Foreign Investment in China

China e-commerceE-commerce for Foreign Invested Entities (FIEs) in China is in upheaval. Beginning with the much discussed liberalization of the investment cap for foreign entities conducting e-commerce business in China, and most recently with the draft e-commerce law, big changes are afoot. This post briefly summarizes the more important changes, briefly assesses their effect in practice, and speculates as to the underlying trends and future developments.

Backdrop. As pretty much everyone already knows, China’s retail e-commerce market has grown massively in recent years.  Matthew Crabbe gives some interesting totals and projections: firstly the Chinese online retail market was worth a total of 120.8 billion RMB in 2008, rising to 6,433.9 billion RMB in 2017, including B2C and C2C sales, with B2C overtaking C2C in 2015.  Cross-border e-commerce (Haitao –  defined as goods sold from outside China into China, not including foreign goods sold within China) as a proportion of B2C online retail was 1.3% in 2011, growing to 4.8% in 2017. This means the market estimate is 303.8 billion RMB in 2017, which is significant compared even to the total US online retail market, for example.

Summary of China’s e-commerce reforms. Since 2001, the Foreign-Invested Telecom Enterprises (FITE) Regulations have contained an investment cap on foreign investment in Value-Added Telecoms Services (VATS) businesses of 50% ownership.   There is now a limited exception to this relating to e-commerce business. The following brief timeline will illustrate the main events:

14 March 2011: China’s 12th Five Year Plan contains a broad injunction for the economy to move from an export-led manufacturing economy to a consumer economy.

7 January 2014: the “MIIT SHFTZ Opinion 2014” made it possible for Foreign Invested Entities (FIE) in the Shanghai Free Trade Zone (SHFTZ) to own a 55% share in for profit e-commerce businesses with nationwide reach, an increase from the previously allowed 50% investment cap for (VATS) business under the FITE Regulations, thus meaning that a nationwide reaching e-commerce entity could be majority foreign-owned.

13 January 2015: the “MIIT SHFTZ Opinion 2015” took the changes in the MIIT SHFTZ Opinion 2014 further, by allowing 100% ownership of an e-commerce business by a Foreign Invested Entity in the SHFTZ.

10 April 2015: Part IV s20 of China’s 2015 Foreign Investment Catalogue made an explicit exception for e-commerce when discussing the investment cap of 50% in VATS business. This change was widely understood as removing the limitations on investment ratio in the nationwide regime for e-commerce FIEs.

7 May 2015: The State Council E-Commerce Opinions contain an instruction to various Chinese governmental bodies to remove the current investment cap for FIEs in e-commerce businesses, expanding the SHFTZ liberalization nationwide. Various simplifications relating to licensing were also included. (see China E-Commerce: The New Rules for discussion of the State Council E-Commerce Opinions.

19 June 2015: MIIT Circular 196 appears to be the implementation of the State Council E-Commerce Opinions, and it allows foreign equity ratios in e-commerce businesses to be raised to 100%, explicitly stating that this is a nationwide extension of the SHFTZ pilot program.

27 December 2017: the Draft PRC E-Commerce Law was published. It applies to all e-commerce business within China, including e-commerce businesses outside China that sell into China. It differentiates between third-party e-commerce platforms (e.g. TMall and Taobao) and other e-commerce operators, such as self-operated retail portals. Chapter 5 deals specifically with cross-border e-commerce. However, detail is lacking, and its main point seems to be that China wishes to promote development of “cross-border e-commerce,” which is defined as “imports and exports of goods or services through the Internet or other information networks’.” Chapter 5 deals in particular with customs clearance, “electronization,” and personal information.

There have also been a number of other initiatives, such as e-commerce pilot zones, for example in Hangzhou and elsewhere.

