China WFOE formationThe Chinese media has lately been replete with stories about corruption investigations against Huang Xingguo, former acting Party chief and mayor of Tianjin Municipality. Whenever I read about something like this, I always wonder how many foreign companies will get caught in the crossfire.

How does that happen? Let me explain with an example of a China law story I never tire of telling.

Many years ago, an American company retained my law firm to form a WFOE in a fairly remote China city. Remote in terms of foreign companies anyway. This American company had a Chinese General Manager based in that remote city on whom it relied for pretty much everything. Very early on in the WFOE formation process, it became clear to our China lawyers working on the WFOE formation project that there was (and would continue to be) tension between how our China lawyers wanted to form the China WFOE and how the Chinese General Manager wanted to form the China WFOE. You see, we wanted to form the China WFOE completely by the book, but the Chinese General Manager viewed us as naive and kept insisting that he could do it much faster and with virtually none of the formalities because he had friends in the government. So we put it to the owner of the American company: either give us full control over how this WFOE formation is going to be done or just fire us. Because having us involved and paying lawyer fees to do the WFOE formation “the Chinese way” (the General Manager’s term, not mine) makes no sense at all. The American company agreed with our assessment and told us that it had to go with its General Manager because without that person it would have no Chinese company. We parted on shockingly amiable terms.

So amiable in fact, that about two years later the owner of the American company wrote me to say that though it had managed to get the WFOE formed really easily and really quickly, Beijing had come in and audited the local government and shut down a bunch of improperly formed WFOEs, including theirs. Beijing had come in after terminating a whole crop of local government officials for corruption and then, as it so often does, it throws out a fair amount of the bath water (our client’s WFOE for instance) with the bath (the officials who were terminated and jailed). This sort of thing goes on all the time in China.

So if you have a Tianjin WFOE now would be a good time to go back and figure out whether you have one that is legitimate enough to withstand what looks like will be coming down the pike. And if not, you should do whatever you can to shore it up or even just prepare to have to tear it down.

Just saying….

Bottom Line: If you are not operating legally in China, there will come a time when you will pay the price for that. Going after American companies operating illegally in China is low hanging and lucrative fruit for the Chinese government and it is just one of the ways we see China retaliating against Trump. The Chinese government has stepped up its law and order efforts and that has meant that time is coming more often these days for foreign companies doing business in China. China’s Tax Authorities Want You.

 

China contract lawyersDespite all that you may have read about China’s economy being on the downswing and despite all that you may have read about China factories closing, our China lawyers are starting to see distinctly tougher negotiating by China factories. We attribute this to the following:

  1. To greatly simplify, ten years ago China factories made socks and rubber duckies and with thousands of factories capable of making these things competition was incredibly intense. On top of this, price was oftentimes the foreign buyer’s only real concern. Today, China factories are making incredibly complicated products and oftentimes few or sometimes only one China factory has the capability to make the exact product the foreign buyer wants. Sometimes a China factory even holds a patent for some aspect of the product and so that factory is the only factory that can produce the product with that one aspect. Needless to say, being unique or nearly unique increases pricing power.
  2. To again greatly simplify, ten years ago, there were a number of China factories that knew little to nothing about pricing. It would not be an exaggeration to say that our China lawyers oftentimes dealt with China factories that did not even know their costs, leading us to often joke that they would make up for their selling widgets at a dollar under their costs by selling massive quantities of widgets. Most of those factories either wised up or no longer exist.
  3. Read all you like about factories closing in China, but recognize that there are plenty of profitable China factories these days with very good long term relationships with good stable foreign buyers. Those China factories are in no rush to take on your production on bad terms.

So what we are seeing now is a power shift, with Chinese factories more and more often gaining the upper hand. In subtle ways, this is making our job as China lawyers more difficult, while increasing legal fees for our clients. In the old days, our typical scenario would be that we would draft a manufacturing agreement (a/k/a OEM or ODM contract), send it to the Chinese company and get it back signed within 24 hours. Nowadays, it is far more common for us to receive pushback from the Chinese company on terms, including on terms to which the Chinese company previously agreed with our client. Needless to say, one of the more common push-backs is on price, with the Chinese factory oftentimes saying something like, we quoted $5 per widget with the understanding that we would have 90 days to produce after receiving the PO and now you are asking for 45 days (even though the email trail reveals that our client had made clear it was 45 days all along).

