go on and on.

I remember hearing that really good books on an event are almost never written before at least thirty years have gone by since the event occurred.  Seems there ought to be some similar saying about a grace period before people start exploiting a tragic event for their own purposes. Thirty days maybe?

You want a story on China's train wreck? I'm not going to wade in those waters; I'm just not the guy.

NOTE: i wrote this post before the issue of the Chinese people's dissatisfaction regarding the handling of the aftermath of the wreck had become so front and center. I do not intend for this post to in any way take away from any of those issues.

UPDATE: Morissey (the rock singer) says eating meat is worse than the Norway murders. I haven't had any meat for 17+ years and I think he's an insensitive idiot and clearly off his rocker.

This post is essentially a re-running of a post we did at the end of last year. We are re-running it because as China's economy starts to waver, the Chinese government seems to have stepped up both its tax collection and its closing of illegal foreign businesses another notch. I received two calls just last week from companies who were told that their "Rep Offices" were illegal and that they needed to form a WFOE right away or simply leave China.

Now is really not the time to be operating in quasi-legal mode in China. It just isn't. 

Every couple of weeks my firm gets an email or a phone call from a small business that is seeking to justify forming a Rep Office in China instead of a Wholly Foreign Owned Enterprise (WFOE). These small businesses typically go into advocacy mode explaining why their business can and should be a Rep Office in China. They then go on to explain that they simply cannot afford to form a WFOE in China due to the minimum capital requirements, the legal fees, and the taxes. 

They then want me to condone their Rep Office plans but I never do.

In fact, the increasing number of these requests has caused me to get even blunter than usual, and my most recent response exemplifies this: 

What you are describing doing as part of an RO [Rep Office] is definitely not proper for an RO. Not even close. 

In terms of minimum capital required, because it is Dongguan, it is likely to be pretty high. Sorry. 

You pretty much have two choices. You can operate completely off the grid and risk getting shut down, or you form a WFOE. Probably the worst thing you could do would be to form an RO that operates illegally because they you are just drawing attention to yourself.  

I get the sense that the people contacting us on these things are hoping that they somehow have found THE loophole that nobody else has found and that if only they can get the blessings of an attorney for what they are doing, that their operating illegally will somehow not be illegal. I wish I had some magic oil I could sell (for a helluva lot of money) that I could sprinkle on illegal China businesses to make them legal, but I have no such thing.

Those who think they are going "sorta" legal by forming what is clearly an illegal Rep Office in China are very similar to those who think they are "sorta" protecting themselves legally by doing a "sorta" joint venture with their girlfriend. I wrote about those people in a post, entitled, "Operating Illegally In China. Half-Assing It Does Not Help." In that post, I described the following email I had recently received from my co-blogger, Steve Dickinson:

We had one of these the other day and it precipitated an email from my co-blogger, Steve Dickinson, to me, which went as follows:

If these people are going to go illegal in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don't work in China, because you and I have won enough China contract cases to know that they do.

It is because the Chinese judges are totally on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking that somehow they are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember John Smith’s [yes, it is an alias] company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His US LLC [and with it, the China WFOE] were just purchased by _______ [a pretty big name U.S. company]. The reason the purchase was successful is that the whole company was "clean" and therefore it could be purchased by a foreign public company.

I then concluded that post with the following:

As lawyers we are never going to tell our client to go full illegal, but in my role as a blogger, I have to think going full illegal would probably make better sense than paying a lawyer to draft a void contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.

The same holds true with respect to forming a Rep Office when a WFOE is required. Forming the Rep Office in that situation will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE. On top of that, as I am always saying, you should not form a Rep Office with plans to form a WFOE in a year or so "if everything works out." You should not do this because you will end up paying THREE times as you will pay for forming the Rep Office, pay for shutting down the Rep Office (and this is not cheap), and then pay for forming the WFOE.

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written me to tell me that "so and so" company formation company is willing to form the Rep Office for them, as though this mere fact means that my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE.

For more on what is involved in forming a company in China, check out the following:

• How to Start a Business in China: WFOE
• How To Start A Business In China -- The Minimum Capital Requirements For A WFOE
• The Slow Death of the China Rep Office

Doing business in China? Don't do it half right because you are only increasing your risk. 

Get legal now.

By: Steve Dickinson 

Yesterday we were greeted in the foreign press with the following headline: Southern China Sees Wave of Manufacturing Bankruptcies. This was predictably followed by vehement denials vehement denials from the Chinese government. For example, the CCTV Channel 9 business news was full of stories today stating that Chinese SMEs throughout the country are operating smoothly. The result being the usual complete lack of clarity about what is really going on in China as the coastal regions restructure their manufacturing base in the face of reduced demand and higher costs.

The basic story is that that low value added/high labor content manufacturers from Wenzhou in Zhejiang down to Zhuhai in Guangzhou are undergoing extreme financial stress. The affected sectors are in the traditional outsourcing industries: textiles, toys, shoes and furniture. The reports are that many of the oldest and largest manufacturers in these sectors are closing their doors, leaving behind bad debts and unpaid workers.

These stories may be true or false.Certainly the bankruptcy of one or two companies in a competitive world does not constitute a trend. So the truth may be somewhere in between the “the sky is falling” and “what me worry” positions we are seeing in the discussion.

What I find interesting is the consistent misunderstanding of foreign observers on the Chinese government position on the matter. Specifically, many observers are surprised at the relatively casual response of the central and local governments to the issue. This is because these observers do not see that this process is completely consistent with central government policy.

Let’s state the situation more clearly. Assume for now that the stories are true. If true, the process is exactly what the central government intends to happen to manufacturing in China's coastal regions, particularly in the Zhejiang/Fujian/Guanzhou region. Stated bluntly, if Chinese government policy is causing the bankruptcies, this is intentional. If the bankruptcies are the result of market forces, the government intends to do nothing to soften the blow.

Here is a basic explanation of what is going on:

1. The 12th Five Year plan clearly states that a primary goal is to eliminate low value added/high labor content export manufacturing from the entire coast. The intent is to shift to high value added, technologically advanced manufacturing and modern services in this region. The bankruptcies in the low value added sector are entirely consistent with central government policy.

2. Many of the manufacturers in this sector are controlled by foreign capital: Korea, Taiwan, Hong Kong and Singapore. Where not foreign owned, the owners are rebels against the state like the group centered in Wenzhou. The central government is not happy with either group and is quite happy to see them go.