What is behind the reforms? On the face of it, there seems to have been major progress in opening the Chinese market to international e-commerce operators. As is so often true when it comes to doing business in China, all may not be as it seems. It is hard to ascertain what is happening fore foreign companies seeking to do e-commerce in China, but since the above changes were implemented, very few VATS licenses have been issued to FIES. One example is Heiwado (China) Co., Ltd, a Chinese WFOE reported to have two Japanese shareholders and a market capitalization of around US$50 million, and which has been involved in traditional and online retail in central China for several years. See First WFOE Obtains VATS License From MIIT.

So what is going on?  There are several possibilities.

Firstly, one factor may be “bringing order to the market” and eliminating legal grey areas. Much of the selling of foreign goods online in China has consisted of informal grey-market imports, often brought into China as personal goods in suitcases and then retailed on Taobao via “Taobao Agent Purchasing.” This means goods are entering the Chinese market without the relevant customs clearance, duties, and product standard compliance. China has a strong incentive for bringing this industry within the scope of its regulation.

A related point is that although the FITE Regulations contain strict investment caps in telecoms business, foreign investment in telecoms is in fact pervasive in China, through the controversial Variable Interest Entity (VIE) structure. Another argument is that removing the investment cap for e-commerce companies is a pragmatic move to enable full compliance by foreign-invested e-commerce businesses. Why though bring e-commerce businesses under the regulatory umbrella, but not other internet businesses? One hypothesis is that full compliance in e-commerce is seen as an achievable and desirable medium-term aim, with overall benefits to China, whereas the policy pressure on other areas of the internet pushes in the opposite direction, with no desire to liberalize and allow foreign participation.

It is also important to remember that discussion of “cross-border e-commerce” in China includes outbound as well as inbound e-commerce. In fact, the focus of the policy seems to be on encouraging outbound e-commerce. One much-discussed theme in the development of China’s economy has been inviting foreign partners in, learning from them, then applying this knowledge internationally once it has been digested by Chinese entities. Opening the market with one hand, and yet maintaining restrictions with the other hand gives the illusion of liberalization while allowing domestic companies to dominate the market. With respect to examples like Heiwado, it is really a very minor player. One interpretation could be that an example like this makes little impact overall, and yet helps maintain an illusion that the market is opening.

Interestingly, online selling on domestic Chinese third-party retail platforms like Taobao is now relatively easy for foreign businesses. This in some ways represents an ideal scenario for China. If inbound cross-border e-commerce takes place under supervision of a Chinese entity, Chinese government oversight is much easier and Chinese businesses get a piece of the pie. For the foreign retailer, this is also a low-risk strategy. The availability of this alternative may be a strong factor in the apparent lack of applications for e-commerce VATS licenses by WFOEs. Does conducting standalone e-commerce in China as a WFOE even make commercial sense?

From the point of view of foreign investment in third-party retail platforms, the dominance of the domestic players presents formidable obstacles to the market. It is probably more plausible for Alibaba to take on eBay and Amazon internationally than vice- versa. Interestingly, Alibaba, the owner of Tmall and Taobao, is itself structured as a VIE. See Why Alibaba is good for China VIEs.

Future developments. China’s removal of its e-commerce investment cap does not appear to have led to any great increase in market access for foreign investors. However, it does fit into a general picture of increased access to the Chinese market for foreign goods, albeit on Chinese terms. Although the e-commerce market as a whole will continue growing, Matthew Crabbe’s prediction is that the Haitao market will peak at about 5% of total online retail sales in China. If that is correct, China’s e-commerce gold rush may not be quite what everyone expected, and today’s status quo is also the shape of things to come. The future of China’s e-commerce market lies largely in selling through established Chinese channels.

* This post was written by Edward Hillier, a New Zealand-qualified lawyer and researcher. This post is based on academic research he submitted to Anglia Ruskin University in 2017 for his LLM dissertation entitled New Opportunities in Online Retail For Foreign Investors in China. The author would like to thank Matthew Crabbe of Mintel for market and retail industry insight.

China joint venture lawyer
Negotiating the Chinese joint venture maze

We have recently been getting an onslaught of foreign companies (mostly North American and European) looking to do joint ventures in China. China joint ventures tend to be cyclical, rising when the business climate in China is for any reason difficult, and falling when it gets easier. It would seem we are in yet another Chinese joint venture up cycle.