We are also seeing increased toughness even in the pre-quoting stage from China companies. About a month ago, I received an email from a foreign buyer telling me that a potential supplier was saying that it would sign an NNN Agreement with the foreign buyer agreeing not to use any secret information provided by the foreign buyer to compete with the foreign buyer, but if the foreign buyer ended up using another supplier to make its widgets, it would not be bound by the NNN Agreement. In other words, it would be free to use the foreign buyer’s top secret information to compete with it. The foreign buyer asked if something like this would work, to which I replied as follows:

No, this will not work. Not at all. This could be terrible for you. Imagine this scenario. Imagine you get quotes from five other good manufacturers ranging from $5 per widget to $7 per widget, but this one Chinese company is quoting you at $12 per widget. Do you pay the obviously inflated $12 per widget price, because if you do not, that Chinese company can (and likely will, otherwise why is it’s price quote so out of line with everyone else’s) will start making your widgets and competing directly with you. So you can see why this is not acceptable. We have actually never heard of a Chinese company making this sort of proposal so you should not face this situation with any other potential suppliers.

But then yesterday, one of our China lawyers got a similar email from a foreign buyer asking us essentially the same question. I discussed all of this with co-blogger Steve Dickinson and his response was “that’s what’s so cool about Chinese companies. They tell you what they are going to do. These two Chinese companies are saying if you don’t choose us we will steal your product. The choice is up to you. It’s up to our clients to listen”

I guess that is true. To which I can only ask whether you our readers agree that doing business in China and with China is only getting tougher.

For more on China manufacturing pricing, check out China Manufacturing Agreements: Binding Contract or Contract Terms.

China AttorneysBecause of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

In yesterday’s post, Defrauded by an Alibaba Seller? Here’s What To Do, we talked about what to do if you order and pay for a product on Alibaba, but receive nothing in return or something way way different from what you have ordered. In response to that post, I received two incredibly similar emails, about ten minutes apart (so similar in fact, that they may have been from the same person, using different email addresses). The emails essentially said the following:

Great post on recouping funds from an Alibaba fraud seller, but isn’t it true that even after doing all that you say in the post you will end up with nothing?

No, that’s not true. Not going to get up anyone’s hopes here, but recovering on this sort of fraud is a lot like recovering anything in China. If you can actually trace the actual scammer quickly your odds of getting maybe half of what you lost are probably a bit less than 50-50. This is just a somewhat informed estimate based on the experience of the China lawyers in my law firm and on what we have heard from other China attorneys who, but I think it is a fairly accurate measure to use to determine whether it will be worth pursuing the person or entity that stole your money. So just by way of one example. If you lost $300,000, you have a roughly 50% chance of recovering $150,000. It therefore would probably be worth it to you to spend $10,000 to get to a point where you can then make a new decision as to whether to proceed. But if you lost $30,000, you have about a 50% chance of recovering $15,000 and so it probably is not worth it to spend $10,000 to get a better feel for your chances.

Would love to hear from anyone else about how they do these sort of calculations.

 

Alibaba FraudLexology ran an excellent article the other day, entitled, Catching the Bad Guys: Recovery for a Defrauded Alibaba Buyer. The article was written by Kai XUE of DeHang Law Offices. Our China lawyers can attest to the need for this sort of article as hardly a week goes by where we are not contacted by someone with a major China Alibaba supplier problem. Note though that these issues are certainly not confined to Alibaba. The article nicely sets out how to handle a situation where you have sent payment for an Alibaba purchase but you receive “either junk or nothing and [you] can no longer reach the seller.” As noted in the article, most of these fraud situations involve a Chinese seller that “is a newly registered entity with little registered capital that uses a fake office address.”