3. It is important to understand that the vast majority of these export based manufacturers are not economically viable. They exist because of VAT rebates, open violation of the Chinese wage and labor laws and subsidized energy and raw material prices. They have been tolerated in the past solely because they provide jobs. They provide no other benefit to China and are in many cases actually harmful. Moreover, the jobs they provide are for migrant labor, which is a source of social unrest in China. China wants these migrants to return to Sichuan and elsewhere. They want the businesses to operate according to the requirements of Chinese law. For these reasons it is a sound policy to force these export manufacturers to either become economically viable and law abiding businesses or to force or allow them to simply go away. It makes little sense to continue to support them with subsidies and loans.

4. On a much deeper level, as the 12^th Five Year Plan states, the center seeks to transform the Guangzhou/Fujian/South Zhejiang industrial zone. The goal is to eliminate of most or all of the private, export oriented, low value added/high labor content businesses located in those areas. Though the discussion is couched in economic terms, the underlying reason is political. The center is tired of the independence of the southern coastal regions. Since there is no longer any strong economic reason to tolerate this independence, the center is now moving to reassert control in these regions.

It therefore makes perfect sense that the center is relatively unconcerned about a “wave of bankruptcies” in the south. They believe they can handle the results in various ways. In terms of job loss, the message is: go home and find a job back in Sichuan or Henan or wherever the migrant workers were originally located. There are plenty of jobs for Guangzhou residents, so the issue is really convincing the migrants to go back home.

In my own lectures on this issue, I have commented that elimination of low value added manufacturing on the coast seems to be a bad policy on economic grounds. That is, China is still in the situation where low value added/high labor content manufacturing is a good way to take advantage of the large number of low skill workers available in China. However, now that I look at the situation from the standpoint of the center, I find that it makes sense to conclude that there is no benefit to China in keeping these really bad companies alive through loans and subsidies. It therefore seems that the transformation of this sector and the resulting closing of unviable manufacturers will continue unabated. This is because the process makes political sense, which is the most important consideration in China. The fact that it makes economic sense is a secondary, collateral reason for continuing.

What are you seeing in the South?

Update: Dan actually gave a TV interview relating to this subject a few weeks ago when he was in China. That interview can be found here.

A couple of weeks ago, co-blogger Steve Dickinson did a post on Chinese companies that trade publicly on U.S. exchanges. That post was entitled, "Thinking Clearly About Chinese Companies Listed On US Stock Exchanges. Or, If A Tree Falls In A Sino-Forest....," and in it, Steve distinguished between legitimate Chinese companies and fraudulent Chinese companies.

With all the media coverage of allegedly fraudulent Chinese companies, Chinese share prices overall have suffered, including that of many companies that clearly do really exist and make money every day. In other words, babies are being thrown out with bath water and that usually spells opportunity. We here at CLB do not purport to be China investment gurus (and it never ceases to amaze me some of the people out there who do), but if you are interested in investing in Chinese stocks, I recommend you read, "Why China Looks Like a Buy," by Ben Levisohn, a personal finance writer with the Wall Street Journal. I like its analysis and I particularly like its graphics. 

What do you think? I should not have to mention this, but I will. Any comments left by anyone on this or on any other posts are simply the opinions of those who are leaving the comments and they may or may not reflect the opinions of this blog. This is my legalistic way of telling you that we do not monitor the comments for quality (short of deleting those that are racist, hate-filled, straight out promotions, or simply so beyond the pale that we would be doing a disservice to our readers were we to publish them) and so read and follow (or not) wholly at your own risk.

In the last three years, I estimate that about 25% of the China employee wage/labor disputes on which my firm has worked have involved foreign (i.e., non-Chinese) employees. I think there are two reasons for this. One, companies do not bother calling us if the dispute involves a Chinese employee being paid $12,000 a year. In those cases, they typically just settle the case themselves as quickly and as cheaply as possible. Their foreign employees always make way more than that.

The second reason is more important. Far too many companies are under the mistaken impression that China's labor laws do not apply to foreign workers when they most certainly do. China's labor contract law applies to all of your China-based employees, foreign or not. China's labor contract law even applies to those foreign employees who have a contract with you saying United States or some other country's laws apply. To put it another way, all employment law is local. 

So what this means is that in many ways you are at greater risk from your non-Chinese employees than from your Chinese employees because foreign employees still generally make considerably more than Chinese employees. 

The congruity between foreign and Chinese employees recently got even closer with China's very recent (July 1) enactment of its new Social Insurance Law, which law applies equally to Chinese and foreign employees.

The new social insurance system will cover the following:

• Pension insurance
• Unemployment insurance
• Work-related injury insurance; and
• Maternity insurance.

Local governments (provinces and cities) determine the contribution rates for employers and employees. We generally tell our clients to expect to have to pay about 40% of an employee's wages in social insurance.  

The new law lessens the employer's burden for covering work-related injury costs. The new law also includes penalties against employers that fail to make sufficient or timely insurance contributions. This penalty is set at .05% a day on the outstanding contribution. If the employer fails to pay the penalty, additional fines can be imposed by the local administrative department. If things get really bad, the local social insurance administrative department has the right to collect outstanding amounts directly from the employer’s bank account. The law also requires that each employer register with the local insurance administrative department within 30 days of incorporation and register any employee within 30 days of employment.

Were you aware that your foreign employees in China are now covered by social insurance? What have you done to comply with this new law? How has/will this new law impact your bottom line?

We're on a road to nowhere, come on inside
Taking that ride to nowhere, we'll take that ride
Feeling okay this morning, and you know
We're on a road to paradise, here we go, here we go
       From the song Road To Nowhere, by the Talking Heads

I could not resist asking co-blogger Steve Dickinson to write of his trip last weekend over China's newest engineering marvel: Qingdao's new Jiazhou Bay Bridge. Here goes.

By Steve Dickinson

The opening of the bridge across the Jiaozhou Bay was achieved in Qingdao on July 1, just in time for the 90th Anniversary of the founding of the Communist Party.

At 41.58 km, this bridge is the longest ocean span bridge in the world. On the same day, the undersea tunnel from Qingdao to Huangdao opened. At 9.47 kilometers, this is the longest undersea tunnel in China. Qingdao is rightly proud of these engineering achievements. See the China Daily for a report.

The completion of the bridge and tunnel fulfills the long term dream of the Qingdao government to fully integrate the two shores of the Jiaozhou Bay. Qingdao has long been troubled by the fact that modern development is centered on the Huangdao side of the bay while government and banking is centered on the Qingdao side.