One of the first things we always seek to do when contacted by a company seeking legal assistance on their China joint venture deal is to try to figure out what they want our role as lawyers to be, so we can provide them a good fee estimate. there are three basic things lawyers typically do when providing representation on a China joint venture deal: 1) provide counsel regarding the joint venture agreement; 2) provide counsel regarding the joint venture entity formation; and 3) do the actual work involved in forming the joint venture entity itself.
In our initial communications with potential and actual joint venture clients, we seek to discern what our role will be on all three of these things, especially the third one: how much involvement our firm’s lawyers will have in forming the China joint venture. If the Chinese side (or its lawyers) are experienced with how to form a joint venture, it usually behooves our client to let the China side handle that aspect of the transaction, with our role being to simply oversee that process to make sure it goes smoothly. The below email is from one of our lawyers to a new client that just retained us to provide it legal counsel regarding its China joint venture deal. I am running that email today because it provides a good overview on some of the common issues that arise in China joint venture transactions, while also nicely setting out the different roles your China attorney might play in such a deal.
It appears you want me to review documents, with the actual work forming the entity and setting up the factory to be done by your JV partner.
I briefly reviewed briefly the JV contract. The document is written in a common law style, but it is clear and complete. Are you certain you want to operate in China in JV structure? Are you certain the proposed amount of capital will be sufficient to set up and begin operations for a manufacturing venture? Are you certain you are willing to contribute ownership of your intellectual property to the JV company? Are you certain you would prefer to transfer ownership of your IP to the JV company, rather than just license your IP to that entity? Are you certain you are willing to earn income from this project solely from distribution of profits from the JV company? Are you certain you are willing to give full control over this project to the Chinese side? Your JV contract assumes you can exercise some form of control through the board of directors, but this is an illusion.
If your answer to all of the above is yes, then my review of the documents would be extremely limited. If your answer to any of the above is no or that in light of my questions you are not clear on how you wish to proceed or simply that you need more information, then I would provide for a normal review, outlining the issues. However, if you already understand and are ready to move forward on the basis of this contract, there is no need for this step.
Finally, note that forming a foreign invested enterprise in Shenzhen is a difficult process. Though your partner will be dealing with the Chinese side, much of the process and much of the delay involves obtaining information and authenticated documents from your company and very few Chinese companies (or even Chinese lawyers) have experience in that process. You should discuss with your partner how you will handle that side of the formation process. Note also that setting up a factory in Shenzhen involves all sorts of required documentation and is a complicated and time consuming procedure. However, if your Chinese JV partner has all of the above under control, none of this should raise any issues. You should, however, ascertain whether they understand the JV formation process. In our experience, most Chinese “partners” do not understand this process, which can cause confusion and delay and added expense down the road.
As always, if you have any questions, please do not hesitate.
For more on China joint ventures, check out the following:

 

China WFOE Formation lawyersMany of our China clients are interested in setting up WFOEs in China to provide some sort of education to Chinese citizens. The problem though is that China does not particularly like foreigners educating its own citizens.

What WFOEs can and cannot do in the realm of education are vague and variable by locality. Oftentimes, what it comes down to is whether what is being taught is something China wants foreigners teaching, or not. To put it on a spectrum, if your WFOE plans to teach Chinese citizens how to utilize some sort of new and obscure technology in demand in China and good for China, your chances of operating problem free are good. But if your plans are to teach something politically sensitive, your chances will be far less good.

Exacerbating this problem of educational vagueness for foreign companies is the large number of unscrupulous WFOE formation companies that take the money to form a WFOE that will never be able to engage in the sort of work its foreign owners hoped for it.

One of our China recently lawyers wrote the following email to a client about this (the email has been stripped of any identifiers):

The key point is as stated in your response:

After we set up our WFOE in China, we asked for advice from a Chinese government officer tasked with approving the scope of work in the Industrial and Business department. She told us that WFOEs are not allowed to engage in educational training in __________.