Initiate a police report. The article notes that in a fraud case, you should report the crime to the police to try catch the fraudulent seller and to try to recoup your monetary loss. The article rightly notes the importance of going to the police quickly and ignoring various stalling tactics employed by the seller:

When confronted fraudulent sellers will reflexively claim that the matter is a commercial dispute to avoid involving the criminal justice system. For this reason, in cases of clear fraud it is advisable to proceed quickly to report to police and ignore last minute entreaties by the suspect to amicably settle. These apparent attempts by the fraudulent seller to settle not only may be an insincere attempt to delay for time but are also designed to create the appearance of a commercial dispute to dissuade police from pursuing an investigation.

The article notes the importance of going to the right police department (Hong Kong or Mainland) and of going to the police department with sufficient evidence to entice them to pursue an investigation.

Negotiating a settlement with the suspect. The article goes on to discuss how negotiating for restitution with the seller often should be undertaken, even in conjunction with the police pursuing its investigation of the seller:

Once put in detention and questioned by police, the realization of serving prison time acts as a strong impetus on the fraudulent seller to settle claims with the buyer. In exchange the buyer can agree to make best efforts to end the police investigation or ask for leniency for the fraudulent seller before the court if the case has advances to an indictment.

According to Chinese law, if an accused person returns some or all of the defrauded money and obtains a written pardon from the victim, her/his criminal responsibility may be mitigated. It’s on this basis that a fraudulent seller looks for a reduced sentence or release from detention by striking a deal with the buyer.

The article notes that one way to be able to tell whether the fraudulent seller has exhausted its available resources is “the extent that the fraudulent seller’s immediate and extended family make contributions:”

If a family member of the fraudulent seller provides a mortgage over real property or liquidates real estate assets to pay for restitution, then it’s likely that the fraudulent seller has cobbled together the maximum possible restitution payment.

 

Bottom Line: If you have been defrauded by an Alibaba seller (or any other China seller for that matter), the key is to act as quickly as you can in going to the police and in trying to negotiate repayment from the defrauding seller. The quicker you act, the more likely you are to get at least some of your money back.

China trademark registrationUnlike the United States, China does not have an affirmative requirement to prove that a trademark is being used in commerce. You do not have to prove use for a trademark application to proceed to registration, and once a trademark is registered you do not have to prove you are still using it to maintain or renew the registration.

Foreign companies have come to realize that China’s lack of a use requirement is a double-edged sword. On the one hand, it allows trademark squatters to register marks for a wide range of products and services they have no intention of ever providing. On the other hand, it allows “real” trademark owners to register their marks to cover a much wider range of products and services than would be allowed in most other countries. As we have noted before, Starbucks employs this strategy better than anyone: it has registered “STARBUCKS” as a trademark in all 45 classes of goods and services.

However, China will require evidence of use if a trademark registration is challenged for non-use. The basic rule is that once a mark has been registered for three years, it is vulnerable to a non-use cancellation. At that point, if a third party files a non-use cancellation, the owner has two months to provide evidence of use within the past three years.

If you are actively marketing your goods or services in China, then it should be fairly easy to provide evidence of use. Your use of the trademark in question on packages, containers, labels, manuals, advertisements, product displays, signage or at exhibitions are all likely to be sufficient. In general, original documents are required, but when a product has a lot of ephemera this is a low bar.

Where it gets difficult is when the only use of the trademark in question is on a product manufactured solely for export. It is not completely resolved in China whether such use constitutes either (1) use in China with respect to a trademark infringement action or (2) use in China with respect to a non-use cancellation. But in our experience, the Chinese Trademark Office (CTMO) will generally accept manufacturing in China, even if solely for export, as sufficient to defeat a non-use cancellation.

But you still need original documentary evidence!

It is all too common for foreign companies to order products from their China manufacturer for years on end using English-only documents that never identify the trademark on the products, and often never even identify the product with sufficient specificity. That makes it almost impossible to prove use to the CTMO’s satisfaction. What you want is documents that are in Chinese and clearly demonstrate your use of the mark in China on the products covered by your trademark registration: documents like invoices, shipping documents, quality inspections, and customs export declarations. Photographs are helpful to provide context but, standing alone, are usually insufficient to demonstrate use.