In honor of the opening, I took a trip with a local group last Saturday. The trip suggests that more work needs to be done to achieve the full potential of the bridge and tunnel. Here are some of my observations:

1. There is already a high speed highway that rings the Jiaozhou Bay. The bridge is built across the very widest part of the bay, quite close to the shoreline. It runs pretty much parallel to an existing highway. As a result, local reports have indicated that the bridge will reduce the travel time by only ten minutes. Locals wonder why $US2.3 billion was spent for a ten minute reduction in travel time.

2. I took the bridge from Qingdao to the Qingdao container port in Huangdao. Normally, this trip takes about 1.5 hours. The trip across the bridge was smooth. However, upon exiting the bridge, we were confronted with a massive line at the toll booth. Three lanes of bridge traffic dumped into three toll booths. On most bridges of this size, one would expect six to eight toll booths. The resulting back up at the toll booth caused a three hour delay. As a result, our 1.5 hour trip turned into a hellish 4.5 hour trip. There is no indication that this issue will be resolved, since there seems to be no room to build additional toll booths at the exit area. I see this as another instance of China doing well with "hard engineering" but neglecting the soft stuff like the user's overall experience.

3. Private vehicles must pay a 50RMB (~USD$8) toll for the bridge and 30RMB (~USD$5) for the tunnel. The toll for our bus was 90 RMB for the bridge and 100 RMB for the tunnel. These fees are quite high. Considering that in the best of circumstances only 10 minutes is saved in using the bridge, locals have indicated that they do not plan to use the bridge for normal transportation purposes.

4. We took the new tunnel to return home from the port. The experience was quite different. We were greeted by eight toll booths at the mouth of the tunnel and there was only a five minute delay in entering the tunnel. The tunnel is quite modern and was a pleasure to use. However, the tunnel connects the beach portion of Huangdao with the downtown area of Qingdao. It is therefore not really useful for cargo transport needs. Locals also indicate the the high toll will discourage private car use. It is anticipated that the main use will be for bus traffic across the bay. The big problem with the tunnel is that it links to slow local roads, so this route took us three hours. 

Nobody is even sure why either the bridge and the tunnel were built, much less the two of them. The bridge seems to be mostly aimed at connection by highway for goods from the ports and airport and tradezones. The tunnel does not provide access to any of this. The high toll for the tunnel means that it will not be used for normal surface transport (private cars and taxis). So why was it built? No one has ever been able to provide me with an explanation. Why was the bridge built at the WIDEST part of the bay? Why was it built when it only provides a 10 minute improvement in travel time? Why was it built with no attention to access and exit? Why were the connecting highways not improved? Who knows

It appears that these two massive projects are typical of so much of the infrastructure being built in China. Liittle attention was paid to the human element in actually putting the infrastructure to work. Our group of 40 was disappointed that our outing was ruined by the long delay on the bridge. However, I have to say that no one was surprised.

By Steve Dickinson

A foreign company who got caught in a commercial fraud perpetrated here in Qingdao recently contacted me. The basic trick is as follows. A non-Chinese trading company offers “Chinese” manufactured goods at a very low price. The trading company then issues numerous confusing invoices and receipts. Eventually, the trading company convinces the foreign buyer to make most or all of the payment for the goods to a bank account located outside of China. When the foreign buyer demands delivery of the product, the trading company either disappears or claims that no payment was ever received. The claim that no payment was made is based on the fact that the payment was made to a bank outside of China and to a payee with a name different from that of the trading company. The buyer is then left holding the bag: no product, no money and no one to sue in China.

These types of fraud cases are common and should be fairly easy to spot. It surprises me that foreign buyers still fall for this basic form of fraud. Here are some of the issues you should consider to avoid becoming a victim:

1. Since the payment is made to a foreign bank account, the party committing the fraud is usually not Chinese. This particular fraud appears to have been committed by a Korean company. Russian companies have committed earlier frauds of this type in Shandong and Liaoning provinces. Consider carefully with whom you are dealing with when operating with a trading company. A simple Google search will usually tell you that you are dealing with a questionable party.

2. The fraud in this case was committed by a trading company; the actual manufacturer of the product did not commit the fraud. For manufactured industrial products, the use of trading companies has become unusual in China. Any potential purchase of manufactured industrial products from a trading company should therefore always be viewed with at least some suspicion. For various reasons, it is usually better to deal directly with the manufacturer. If the manufacturer (or you) want to bring in a trading company to facilitate payment or shipment, you will be much better positioned if you require that your main contract remains with the manufacturer.

3. I have dealt with dozens of frauds in my legal career and in virtually every instance there were various giveaways that showed the transaction was a fraud. In this case, the three invoices issued by the trading company were a dead giveaway based on the following:

• The address and the name of the seller on each invoice was different from the next. Chinese companies are very careful with their invoices. Their invoices are always exactly the same. Where an invoice varies in the address or the name of the seller, you can be pretty sure there is something wrong.

• Each invoice provided for payment to a different bank account. This virtually never happens in a legitimate transaction. Even though the seller address on the invoices was Qingdao, the payee’s bank was located in first Shanghai, then Shenzhen and then Korea. The payee for each bank was a different company than the seller. This is almost always a dead giveaway for fraud. Legitimate Chinese companies take payment in a bank in their hometown with the Chinese company itself, not a third party.

• The final payment provided for payment to a Korean bank. Again, legitimate commercial sales transactions in China do not provide for payment to a foreign country.

• The invoices were signed with a stamped signature with no company seal. Legitimate Chinese invoices will be stamped with a standard round, red, registered company seal. A signature is a sure sign of a problem, particularly if the signature is a stamp.

4. The final mistake of this buyer was to pay before receiving a bill of lading. It is always best never to make a payment for product until you receive a bill of lading from a reputable carrier issued in the name of the seller. Even bills of lading can be forged, so it is important to ensure that a reputable carrier issues the bill of lading and that an agent or other intermediary has not issued it. I say reputable carrier for a reason. For this type of fraud, the product is often bulky and not subject to containerization. The carrier is then often a non-standard bulk carrier. View any transaction with a tramper or bulk-carrier with suspicion.

Of course, the ultimate reason that the buyer was deceived in this case (and in most of those that we see) is that the fraudulent trading company was offering the product at about half the normal commercial price for this product. External market forces determine prices in China for simple industrial goods and it is nearly impossible for a trading company to acquire product for abnormally low prices. Beware the “too good to be true” price. We are constantly seeing this type of fraud, particularly with bulk goods like chemicals and basic manufactured products like steel and glass. When the price is too low, the result is never good.  The product either never shows up at all or the product delivered is of such poor quality as to be unusable.