This prohibition applies generally. That is, no direct training, no training of _________ and no training of ________. This also means no direct publication of related training materials and no use of the Internet or social media to disseminate such materials. “Commercial consulting” is an intentionally empty term, no doubt intentionally chosen by the company you used to register your China WFOE. As I noted in my previous email, the scope of your WFOE’s business clearly states the absolute law: “where specific approval is required, the specific approval/legal restrictions apply and the scope of business is ignored.” You almost certainly will need specific approval to do _______ training and if that is not allowed by WFOEs, then your WFOE will in fact not be able to do what you thought it could do when you paid to have it formed.

There is, however, a way to do your business in China. There are several alternatives. Note, however, that the implementation of these alternatives depends ultimately on the attitude of the PRC government authorities to the content of your program. You have the most complete information on that issue and our plan will be to get all of that information from you and then research in the books and with government officials what is actually allowed and not allowed. The decision on whether you will ultimately be allowed to proceed will not be made by your clients and supporters (including Chinese companies that are encouraging you to move forward, but rather by Chinese bureaucrats, such as the “Chinese government officer” you mentioned in the quoted paragraph above.

And this same lawyer then emailed me to muse about how so many of WFOE formation entities are willing to set up a WFOE in this situation knowing that it will not be able to accomplish the business its owners intend for it, but “with little or no concern for the ramifications of this.”

China WFOE formation
China WFOE formations: It’s funny because it’s true

Those of us who do China WFOE formation work must constantly fight the temptation to use the sort of hackneyed phrasing usually found in inspirational corporate desk calendars, tech startups’ mission statements, and ironically titled albums on Bandcamp. “Expect the unexpected.” “Embrace the contradiction.” “Winners never quit. Quitters never win.” But WFOE work can be so frustrating and counterintuitive that speaking in clichés often seems like the only appropriate response. Dignifying the Chinese authorities’ actions with measured analysis and rational thought is a path to madness, or at least extreme frustration.

The latest annoyance is that during the WFOE formation process, an increasing number of districts (even in China’s largest cities) are requiring the WFOE’s legal representative appear in person at the Public Security Bureau (PSB), passport in hand, to prove their identity. Setting aside the inefficiency of requiring a personal appearance, what makes this request truly bizarre is that the same local authorities have already required the legal representative submit an authenticated copy of their passport. The exact procedure for producing an authenticated passport copy can vary by state, but a typical example would be as follows:

  1. The WFOE’s legal representative goes to a notary public, photocopies their passport, and signs the photocopy in front of the notary.
  2. The notary then signs and stamps the photocopy.
  3. The notarized photocopy then goes to the county clerk’s office of the county in which the notary is commissioned, which produces a written document with a seal confirming that the notary is in fact a commissioned notary public.
  4. That document then goes to the Secretary of State of the state in which the county is located, which produces another written document confirming that the county clerk is in fact the official county clerk of that county.
  5. That document then goes to the U.S Department of State, which produces another written document confirming that the Secretary of State of the relevant state is in fact the duly elected official of that state.
  6. That document then goes to the Chinese Embassy in Washington, DC, which affixes a certificate on the back of the U.S. Department of State documents, authenticating that the documents were in fact created by the U.S. Department of State.

This process usually takes several weeks and costs a few hundred dollars, assuming everything goes smoothly. The procedures for countries in Europe are roughly similar.

The purported reason China requires so much rigmarole to prove the identity of the legal representative is because they receive so many forged documents, and the Chinese Embassy’s imprimatur is the only way to confirm authenticity.

See if you can guess why we are now being asked to produce the legal representative in person. Remember the clichés at the beginning. And … wait for it … yes, it’s because the Chinese authorities allege they have been receiving counterfeit Chinese Embassy authentications.