Typically, most (or all) of the documents that can prove trademark use for export-only products are held by the factory. So while you are still on good terms with your factory, you should make sure to keep a complete, regularly updated set of documents for each of your China trademark registrations. If things go south with your supplier, you don’t want your trademarks to be at risk too.

Doing business in China.
Doing business in China: relax, you have choices

CNBC recently quoted me in a fascinating article entitled, More and more American companies have decided their big China opportunity is over. The article is by Evelyn Cheng, who consistently writes excellent pieces on China.

The article starts out by noting how China may no longer be “the world’s biggest business opportunity” for American companies. It then cites McDonald’s being in talks to “sell its China unit and license its name to a Chinese company instead, following Yum Brands’ decision to do something similar.” It then (100% accurately) quotes me saying the following:

“The trend is that opening retail business on the ground in China as a foreigner is difficult and expensive,” said Dan Harris, lawyer at Harris Bricken and author of the China Law Blog.

We have for years tried to push a lot of our clients not to do that, but instead do what McDonald’s and Yum Brands are doing, which is … monetize your name and your knowledge without actually being the one who does all the work to make it work in China,” Harris said. “China is a tough, tough market.”

All true.

Except, and just to be clear, the China lawyers at my law firm do not believe there is a one-size-fits all solution for going into China in the retail industry, or in any industry for that matter. And — again, just to be clear — I would not in a million years claim to know better what is right for McDonalds or for Yum Brands in China, as I am quite certain both of those companies know 1000 times better than I do what is right for them.

So, yeah, not going into China with 5-200 retail outlets makes a lot of sense a lot of the time, but a lot of the time it does not. Yeah, our China attorneys oftentimes try to steer (or “push”) some of our retail clients to get away from the idea that the only way for them to make money from China is to set up their stores in Shanghai, Shenzhen and Suzhou, just as they have done in Palmdale, Portland or Peoria. Our goal (indeed our job) as China attorneys is to explain the various options to our clients and to give them the pros and cons of each. The key thing we want them to know is that they have choices and that they should analyze their choices and not just do what some similar company down the street from them did two years ago in China, nor even necessarily what their China consultant is telling them to do.

So let’s talk about some of the options for a Western retail company that is looking to profit from China by doing business in China, and the pros and cons of each.

  1. Go into China Full-On as a WFOE. Under this scenario, the Western company forms a WFOE in China (for all that entails, check out How to Form a WFOE in China). The benefits of doing this are that you are in full control of your China operations because you 100% own your China operations and you can operate them as a subsidiary of your US or your European operations. This way of going into China makes sense if 1) you cannot — for whatever reason — relinquish control of your stores or your product to another company or 2) you eventually want to franchise your stores in China as China requires that you first own your own stores there before you can franchise them out. The negatives are that setting up a WFOE is time consuming and expensive. See Forming a China WFOE: The Method and the Madness. And going all into China as a WFOE in the retail sector can be particularly difficult because your WFOE in Shanghai does not entitle you to just start doing business in Shenzhen. No, to get into Shenzhen, you typically will need to set up a new WFOE or a branch office there, and then figure out all of the issues that come with that, including even whether. Is your company truly ready to navigate China? I cannot urge you enough to read this post from 2012: Are You China Ready, which details a speech on this topic given by Ben Shobert.
  2. Go into China as Part of a Joint Venture. The big plusses of China joint ventures are that you typically share in the costs with another company and you have a Chinese company as your partner in China. For the big negatives, of which there are many, check out China Joint Ventures: The Tide is Out.
  3. Go into China Via a Distributor Relationship. A great thing about distribution relationships in China is that you have a lot of flexibility in how you structure that relationship. See China Distribution Agreements in Real Life. You can give your China distributer exclusive rights for all of China, or for just one city, or no exclusivity at all. You can set all sorts of sales requirements for your China distributor, ranging from sales amounts to exactly how your product will be placed on store shelves. But better than this is that you can usually get your retail products into China cheaply and quickly via a distributor. The downside of this is that by sharing the risks with your distributor, you will also need to share in the profits.
  4. Go into China Via a Licensing Agreement. Under a licensing agreement, you can license your product name and other attributes to a Chinese company, and you can even add in many of the same requirements you might put into your distribution contract. The upsides and the downsides of a licensing agreement are very similar to those of a distribution contract. For more on China licensing agreements, check out China Licensing Agreements: The Extreme Basics and Fear The China Joint Venture And Front-Load Your China Licensing Agreements.