Be careful out there.

This post was written by Mathew Alderson, a Beijing-based Australian attorney who joined us earlier this year after having worked with us on a number of matters involving the creative services industry. Since Mathew has considerable experience representing foreign companies involved in China's film industry, I asked him to write this post setting out the basic rules for foreign companies doing film co-productions in China.

Foreigners engaging in film production in China need to comply with a set of rules administered by the State Administration of Radio Film & Television (SARFT) and China Film Co-Production Corporation (CFCC). CFCC is a subsidiary of China Film Group Company.  I have overall found both SARFT and CFCC quite accommodating to foreign film productions in China. 

Though at first glance the rules for Sino-foreign film co-productions in China seem fairly clear, a closer review gives rise to a number of issues. Some of these issues and questions will be discussed in subsequent postings. The following summary of the rules is intended to provide a frame of reference for such a discussion while at the same time setting out the basics

1. No film can be co-produced in China without a co-production license. The license is granted by SARFT but processed by CFCC. Anyone engaging in film production in China without the required license is in violation of the law and subject to monetary penalty.

2. There are two types of co-productions of interest to foreign players. The first is "collaboration," in which the Chinese side and the foreign side both invest cash in the project. The Chinese side provides both cash and infrastructure. In this case, the foreign and Chinese producers are co-owners of all the copyright and related intellectual property (IP) in the film. Contribution of assets and distribution of proceeds is flexible and is determined by contract. However, the whole arrangement is subject to approval by both CFCC and SARFT.

The second type of co-production is the "entrusted production," in which the foreign side contributes all of the funds and hires the Chinese side to do the production in China. In this case, the foreign side owns the copyright and the related IP. This approach still requires the same approvals and reviews required for a collaboration.

3. The project must receive a co-operative production license from SARFT. Application is made through CFCC. CFCC reviews the script (which must be submitted in Chinese translation), the financial status of the foreign co-producer and the basic structure of the project, with particular emphasis on the percentage of Chinese actors in the film and the location of production work.

Matters such as capitalization and distribution are left primarily to the parties. However, the basic principle is distribution based on percentage of capital contributed. Initial review is done by CFCC and the regional (provincial) level of SARFT. Once approved at that level, approval by SARFT Beijing is also required. The regulations provide that SARFT Beijing must respond within 10 days. However, there is no rule on how long the lower level bureaus may take for their review.

4. The script must be submitted in Chinese. The script is reviewed and approved by CFCC for compliance with China’s various censorship rules. After the film is completed, the film is again reviewed to ensure that it accords with the previously approved script. The project is not complete until after the final review and the issuance of a film public showing license. The rules contemplate that the film will primarily be done in Chinese and then translated into foreign languages. The rules have no provision for films that are in English or some other foreign language in their original form. Presumably this is a matter that is subject to the discretion of the CFCC.

5. After the film has been approved and licensed, the co-producers enter into a co-production agreement. SARFT has a standard form for that agreement. In its most basic form, the project is treated in almost exactly the same manner as an equity joint venture. The producers open a joint bank account for deposit of the capitalization funds. Both producers have control over that account. The accounting too is similar to that of an equity joint venture. The co-producers share in profits and losses based on their equity contribution. An annual audit is conducted, profits and losses are allocated, and taxes are paid. Though the regulations and form agreements are silent on this, proceeds of the foreign co-producer presumably can be remitted on an annual basis after payment of tax is confirmed. Details of when and how capitalization occurs and when and how profits are paid are flexible and are set out in exhibits to the main co-production agreement. However, all such arrangements are subject to review and approval by CFCC and SARFT.

6. CFCC remains involved in the project after production begins. For example, CFCC handles the visas for foreign workers and the customs for any imported production equipment.

7. In principle, all production work is done in China. Work can be done outside China, but only with CFCC approval.

In my next post(s), I will discuss the tax, international money transfer, collection agent and completion guarantor issues that often arise in the context of financing Sino-foreign film co-productions in China.

Many importers have a bad relationship with their key Chinese supplier(s), but they don’t look for other companies. Sometimes it leads to unbelievable situations. For example, some buyers got screwed on 3 orders in a row by the same manufacturer!

On the face of it, it is surprising, especially given the thousands of Chinese exporters competing for buyers’ attention. When one supplier is not performing as expected, the importer should terminate the relationship, right?

Unfortunately, things are not that simple.

Reanaud then goes on to methodically set out why this is so often the case:

1. It takes time to develop perfect samples, and some materials/processes have to be adapted to the factory’s capabilities.
2. Buyer does not check quality until delivery in importing country (i.e. after full payment).
3. Quality issues are discovered; buyer asks for a compensation.
4. Supplier only promises a discount on the next order; buyer has no leverage to negotiate a better deal.
5. Importer is upset, but places a second order to get the discount.
6. Manufacturer finds a way to increase the price after the deposit of the second order is wired; importer has no choice but to accept.
7. This time, buyer checks quality before shipment. Some issues are noticed. Supplier refuses to repair. Importer’s customers are asking for the goods. Shipment is authorized, and part of it is by air (at buyer’s costs).
8. Buyer looks for another factory, finds a few candidates, is very wary this time.
9. Production has to start again fast. New developments with a new factory would take 2 or 3 months. Importer gives a last chance to the same supplier.
10. Third order is even worse than second order; buyer gets really upset and desperate; production is canceled and deposit is lost.

Renaud notes how the buyer did many things wrong in this situation, including having failed to qualify the supplier properly, failing to have followed quality closely, and failing to have secured a back-up manufacturer. It is a no-brainer for me to agree.

Renaud then asks when in a bad situation should a buyer of Chinese goods cut off its Chinese manufacturer for good:

But, after he was engaged in this situation, when should he have stopped the relationship? Just after the first order? Or maybe the second order should have been smaller? There is no right answer.

In any case, a back-up source should have been developed right after the first quality problems were found (and after difficult negotiations led nowhere).

Am I right?

Is Renaud right? I think he is and, in fact, it is easy for me as a lawyer (as opposed to someone who needs product right now) to say that the best time to walk away from your Chinese supplier is at the first hint of trouble. But at the same time, I also recognize that no Chinese supplier is perfect and that some of them must recover from their problems.

So here's my question. What percent of the time does a Chinese supplier who has provided bad product and not owned up to it provide good product the next time? What has your experience been? Please speak up.