At its very core, this new procedure makes no sense. My colleague Steve Dickinson doesn’t get it either, noting: “The whole point of Embassy authentication is to guarantee the authenticity of the document: local country notarization and then embassy authentication is the “gold seal” for guarantee of document authenticity. If the PRC abandons that international practice due to its massive internal corruption, then the whole system China created to deal with these issues will collapse. No one benefits from that.“

The bottom line is that in to form a WFOE, the parent company will likely need to make the WFOE’s legal representative available to spend a couple weeks in China to make a personal appearance at one or more government agencies, producing their passport and signing documents as necessary. If the parent company is unable or unwilling to make the legal representative available, they take the risk of having their WFOE formation delayed, or perhaps even cancelled. Our lawyers in China, along with our local agent, are working hard to try to find a solution to this and there is at least a decent chance that we will. Yet this requirement seems to be spreading and based on the way things so often go in China, this requirement could very well become entrenched (or not) in the near future.

Ultimately, the only way to stay sane if you do WFOE formations is to keep a sense of humor about the process. You could get angry, but what’s the point? Like Homer Simpson says, “It’s funny because it’s true.”

China employment laws and foreign companies. One tough mudder.
China employment laws and foreign companies. One tough mudder.

The China Labor Bulletin just did a post revealing something my law firm’s China lawyers (especially our China employment lawyers) have sensed/felt for quite a while: China employees increasingly know their rights and have no compunction about doing what they can to enforce them:

While latest national LDAC case data compiles data only up to 2015, local government reports reveal more recent statistics, and tell stories of the rising rights awareness of workers.

A whitepaper on labour disputes from Guangzhou noted the increasing diversity of grievances raised by workers in recent years. Unpaid social insurance, for example, account for over 40% of all arbitration cases over the past three years. Women workers are an increasing portion of all cases, and are taking action against unequal treatment, illegal firings or wage cuts during pregnancy or maternity leave, and discriminatory hiring practices.

Though this article does not specifically address employment cases against foreign companies doing business in China, I would venture to bet that employment disputes between Chinese employees (and expat employees as well) and foreign companies have increased at an even faster pace. We see this in the number of emails we get from both employees (expats mostly) seeking to sue and from employers threatened with lawsuits. In virtually every employment dispute we take on as counsel, however, the parties eventually settle, meaning they never become a part of any Chinese government statistic.

I wrote on this last year for Above The Law, in an article entitled, China Employment Disputes: Settle, Settle, Settle: Attorney Dan Harris says there’s only one way to deal with labor disputes in China. That article started out with the following:

Every few weeks, one of our China lawyers gets an email from a foreign company (virtually always a WFOE) that is in a dispute with one or more of its China-based employees. These foreign companies are usually surprised to find themselves in such a dispute because they are of the view that they did nothing wrong. They too often believe that hiring my law firm will consist of us spending an hour or two reviewing the facts and the law and then telling them that they did nothing wrong and then making the case go away.

The only difference today is that we are getting those emails every single week, and usually more than one. But what hasn’t changed is what causes foreign companies to get themselves in this situation, nor what they need to do to get out of them. The two leading causes for the employment disputes we see are a failure to have a well-crafted set of Rules and Regulations combined with maladroitly handled employee terminations. See China Employee Termination: Avoid These Mistakes. We also have seen no slow down in foreign companies getting into big trouble for having “employees” in China without their actually having a China WFOE to serve as the employer. See Doing Business in China with Deportation or Worse Hanging Over Your Head.

Bottom Line: China wants foreign companies doing business in China for financial reasons and those companies that are not fulfilling their China financial duties, be it via taxes or employee payments are at risk.

China WFOE A while back (I am being intentionally vague here to avoid identifying anyone) a U.S. client company contacted me about shutting down its China WFOE and/or terminating all of its roughly 20 China employees in one fell swoop. The U.S. company had discovered rampant corruption among its employees and its CEO wanted all of this to be done “by tomorrow.” I am not kidding!

My response (modified to hide any identifiers and ` into one email) was as follows, with the client identified below as “Company A.”