Bottom Line: The one right way to start doing business in China is to work on figuring out the best way for you and your company.

China LawyersIn the original post in this series, Getting Money Out of China: It’s Complicated, I wrote on how incredibly frequently Western companies have been seeking the help of my firm’s China lawyers in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.” That has turned out to be no exaggeration as that Facebook post alone has generated nearly 10,000 views. And the requests for help from American and European companies seeking assistance in getting paid from China show no signs of letting up. But as I noted in part 2 of this series, most of the requests deal with purchasing single family homes in the United States and “slapping together 3-5 single family homes and calling it a fund is not likely to make a difference with the Chinese government allowing money to leave!”

In part 2, I discussed how the Chinese government seems to apply a three part test in determining whether to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. Part 2 focused on legitimacy.

In part 3, I looked at the “benefit to China” element and in part 4, I looked at what is actually happening in China that is slowly down payments from China.

In this part 5, I will look at what has historically been the primary reason why foreign companies face China payment problems: how they structure and write up their deal. This post will also discuss what you can do to increase your odds of getting paid.

The one thing you as the foreign company can control is whether you provide your Chinese counter-party with your product, your company shares, your assets, or your services before you receive payment for those things, or after.

With all of the recent problems in getting money out of China, it makes sense that when doing a deal with a Chinese company or individual, that you demand a nontrivial amount upfront, and confirm payment before you even lift a finger. Do this to prove that the Chinese side can in fact make a payment on the contract. The renminbi is still a nonconvertible currency, and aside from a $50,000 annual exception, any time a Chinese entity wants to send US currency to a foreign entity, it needs to get approval from the transmitting Chinese bank. This generally means that the parties have executed a contract for goods or services that are acceptable for foreign entities to provide, and that you have submitted a formal invoice in a form acceptable to the bank – because the bank in turn usually needs to get approval from government authorities. Sometimes this approval never comes, and the Chinese counter-party is unable to make any payments at all. It’s a lot better for you to find this out at the beginning.

To get paid from China, there have always been and for the near future will always be two critical points you must consider: documentation and tax.

Documentation. When a Chinese company seeks to send you as a foreign company money, it is not a simple matter. The Chinese company must go to its foreign exchange bank. At the bank, RMB must be converted to U.S. dollars or some other convertible currency. This conversion is subject to strict rules issued by the State Administration of Foreign Exchange (SAFE). The foreign exchange bank acts as the agent for SAFE in enforcing the rules. These rules were originally designed to protect China’s foreign exchange reserves but now they are used to prevent capital from illegally leaving China. Payment of falsified invoices is one of the primary ways capital illicitly leaves China, so careful review of all transactions is therefore required to prevent fraud.

To comply with these rules, the Chinese company is not permitted to simply make a wire transfer request; it is required to provide documentation proving there is a legitimate underlying transaction for which payment is being made. The following is the basic documentation usually required for money to flow:

  • A formal written contract, executed, dated by both parties and sealed by the Chinese party. Though not officially  required, it is best if this contract includes a Chinese translation.
  • A Formal, written invoice, signed and dated by the foreign service provider. There must be a separate, signed invoice for every required payment. Again, though not required, it is best if this invoice includes a Chinese translation.

These first two requirements are mandatory and will always be required. Depending on the specific situation, the foreign exchange bank may also impose the following additional requirements:

If the invoice amount is high, or if the bank otherwise suspects fraud, the bank may request proof of existence of the foreign company. The proof required varies from bank to bank. For some banks, a copy of a business license is sufficient. Other banks will require a formal certificate of good standing from the secretary of state or a related document. China just keeps getting tougher on this front.

If the bank determines that the payment is a royalty for a technology license or similar licensing agreement, it will require the contract be registered in accordance with the requirements of Chinese law. Depending on the locality, this registration can take from three days (Shanghai) to six months or more (Shandong Province). Our China intellectual property lawyers register China licensing agreements as a matter of course, and you should too.