David Wolf of Silicon Hutong just did a great post on ethical issues in China. The post is entitled, "Business Ethics and Culture Clashes in China" and I love it for three reason. First, it is very well written. Second, it imparts very useful advice. Third, and most importantly, it says many of the things that we repeatedly preach (yes that is the right word here) on CLB. In fact, replace the word "ethics" with "following the law" and you have one of our standard posts. 

The gist of David's post is that if you are a foreign company you will be under a microscope in China and you will be held to a higher standard than your Chinese competitors. And you had better think about how you are going to deal with this before you go into China.

Before I talk more about David's post, I am going to divide up the way companies seem to approach ethical issues in China, going from bottom to top:

1. The "it is so fun to ignore the laws in China and to act like I am a Chinese company and I pity the naive foreign companies that don't realize how things "are really done" in China company. We usually tell this sort of company not to hire us because there is no point in paying for a lawyer if you are going to be at huge risk for getting in trouble or getting shut down for operating illegally. I love emailing these companies a year or two later to see how they are doing in China. They typically do not respond or when they do, they give some really vague answer. A few of the more honest ones admit to having gotten into trouble or to having "given up" on China.

2. The "we will just leave it up to our Chinese partner on how to handle things in China because they have to know better than us how to deal with things there company."  I try to talk this company out of relying too much on their China partner (be it their general manager, their JV partner or whatever). I tell them horror story after horror story to try to convince them that their Chinese partner may know China, but that does not mean this person or company knows anything at all about how foreign companies are supposed to act in China. My implorations work about fifty percent of the time and when they don't, I typically tell this sort of company that it does not make sense for them to hire us because their Chinese partner almost certainly will not allow us or them to do things correctly in China. For more on this type of company, check out "Your Chinese-American VP Don't Know Diddley 'Bout China Law And I Have Friggin Had It."

3. The we are going to need to figure out how to handle China without self-immolating company. These sorts of companies make up at least 95% of the companies that seek to retain my law firm and about 99% of our clients. It is to this sort of company that Wolf seems to be directing his post. 

As David so succinctly puts it, the ethical issues foreign companies will face in China cannot be ignored:

Ethical conflicts are endemic to foreign businesses operating in China. Failure to recognize this represents either obfuscation or denial. The best way to deal with most of them is to avoid them altogether, and for the rest there has to be an iron set of principles to guide managers.

David then sets out the following five ethics-related questions foreign companies need to ask themselves before they go into China:

• What do our local competitors do to get and keep customer business? Is there anything that they do as a matter of habit that is simply out of the question for us?
• What would our joint-venture partner really do if we had to make a hard choice between ethics and sales?
• Can we turn our more ethical behavior into a business advantage, or indeed lead the industry to more ethical practices, or are we shooting ourselves in the foot by trying to play a “cleaner” game than our competition?
• Are foreign companies held to a higher ethical standard in our industry than local companies?
• Do our customers care whether we do things better? Or do they only care about price?

All but one of these are great questions. The only one I do not like is the next to the last one, "Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because I am of the view that one need not even bother asking it because the answer will always be "yes."

David sees the above questions and their answers as determinative on "whether a venture will succeed or fail." David also thinks these "same questions need to be asked about quality, and whether customers and consumers really care about the value we see in our products and services, or whether price is all." I completely agree.

David then states that once in a China venture, the above questions become moot and all "that is left is for the company to determine where it draws the line between sales and ethics." According to David, foreign companies doing business in China need to give their managers "a clear set of non-negotiable principles on matters ranging from worker safety to kickbacks to employee infractions, but a guarantee from the company that losing sales for reasons of ethics will not count against sales targets and budgets." Again, I completely agree. 

David notes that ethics in China costs money and companies need to budget for this and count the expenditure "as a long-term investment in corporate reputation." I would add that smart companies already do this wherever they do business, not just in China. If the cost of acting ethically means losses for the company, it "might make sense to cut those losses and run." My advise is even stronger. If your profits depend on your operating on the margins in China, do not even bother because your ability to operate on the margins will probably not last long enough to make going there worth your while.

David then addresses in detail the double standard between what is expected/required of Chinese companies and what is expected/required of foreign companies:

One area not touched upon by the case is the issue of government and popular expectations. As I've discussed before, foreign and private enterprises operating in China are held to a higher standard of operational ethics than local and state-owned enterprises. The ethical playing field is not level, so behaving unethically just because the local competition does is not an acceptable defense. Indeed, the government is more likely to make an example out of the foreign enterprise that behaves badly than local companies that do so.

David sees operating as a joint venture as providing no real additional cover, "especially when the brand on the joint venture is – or includes – the name of the foreign enterprise. A joint-venture is as good as a foreign company when it comes to juicy targets for fines and other forms of prosecution."

Lastly, David posits that unethical behavior by a foreign company will eventually come out, and usually sooner rather than later:

Another point that the beleaguered manager can toss at his joint venture partner is the inevitability that the unethical behavior will become public knowledge, and that such knowledge could be even more disastrous than missed sales targets. Some of the best investigative journalists in China have chosen to make a career out of catching unethical businesses in the act, and while taking on locally powerful SOEs can be tricky, they have editorial carte blanche to target foreign enterprises. Add the media bulldogs to the prospect of a frustrated competitor or disgruntled employee, and engaging in unethical behavior looks plain stupid.

And if you think your "connected" local partner is going to provide you with sufficient cover, you are probably thinking wrong:

Some local partners, especially the larger, better connected ones, will protest that they have the ability to put the muzzle on the local media. This may have been the case a decade or more ago, but it is no longer. There are simply too many reporters and too many outlets, a growing number of whom seek to build their careers as either muckrakers or crusaders against shoddy business practices. Lenovo, Li-Ning, and Mengniu Dairies comprise a short list of notable companies who have discovered that the number of reporters in China who can be bought is shrinking, as is the number of reporters who will stay bought once they have been paid off.

So based on the above, when should foreign companies deal with their ethical issues related to their China entry? Now:

All of which serves to reinforce the most important point: the time to deal with ethical problems in China is at the point of entry, not when the problem shows up like a letter-bomb on an executive’s desk.

For more on this double standard, check out the following:

• The Painted Veil On China Law
• Busted In China: McDonalds And KFC
• How We Really Feel About China, Part I: Guanxi
• China Legal Issues For Business. The Ten Minute Version. Part I

I also have to bring up one of my favorite comments, left here by one of the writers (Pipi) of the late great Sinocidal blog:

When in China, do as the law says, not as the Chinese do. The laws are not intended to be enforced fairly - they're their to be interpreted and enforced as local government sees fit to protect their clan, kin and cash-cows.