I spoke with Grace Yang (our lead China employment lawyer) and with Steve Dickinson (our lead China corporate lawyer) and both agree that there is no way we can provide you with anything even approaching sound advice by tomorrow.

You essentially have two choices. One, you slink away in the middle of the night and neither Company A nor anyone who China might ever identify as having been associated with Company A ever goes to China again and Company A never conducts any business with China again. If (as I pretty much know will be the case) this does not appeal to you, then you must provide prior notice to the government because what you are proposing to do almost certainly constitutes what China calls a “mass layoff.” We will need to confirm with the authorities that such notice will be required because the definition of mass layoff varies depending on the local labor bureau. But we are virtually certain it will be.

Once we know exactly the layoff situation with which we are dealing, we can work with you to figure out the best, the fastest, and the cheapest way to accomplish it. If you have any employees who are pregnant or any employees for whom this will present a significant financial hardship, this will get even more complicated.

In addition to the employee issues, you also will need to work with the government in shutting down the WFOE itself and that can be an even longer and more drawn out process than dealing with the employment issues. We typically bring in accountants to assist with WFOE closures because taxes are so central to this. We have worked with a couple of very good accounting firms in ___________[Chinese city] and we would want to bring one of them in for this closure. This is going to take a substantial amount of legal work on our part, gathering up the facts, researching the law, and meeting with government officials.

What I can tell you at this point is that how we handle this will very much depend on the facts. It will depend on the size of the WFOE (my client contact did not even know how many employees the company had in its China WFOE]. The reason for the layoff. The types of employees you have: some may need to be differently than others. The location. The economy in your location. The labor bureau office. Your company’s history. Your company’s plans for the future, including not just China but other countries. I could go on and on and I’m sure Grace and Steve can and would add many more things to this list once we get going on this. We have seen these sorts of terminations/shutdowns done right and we have seen these terminations/shutdowns done wrong and usually when they are done wrong really bad things happen, like people being held hostage in China or seized by the government when they go over there a few years later. When they are done right, they take a lot of thought and a lot of varied expertise and, most importantly, a lot of time.

If what you are proposing is a mass layoff — and we are virtually certain it is — there are certain procedures that must be followed, and those procedures vary by district, by city and by province. If it is a mass layoff, almost everything will likely need to be made public and the language used in the public notice thus becomes absolutely critical. The last thing you want is for your terminations to become this week’s big issue for labor activists. We will need to meet with the employee/union representatives or all of the employees to discuss severance. What can go wrong there? Well, one of the last times I was in Beijing, the talk of the town was an investment banker who went to meet with employees in a situation not all dissimilar to this, but without a plan. He was literally beaten to death. That’s obviously a rarity, but it does show the need to have a well thought out plan in place before doing anything.

The labor authorities will get involved and they have tremendous power to correct anything they think wrong with the WFOE’s mass layoff proposal. And the last thing you want to do is start out too harsh and thus anger them from the get-go. On the flip side, if we can win over the local labor authorities with a good plan, we can likely get them to assist in the whole process.

The above is mostly just the labor issues. Closing down the WFOE will have its own issues, mostly relating to first clearing up the labor issues, and any debt and tax issues. The tax issues tend to be worst of all because once a company starts closing, taxes start coming out of the woodwork. That is why we also will almost certainly want to bring in a high level yet local tax accountant. Oh and employees almost always file a claim against the WFOE regardless of how good a severance package they get; they nearly always think they deserve more. Which is why it will almost certainly be worth it for you to pay each of them enough to get each and every one of them to sign a settlement agreement in addition to everything else. I understand why you do not want to pay most of your employees anything right now, but it will probably end up making financial sense to do so.

Our China lawyers continued working with this company on a strategy and as time went on, their anger subsided and they chose not to shut down or layoff all of their China employees. But for anyone out there thinking of shutting down their WFOE or laying off all or nearly all of your China employees and needing some ultra-quick advice, the above should do, with the usual proviso that China’s laws on this sort of thing are always changing and always hyper-local.