Banks can impose other requirements, depending on their mood and their concern about the legitimacy of the transaction. The bank controls the situation and you have no real standing to discuss the matter. No payment can be made until the bank is satisfied and the bank has no incentive to approve the transaction. Delay in processing payment for services is therefore the norm rather than the exception.

Your Chinese counter-party is going to be better positioned than you to secure China bank/government approval and it is therefore essential then that your deal and your contract with your Chinese counter-party both put the onus on the Chinese company and incentivize it to get the job done.

Taxation. It comes as a shock to many foreign service providers that the amount paid to them may be subject to Chinese tax. The Chinese tax authorities deem all service work provided to Chinese clients as Chinese source income. Licensing fees are also usually subject to tax. As with the SAFE rules, the foreign exchange bank serves as an agent for the local tax office to ensure that the correct amount of tax is imposed and paid. No wire transfer can be made until this happens.

We have seen tax amounts imposed ranging from 10% all the way to 40% of the invoice amount. Even the same tax office will take an inconsistent position on the amount of tax to impose. One payment will be taxed at 10% and the next payment for exactly the same services will be taxed at a substantially higher rate.

The resolution of the tax issue is critical because the invoice cannot be paid until the tax amount is calculated and paid. Your Chinese counter-party acts as the agent for the foreign service provider and pays the required amount on behalf of the foreign party. Since the total amount paid by the Chinese company does not change, it has virtually no incentive to work with the tax office to lower the tax amount unless your contract with. Since you, the foreign company want to get paid as soon as possible, the incentive for the Chinese company is to agree with whatever the tax office decides and to make the tax payment as soon as possible without complaint about the amount imposed.

The amount of tax can be high and the time required for processing can be very long. It is therefore important that you understand the issues and enter into an agreement with the Chinese party on how to proceed. Under international commercial practice, it is most common to simply provide that 1) the Chinese side is liable for all taxes imposed by the Chinese government and 2) the amounts payable by the Chinese side are net of taxes. That is, the amount invoiced by the foreign party must be paid in full without regard to any taxes imposed in China. This provides certainty to the foreign party and places the burden of dealing with the complex, uncertain and constantly changing Chinese tax system where it belongs: on the Chinese party. Since the Chinese party is responsible, the Chinese party will then have the appropriate incentive to advocate for the lowest tax possible. Certainly the Chinese party is better positioned to do this than you are.

It is common for the Chinese party to strongly resist this standard approach and to seek to place all of the risk of the Chinese tax system on you, the foreign party. This means you must consider whether to abandon the transaction or move forward without certainty on the amount of payment you actually will receive. There are various complex ways to mitigate the risk of tax payment, but these measures must be negotiated carefully in advance.

Any time you enter into a contract with a Chinese company that requires it pay you outside of China, there is risk of delay and there is risk that no payment will ever be approved by the Chinese bank. It is therefore important that you confirm the ability of the Chinese side to make payment very early. Usually we provide in the contracts we draft that the Chinese side will make an initial payment before any substantial work is done or anything of much value is sent.

We do this to determine how quickly the payment will be processed and the tax that will be imposed on payment. Often, the Chinese side itself has no idea what will be the result.

We also often get called by service companies upon learning that their payment is going to be delayed and taxed heavily. By that point, there is little we can do.

Please do not let your company be another name added to the China payment casualty list.

China lawyers

In the original post in this series, Getting Money Out of China: It’s Complicated, I wrote on how incredibly frequently Western companies have been seeking the help of my firm’s China lawyers in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.” That has turned out to be no exaggeration as that Facebook post alone has generated nearly 10,000 views. And the requests for help from American and European companies seeking assistance in getting paid from China show no signs of letting up. But as I noted in part 2 of this series, most of the requests deal with purchasing single family homes in the United States and “slapping together 3-5 single family homes and calling it a fund is not likely to make a difference with the Chinese government allowing money to leave!”