What do you think? Is there still a double standard in China regarding the expectations/requirements/treatment of foreign companies as compared to Chinese domestic companies? Is this gap between foreign and domestic companies any smaller now than it was five years ago or is it even larger? What are you seeing out there? 

This post was written by Damjan DeNoble, a 1L at University of Michigan Law School and a summer associate at Harris & Moure (Hey, check out the new website). Damjan (pronounced Dame-Yan) is also co-editor of Asia Health Care Blog.

By Damjan DeNoble

Meet Gigamedia, a NASDAQ-listed Taiwanese video game company at the center of a controversy that nicely highlights some of the inherent shortcomings/risks of variable interest entities (VIEs). The SEC case file on the dispute between Gigamedia and T2CN reveals nearly all the ways a VIE structure can go wrong in a country where he/she who posses the chop and license reigns supreme.

The following very briefly summarizes the facts:

1. Gigamedia (Taiwanese company registered in Singapore) acquired control over a Chinese online game company, T2CN (a BVI holding company).
2. T2CN owned 100% of T2 Technology. The VIEs contracted to T2 Technology are: Jinyou, T2 Entertainment, and T2 Advertising.
3. At some point, Gigamedia became dissatisfied with the performance of T2CN Corporate Executive Officer, Wang Ji, and tried to push him out with a dressed up corporate restructuring maneuver that involved Wang Ji stepping down as CEO, and stepping into a board position
4. Wang Ji retaliated: he walked off with the seals and chops to T2 Technology (the WFOE) as well as the VIEs.
5. Gigamedia lost out.

The point of conflict arose when Gigamedia fully expected Wang Ji to go along with its restructuring plans, just like countless other executives in corporations across the world had done before him.

As sole owner the VIEs, however, Wang Ji knew he held all of the cards and he intended to use them. He controlled T2CN's chop and the business registration certificates of T2 Technology and GigaMedia’s VIE.  Just as importantly, he also controlled key PRC licenses and records necessary for T2CN to operate in China. Unless Gigamedia could somehow gain physical control over these things it would not be able to do business in China without having to negotiate with Wang Jin.

Wang Jin must have been fairly confident, therefore, when he chose to execute "Dealing With Foreign Companies 101": stay quiet and appear to do exactly what the foreign company wants you to do, while actually wholly undermining what the foreign company is seeking to accomplish. 

Gigamedia made the first move against Wang Ji:

As a result, T2CN, as the sole shareholder of T2 Technology, removed Wang Ji as a director of T2 Technology on July 27, 2010.  Wang Ji was also duly removed as a director of T2CN on July 29, 2010.  On August 7, 2010, Wang Ji was removed as the legal representative, executive director and manager of T2 Entertainment with immediate effect by way of a shareholders’ resolution passed at a shareholders’ meeting of T2 Entertainment.  On August 10, 2010, the newly appointed legal representatives of T2 Technology and T2 Entertainment, together with their PRC legal advisers, went to the office premises to request that Wang Ji return all properties of T2 Technology and T2 Entertainment in his possession, custody or control.  At that time, the newly appointed legal representatives were forcibly removed from the office premises.  Also, Wang Ji’s employment contract with T2 Technology was terminated on August 12, 2010.

Seven months after Gigamedia announced the restructuring and right about when it was actually time for it to begin, Wang Ji made clear what he really intended to do:

GigaMedia believes that Wang Ji currently has in his possession, among other things, the company seals, financial chops and business registration certificates of T2 Technology and GigaMedia’s VIEs.  Wang Ji also has in his possession all documents, records and data and tangible property, including license agreements, trademark and domain name documentation, held in the offices of T2CN’s wholly-owned subsidiary, T2 Technology.  The company seals, financial chops and business registration certificates of T2 Technology and GigaMedia’s VIEs are necessary for the respective entities to declare dividends and approve service fee payments to GigaMedia, among other things. These documents are necessary for GigaMedia to run its online games business in the PRC.  Under PRC law, the company seals, financial chops and business registration certificates are essential for entering into contracts, conducting banking business, or taking official corporate action of any sort.  Consequently, GigaMedia has not been able to register the resolutions removing Wang Ji from his position as a director of T2 Technology and as the legal representative, executive director and manager of T2 Entertainment.  In short, Wang Ji has effectively usurped control over T2 Technology and T2 Entertainment’s operations and accounts.

If Gigamedia had an actual ownership stake in the VIE's controlled by T2CN,  the situation would have been salvageable, since it could have argued for the right to gain back control of the chop and relevant documentation. But because Gigamedia enjoyed only a contractual relationship with those companies through T2CN's VIE set up, its legal options were essentially limited to regaining control of its holding company, which would not be of much help, as Stan Abrams of China Hearsay explains in "GigaMedia: the Answer to the ‘What If?’ VIE Question."

If so much of the Gigamedia dispute comes down to someone physically controlling the right documents, where does it leave VIEs?

Probably in the same place as before any of this happened. Foreign companies do not go into VIEs so much because they like them, but because they have no other choice if they want to get involved in Chinese markets closed to foreign businesses.

Gigamedia's T2CN's problems should be filed away in the multi-volume treatise of China caution stories, as an example of what can go wrong between a foreign company and its Chinese partner. This story should probably be go in the section of the treatise on the importance of holding on to that still important anachronism, the Chinese chop.

For more on the Gigamedia case, I urge you to check out Seeking Alpha's "GigaMedia Will Survive Current VIE Turmoil,"and China Finance "What’s going on with GigaMedia?"

Just arrived Seoul after a quasi-whirlwind China tour. Started in Shanghai, then went to Beijing and then to Qingdao. It had been around four months since I was in China last, and as is my habit, I am going to toss out my random thoughts from my trip.

Here is what I saw/thought.

1. Shanghai, Beijing and Qingdao all seem to be booming. However, those who are on the fringes of the boom, seem to be getting angrier by the day. in particular, Beijing cab drivers have gone from being the surliest in the world to bordering on being serial killers. My favorite was the one who told us to f--k our mothers after HE missed our hotel and then drove into a dead-end street after we told him to circle back. It's tough living on $300 a month in a very expensive city. #7 below also does not help much in relieving their stress. 

2. Three people (all foreigners) told me they have pretty much stopped eating out because they are afraid of the food. As one well-known China lawyer told me, "if I buy my own food, i have taken away one more potential trouble spot." On the flip side, at least a dozen people said there's no place they would rather be. China is where "everything" is happening. And fast.