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

 

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

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

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

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

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

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

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

China joint venture lawyersOur own China lawyers have written countless articles on China joint ventures (for this blog, for AmCham, for the Wall Street Journal, for Above the Law,  and for many others), so it good when someone we know and respect says the same basic thing about them, which is that you should watch out.

The writer is my friend Randall Lewis, who has headed up Asia legal out of China for both Danone and ConAgra and who truly knows China. Last month Randall wrote about setting up joint ventures in emerging market countries. Randall stated that his article “is intended to be your general “watch-out” guide to avoid basic and simple joint venture mistakes.”

Randall begins his article by commenting on how people are wrong to believe that if they “set up a good platform for a business, agree on ownership percentages and the business plan/finances work. . . . the lawyers will work out the rest.” He then proceeds to list a ton of “common mistakes your commercial folks WILL make when taking your company into a foreign market. He makes clear that his list is “not hypothetical” as he has encountered every situation personally. Guess, what, our China lawyers have encountered every situation personally as well, and multiple times.

But without further ado, here are the more China-relevant mistakes Randall has seen and about which he wants to warn you, with my comments about China joint ventures in italics:

  • Commercial people frequently engage in detailed discussions with potential partners before discussing options, strategic structures and legal issues with their own legal counsel. This leads to promises being made and structures being agreed to that are completely against your own best interest and which benefit only your JV partner. Once these “agreements” have been made, it is difficult to change once you bring in legal counsel. In short, a wise approach is to consult legal counsel BEFORE you have discussions on structure, methods of investment, holding companies, corporate governance structures or just about anything outside of pure commercial matters and general alignment. Definitely true for China as well. 
  • Never take legal advice from your potential JV partner. This happens more often than you know. Your commercial people will start a discussion and the “local” will advise your team on what they can and can’t do in their country. This advice is more likely than not, 100% incorrect or misleading for a good reason; it is being given to take advantage of your company and to secure a structure not in your best interest. I wrote about this in China Joint Ventures, The Tide is Out: We have seen US companies that have put tens of millions of dollars into a Chinese joint venture, using no legal counsel at all, using the legal counsel of their joint venture partner, or using a local Chinese lawyer who has no experience with foreign joint ventures and no real incentive to protect the foreign company. 
  • If someone says; “we don’t need to involve the lawyers yet” or “we don’t need to have your legal counsel in the room for this discussion” or “we prefer to let the lawyers work out the contracts after we agree on XYZ,” stop immediately and ask yourself if that makes any sense.  Usually, excluding lawyers is not for cost savings or to do you a favor in terms of simplifying your discussions; it is, simply enough, to pull the wool over your eyes. True for China. 
  • If someone says “ we have someone that will act as our CEO/GM and CFO/finance people” be wary that you have enough control over key functions so that you don’t end up a financial investor in a JV vs a real partner. Keep in mind that if someone is appointed to an executive function by your partner, that person is more likely than not, viewing your partner as their “employer” vs the joint venture entity or your company. Their interest will be completely aligned with your partner and not to your company. 100% true for China as well. The key is control and one of the biggest mistakes we see is Western companies wrongly assuming that because they own 51% or more of the joint venture, they control it. See Avoiding Mistakes in China Joint Ventures.
  • When your partner says to you they will build your factory and secure all the licenses and permits for your new business, use caution! If you are in a JV and your partner is engaging in illegal behavior that violates the UK Bribery Act, FCPA or other local equivalent you may find yourself on the hook for all of your partner’s activities! In short, you need to be able to manage and control your partners activities beyond just signing a contract that obligates them to comply with your FCPA and UK Bribery Act obligations. Many times a JV partner will sign anything and proceed to do whatever they desire because they don’t understand the obligations, nor do they care or “that is not how they do things in their country”.  Way too many companies enter into contracts thinking they can trust their partner to follow the rules (hey, you have a contract) and then they get burned. This happens in China all the time.
  • Don’t be impressed by your partner’s government connections and think this is of great benefit to your new potential JV.  It is 99% possible, those connections will be used to benefit your partner in the future and to your detriment. I have seen more than my fair share of commercial people get overly excited about a “connected” potential partner only to find out a few years down the road that those connections are being used privately to do things and take actions the partner is not contractually or legally able to do. Definitely true of China.
  • Don’t be led to believe that if you have a controlling position at a Board level you are in control of your JV in many countries. For example, in China (and other locations), the right to control the Board does not give you effective control of the company. For actual control you need to control the appointment of the General Manager and ultimately the company “chop” or seal (which allows the possessor the power to make binding contracts on behalf of the joint venture company and to deal with the company’s banks and other key service providers).  In addition, your access to financial information and the ability to audit will not necessarily be assured unless you control the CFO position. Securing this finance position will also assure early warning of problems with the business and potential fraud. Agreed. See Avoiding Mistakes in China Joint Ventures.
  • Don’t let your partner convince your team that setting up a JV on a 50/50 basis with no mechanism to resolve a deadlock is a good idea.  I have seen more than my fair share of JVs that have 50/50 shareholding and no deadlock mechanism leading to a complete breakdown of the JV business.  This usually only benefits your local partner that had this as their goal from the beginning. Once the JV is successful (or they have what they need from the partnership) they manufacture a way to push you out so they either buy your interest (in a manner outlined by a local court) or exit to run a new business that looks identical to your own. We see one of these pretty much every year involving China joint ventures and they are never a good situation. 