In part 2, I discussed how the Chinese government seems to apply a three part test in determining whether to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. In part 2, I looked at legitimacy. In part 3, I looked at the “benefit to China” element. In this post, part 4, I look at what is actually happening in China that is slowly down payments from China. In part 5, I will look at what has historically been the primary reason why foreign companies face China payment problems: how they structure and write up their deal. That post will also provide tips to increase your odds of getting paid.

It is widely believed that China recently changed its rules regarding outgoing funds, but that is not really correct. China’s regulations on sending money out of China have not changed. There is no limit on the amount a compliant Chinese company can send abroad. But Chinese banks — acting on instructions from Beijing — are becoming much stricter with remittances. This new strictness has come about in an effort to limit capital outflows and to make sure taxes are paid in China before money leaves the country.

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

The regulations provide for a blanket $50,000 exemption from approval. No proof or justification is usually required for up to the $50,000 limit. However, we are getting many reports of Chinese banks denying requests for RMB conversion of amounts below the $50,000 limit.

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

In my next post I will discuss what you can do in structuring your deal and drafting your contract to improve your odds of getting paid in full.

China attorneysIn the original post in this series, Getting Money Out of China: It’s Complicated, I wrote about how incredibly frequently Western companies have been seeking the help of my firm’s China lawyers in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.”

That has turned out to be no exaggeration. That post has already had nearly 8,000 views and over the weekend, I alone received four reporter queries and nearly a dozen e-mails from people asking for help to get money out of China. I assume that were I to survey my firm’s China attorneys they would report something similar. But as I noted in part 2 of this series, most of the requests deal with purchasing single family homes in the United States and “slapping together 3-5 single family homes and calling it a fund is not likely to make a difference with the Chinese government allowing money to leave!”

In part 2, I discussed how the Chinese government seems to apply a three part test in determining whether to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. Part 2 focused on legitimacy. In this post, I will examine the “benefit to China” element.

There is no doubt in my mind that a key element to money leaving China is simply whether the Chinese government wants the money to leave for its intended purpose or not. Nothing scientific here and it is more art than science, but based on my experience and my conversations and my gut feelings, I would rank the likelihood of the Chinese government approving your deal in roughly the following ways.

  1. Near certain the money will leave deals. We have many clients who sell their products and their services to China for less than $10 million at a time, using China-centric contracts, and I cannot recall a single instance where any of them have had any trouble getting paid. These are real deals with real contracts with real parties with real pricing and it is pretty clear China so recognizes these and has little to no problem with them. These are the deals that help keep China businesses running smoothly. For what you need to do to make your contract work on these deals, check out Selling Your Product or Service Into China: The Contract Basics.
  2. It depends deals. Technology licensing deals fit into this category. The Chinese government wants its companies to acquire Western technology, but it is not clear that it wants its companies to pay too much for this technology, especially if a denial of payments will mean the Chinese company can pay less. For more on what is involved in doing a China technology transfer deal, check out Three Myths of China Technology Transfers and China Technology Transfers: The Relationship and Deal Structure Myths.
  3. It really really depends deals. Chinese companies investing in Western companies. Yes, you can read about this or that Chinese investment deal getting done, but you should know that many of these deals do not involve money going from Mainland China to the West: they involve money going from Hong Kong to the West. In trying to determine the odds of your deal going through the first question to ask is from where the money will be coming. If your Chinese counter-party has $200 million in an HK bank account and your deal is for $150 million, then what the Mainland will say about your transaction obviously becomes less important. But if you are counting on the money coming from the PRC, the nature of your business could well be determinative. If the investment is going to be in real estate, your odds are not good because it is difficult to argue how a Chinese company sending $150 million to the United States to buy a couple apartment buildings there will benefit China. But if the investment is going to give the Chinese company access to a technology needed or desired by China, the odds just went way up.
  4. Are you kidding me deals. We are not aware of a single instance where the Chinese government has said, “yes sure, go ahead and send that $5 million so you can buy a luxury condo in Vancouver or New York.” Sorry.

Determining whether money can come in on a specific deal — even when it is legitimate and the contract is good — is more art than science and nobody can get it right every time. For this reason, our advise is always to assume that getting the money will be difficult and act accordingly. We give this advice even for our lowest risk clients: the product sellers. See Payment Terms When Selling TO China: Possession Is Ten-Tenths Of The Law. This means setting up your deal to reduce your risk of not getting paid and to reduce your risk if you fail to get paid.