3. I stayed at a brand new Crowne Plaza in Beijing. Though nominally an American hotel, it is very Chinese. One day, I remarked to Steve how the risk of staying in a brand new hotel is that the whole thing might just collapse on us because it has yet to stand the test of time. Very next day, there were sticks propping up a couple of mirror tiles on the ceiling by the elevator. After that, I was perpetually worried about the ones without the sticks.

4. One night a bunch of us had dinner at South Silk Road restaurant. The restaurant, owned by Beijing artist Fang Lijun, was gorgeous, with his paintings festooned everywhere. The food was excellent, as was the service. We then crossed the street and met some more people for drinks at the Pavillion, a high-end bar/restaurant. We were sitting outside when we all of a sudden started smelling something and then realized that a truck was going by spraying massive amounts of pesticide. We ran inside. I mention all this because Beijing does remain a city of contrasts. High end restaurants but spraying of pesticides at 9 at night without a care for the countless people in the path.  

5. China does not have a housing market; it has a speculative market made up of people who buy property strictly as investments. Think of the condos as gold, not housing. A decent (not great) condo in Qingdao now costs around $500,000 but rents for only around $500 a month. Everyone said that half the condos in Qingdao are vacant, mostly bought by investors who don't live in them. More and more are being built.

6. There were a number of important government type buildings that were 80-90% finished but then construction stopped. The explanation given to me by the Chinese lawyers was that they never made much sense in the first place, other than as vehicles for enriching bureaucrats' pockets. 

7. Man but I had some amazingly good food. All three cities are getting increasingly diverse and sophisticated in their offerings.

8. Beijing has more $300,000+ cars than any city in the world, I think. It is a good thing China's peasants do not go to Beijing very often (other than as cab drivers). Not very subtle. 

9. Had many discussions with Chinese lawyers. They are very frustrated with China's court system. Their complaints are that there is little predictability and that the judges are random. Randomness/lack of caring/lack of scholarship were the big complaints. Why bother killing yourself on a brief and a hearing when the judges won't read it and don't really care?

10. China's Internet was worse than it has been within the last five years. My old standby VPNs did not work to allow me to watch US TV shows or to get on Facebook. Again and again, people (both Chinese and non-Chinese) talked of how Beijing is doing what it can to try to stay ahead of the people and it is doing so with both carrots and sticks. The carrots are things like more accessible health care. The sticks are obvious. 

11. Can China become a great economic power without massive improvements in the above, or will it get to a Thailand-like prosperity and then peter out? Or will it change?

12. While in Beijing I did a TV interview for a Hong Kong program on how American manufacturers are leaving China. I mentioned that as my firms' manufacturing business declines, our creative services business is growing and more than taking up the slack. Five years ago, a large part of my firm's business was in the Shanghai-Suzhou area and consisted mostly of manufacturing companies that were headquartered there. Five years ago, we did almost no business in Beijing. Beijing was for government and we were not very involved with that. Now, we do more business in Beijing than anywhere else. By far. Beijing has become the center for software, gaming, film, media, photography, sports and entertainment and various other creative service businesses and that is where we are seeing massive growth. We recently brought on a new lawyer (Mathew Alderson) whose practice focuses on these industries so I am sure that is clouding my view a bit, but at the same time, one of the reasons we brought Mathew on board was to handle the increasing number of such clients and to give me a foil for my Australia jokes. Are you seeing the same thing? 

13. I have traveled all over Asia, North America, Europe and much of Latin America, and in no country of which I have been other than China do the people stand up on the airplane too early when landing and then try to push their way through. Am I making too much of this or should this be instructive on how business is done there? 

14. I attended a talk given by co-blogger Steve Dickinson on how to protect your IP in China. The talk was put on by the China Helpdesk (a superb source for China IP info) and was geared a bit towards those in the creative industries. Steve mentioned how in virtually every instance where he has confronted IP and trade secret theft, it has germinated from an ex-employee or a customer. As Steve put it, it is almost always your "good friend who you have known for 17 years."  Two Chinese lawyers in attendance told Steve that of course that would be the case. At least one Westerner expressed surprise at this.

15. Didn't get a cough from Beijing this time. Has it really gotten better?

16. Went by a number of massive buildings that were 80-90% finished when construction stopped. Best explanation I got for those was that the skimming had already been taken out of them, so no need to continue. Developer borrows $25 million, skims $5 million off the top and then hires his cronies to build and skims another $3-5 million off that and then why even bother continuing? This seems to happen most often with quasi-government type buildings.

Fire away people. What do you think?

We have written frequently on how it is critical for a company that wants to form a WFOE in China to have a proper lease.  Among other things, a proper lease means that the property will be used per its zoning requirements and that it is being leased out by a registered landlord in good standing on its taxes. If these requirements have not been met, no WFOE is supposed to be formed.

We are aware of WFOEs that have been registered despite being out of compliance. This mostly happens in remote regions where the local government permits an improper registration because it wants the registration money (or more?) and/or because it wants the business. We think such improper registrations are ill-advised because they make your WFOE subject to closure by Beijing if discovered in an audit of the local company registration bureau. 

Last week, I received an email that gives another good reason for not going forward with improper WFOE registrations. The email was from a small company in a remote region. This small company had been able to register its WFOE even though its landlord was not properly registered. The company was writing me because it had just been denied a tax deduction from for its rent because its landlord was not able to issue a fapiao because it is not a legal landlord.

In addition to their tax problems, this company also should worry about the tax authorities reporting them to the company bureau (MOFCOM) for having been illegally formed. Beijing now knows this company was illegally formed and thus is operating illegally and it is at risk of being shut down.  

Bottom Line: It pays to operate legally. 

I was on a panel of speakers yesterday at the Offshore Investment Conference 2011. We panelists were to give a statement enunciating "the one key point" from the talks we had given earlier in the day. Yongjun Peter Ni, who heads Zhong Lun's tax practice, said something about how foreign companies need to abide by China's tax laws because China is now very serious about enforcing them. My first thought when he said that was "absolutely" and my second thought was that this is becoming true of all the laws that apply to foreign companies.

In the last few years, corporate taxes in China have assumed pretty much the same level of significance for Western companies as in their home countries. China's increased emphasis on maintaining transfer pricing controls is a salient example of this.

Which brings me to the China Accounting and the China Finance blogs. Both of these are relatively new blogs dealing with China accounting/finance issues and both are well worth reading.