What are you seeing out there?

 

Chinese lawyers
Getting money out of China. It is super complicated.

In yesterday’s post, Getting Money Out of China: It’s Complicated, I wrote about how incredibly frequently Western companies have been seeking the help of my firm’s China lawyers in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.”

That has turned out to be no exaggeration. That post has already had nearly 5,000 views and despite it being the weekend, I alone have received two reporter queries and at least a half dozen e-mails from people asking for our help to get money out of China. I can only assume that were I to survey my firm’s China lawyers that half dozen number would be at more than a dozen. Again, though, most of the requests deal with the purchasing of single family homes and, people, slapping together 3-5 single family homes and calling it a fund is not likely to make any difference with the Chinese government allowing money to leave!

In this post, I will discuss the three factors the Chinese government uses to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. In this post, I will address “legitimacy.” In subsequent posts, I will address the other factors.

By legitimacy we mean exactly that. If a China company needs a $5 million dollar piece of industrial equipment for its factory and it pays $5 million for that industrial equipment, the deal will almost certainly go through. My law firm has a number of U.S. and European clients who sell this sort of equipment and for whom we have drafted contracts that work and none of these clients have reached out to us with any problems. Nor has any other company selling such equipment legitimately.

Just to repeat. Chinese company needs $5 million in industrial equipment to make its factory run better, the Chinese government will almost certainly allow the money to go through. Why then do we get so many calls and emails from U.S. and European (usually for us, German or Italian or Spanish) companies who are not getting paid for their industrial equipment sales? Two reasons. Bad contract and an appearance or a reality of illegitimacy. I will save the contract aspects for a later post and address just the legitimacy element in this one.

Here are the situations where we have seen problems on what should be a routine equipment purchase:

1. The foreign company is selling the $5 million piece of equipment for $8 million. Come on. If you have sold your $5 million piece of equipment to China five times in the last year for $5 million and now all of a sudden you are selling it for $8 million, the Chinese government is going to assume that you have some sort of side deal with your Chinese buyer to funnel some large portion of the $3 million extra to a bank account held by the owner of your Chinese buyer in your home country. When we have been armed with evidence to the contrary (perhaps you have added all sorts of bells and whistles to the $5 million machine, for example), the odds are good on your eventually getting the money out. But if you are in fact planning to push over the $3 million or so extra to your Chinese friend, the odds are not so good that the money will ever leave China.

2. The foreign company is selling the $5 million piece of industrial equipment to an advertising agency in China. Come on.

3. The foreign company selling the $5 million piece of industrial equipment has never sold anything to China previously and the Chinese company buying the $5 million piece of industrial equipment has never previously bought anything similar from overseas before. If your deal is truly legitimate, you ought to be able to prove it and you ought to be able to get paid. If your deal is really just a scam, your odds are really more. Note: our China lawyers love taking on the former type of matter but we will not take on the later.

4. The foreign company selling the $5 million piece of industrial equipment is wholly owned or largely owned or even partially owned by an ethnic Chinese. Call it discrimination or call it whatever else you want, but we often see deals involving ethnic Chinese on the foreign side held up to much greater scrutiny by the Chinese government. I first wrote about this Chinese government criteria back in January of this year, in Getting Money Out of China: What The Heck is Happening?

Get this one: Money will not be sent to any company on a services transaction unless that company can show that it does not have any Chinese owners. The alleged purpose behind this “rule” is again to prevent the sort of transactions ordinarily used to illegally move money out of China. Never heard this one until this month.

Things were a lot better in January and this criteria has only become more real. There are various completely legal things that can be done to alleviate this problem and improve your odds on this one, but it would be better for our firm’s clients that I not mention them here.

Bottom Line: When I wrote yesterday’s post on getting money out of China, I envisioned a two, maybe a three part series. The deluge of questions I have received just since then has convinced me that this issue is too pressing, too important, and too multi-dimensional to be contained in a series that short. This seems to be THE big issue right now and we plan to write on it until we have exhausted it. So keep your questions coming.