China Accounting Blog is written by Paul Gillis, an Assistant Professor of accounting at Peking University's Guanghua School of Management. Gillis joined academia in 2007, after an almost thirty year career at PricewaterhouseCoopers. China Finance is by Fredrik Oqvist, one of Mr. Gillis's former students. Both have been providing in-depth coverage on Chinese Variable Interest Entities (VIEs) and reverse mergers.

Accounting and finance are rising to prominence in China and if you want to keep up, you should be reading China Accounting and the China Finance.

What do you think?

The media has been doing a thorough job of covering the Yahoo/Alibaba/Alipay so I am only going to summarize the situation in the briefest terms. Yahoo (along with Softbank) owns a large portion of Alibaba, which in turn, owned Alipay. Alipay is in the online payment business, which, according to Chinese law, means it cannot be foreign owned. A few weeks ago, Yahoo alleges it just recently learned that Alibaba had transferred ownership of Alipay to a fully domestic Chinese entity. Alibaba is saying it did that so as to bring Alipay in line with the laws prohibiting foreign ownership of an online payment company.

Financial advisory services and investment banks frequently call me when something like the above story breaks. Typically, they are calling because they want to know what to advice their own clients (usually either investors or investment firms). In most cases, I spend 1-2 hours reading the news regarding the latest story on which I am to opine and then I draft up a quick analysis and then we talk.

This Yahoo/Alibaba/Alipay story was different. I spent nearly a full day reading just about every story on it (this was a few weeks ago so it is possible something has changed since then, but my quick perusal of the news today did not turn up anything) and even then I still felt that I was lacking sufficient facts. Nonetheless, I went ahead and answered a bunch of questions from various Wall Street firms, consisting mostly of the following:

1. Was what Alibaba/Alipay did ilegal?
2. What can Yahoo do about it?
3. Why did Alibaba/Alipay do what it did?
4. Is it possible Yahoo really did not know about it until just recently?
5. What is the Chinese government going to do?
6. Is this sort of thing unprecedented?
7. Will this lead to a decline in foreign investment into China?
8. Are we going to hear more stories like this in the future?

Here again are the questions, this time with answers to the best of my ability:

Was what Alibaba/Alipay did legal?  I do not know and I cannot answer that without having access to Alibaba's and/or Alipay's corporate documents. China does not protect minority shareholders nearly to the same extent as the United States. Alibaba's or Alipay's corporate documents may very well have given a small group within the company authority to do exactly what was done here. I have not seen anyone from Yahoo claim what happened was illegal, which makes me think that it may have been perfectly legal. In other words, it is quite possible that Alibaba/Alipay had every legal right to do what they did.

At which point, the advisers asked me if it was possible that Yahoo would have agreed to such a  corporate structure and I responded by saying that was possible and I had in fact been involved in many cases where foreign companies had, usually without knowing, put themselves in similar situations.

What can Yahoo do about it? I do not know as it so much depends on whether Alibaba/Alipay acted legally or not. Yahoo has essentially three options: legal, economic, and political. I do not know what sort of strength they have in any of these three arenas vis a vis Alibaba/Alipay. I do not even know in what forum it would be best to fight on any of these fronts (United States, Mainland China, Hong Kong, British Virgin Islands?).

Why did Alibaba/Alipay do what it did? Do what? Make the ownership transfer or do it allegedly without telling Yahoo?  I think what Alibaba/Alipay is saying about the need to make the transfer makes sense, legally. I do not know why it appears not to have kept Yahoo more in the loop.

At which point, many of the advisers told me that they had heard that when Yahoo's new CEO, Carol Bratz, came on board, she tried to rein Jack Ma in and did so in a way that caused him to lose face. The word on the street is that this is payback for that.

What will the Chinese government do? This whole thing is pretty public and if in the end it makes it seem as though Chinese companies can just go off and seize assets that belong to foreign companies (whether this is what happened or not), it will not be good for China business. Therefore, I am guessing that the Chinese government wants this matter resolved and resolved "somewhat fairly" and is probably operating behind (or in front of) the scenes to try to accomplish that.

Is this sort of thing unprecedented? Not at all. My tiny law firm has been involved in probably a dozen similar matters. The only difference here is that we are dealing with extremely well-known companies. This sort of thing goes on all the time with small and mid-sized companies and nearly every time it is due to a fault in the initial structure of the business. The Chinese company took advantage of the legal ignorance of the foreign company and set things up so that it would eventually be able to shut the foreign company out, purely legally. Is this what happened to Yahoo? I do not know.

Will this lead to a decline in foreign investment into China? To a large extent it will depend on how it is finally resolved. But probably not.

Are we going to hear more stories like this in the future? Yes. 

What do you think?

Just read an interesting post on one of my favorite blogs. The blog is China Solved, written by my friend Andrew Hupert. I have known Andrew since forever and I have always found him to be one of the most thoughtful and rational China anaylsyts out there. Andrew is an adjunct business professor at NYU in Shanghai.

Anyway, the post is entitled, Is Bad News Good Again? and it was written by Jeff Coggshall, who handles China investments for Tiburon Partners, a UK-based fund management company. The post is about signs of recent slowing in China's growth. Now as regular readers of this blog know, I am not a fan of long term economic predictions and I am not going to discuss that here.

Instead, I am going to focus on what Coggshall calls the medium-term and on that, Coggshall says he has no worries:

I personally don’t spend much time worrying about China’s medium-term growth prospects – mainly because many of China’s growth constraints are self-imposed (i.e. property market restrictions and other tightening measures). These can easily be rolled back, and on a 1-3 year timeframe I find it very hard to envisage a scenario in which Chinese policymakers are either unable or unwilling to underline growth at a “reasonably fast” level of – say, 7 or 8%.

Coggshall's lack of medium-term worry really struck me.

In one camp, we have the China's economy can and never will do anything wrong crowd. See, e.g., Jim Rogers). In the other camp, we have the China's economy (and everything else) is on the verge of crashing crowd  See e.g., Gordon Chang or Nouriel Roubini.

Then something struck me again.

Roubini has been calling for a China crash landing [free subscription may be required] to happen in or soon after 2013:

“China is rife with overinvestment in physical capital, infrastructure and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns and brand-new aluminium smelters kept closed to prevent global prices from plunging.”

“Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990s – have ended with a financial crisis and/or a long period of slow growth.”

So here's what I am thinking. I think Cogshall is right that China has enough tools to be able to keep its economy going for at least a few more years. Heck, even Dr. Gloom himself, Nouriel Roubini, seems to agree with that. 

So is it pretty much a given that China's economy will do fine until at least 2013? Does everyone agree we can relax until then? Can we all get along on this one China economy issue? What do you think?