Randall ends his article by calling for companies looking at doing a joint venture to “slow down, use caution, exercise common sense and surround yourself with advisors that challenge your assumptions and criticize your deal.” I can agree with that also.

China lawyers
Trading Babe Ruth was a big mistake. So what?
Donald Trump is that fantasy sports team owner who vetoed every trade involving Team China or Team Mexico (except his own, of course).  But now he’s become the league commissioner and he’s promised to fix or renegotiate all of those “bad” trade deals. Yikes.

Donald Trump and Peter Navarro, head of the newly formed White House National Trade Council, are always bitterly complaining about the huge trade deficit the United States has with China and other “bad” countries. But trade deficits should not be equated with unfair trade or with the alleged utter destruction of American manufacturing. This is like complaining that a baseball trade was so bad it caused the team not to win the World Series for, say, 86 years. Or, complaining that your team is suffering from a seven-to-one player trade deficit even though your team gave up seven players who were either nobodies, soon to be has beens, or never will bes, and your team gained a perennial All-Star or future Hall-of Famer in return.

The U.S. trade deficit with China does not mean the United States is losing to unfair trade. Trade of goods is just one part of what drives our economy. Though the United States may run a deficit in the trade of goods (both overall and with China), we run a surplus in the trade of services.  Also, China and Japan each own more than $1 trillion in U.S. Treasury bills, bonds, and other securities. Moreover, foreign companies are “insourcing” and purchasing U.S. assets, such as buying U.S. companies or investing in building new factories, shopping malls, hotels, etc. Harping on the United States’ trade deficit while completely ignoring other economic factors in which the United States has a surplus is an incomplete and misguided way to evaluate how the U.S. economy is performing. Full disclosure: my firm and especially our international trade and our China lawyers have a lot of skin in this game as we generate millions of dollars a year in services directly related to US-China trade.

Looking at trade balances between countries as if they were a zero-sum game to be “won” or “lost” does not make sense because countries don’t actually engage in trade with each other on a national level. Only companies and individuals in each country trade with one another. A trade (for fantasy league baseball players or for real life goods) happens only if both sides believe they are exchanging comparable value with each other. China exports boatloads of goods to the United States because U.S. companies and individuals see those imports as the best value for their specific needs. A good chunk of the imports contributing to the U.S. trade deficit are used to manufacture higher value-added products in the United States. The U.S. imports crude oil for U.S. refineries to produce gasoline and other higher-value petroleum products. Boeing airplanes include all sorts of parts imported from around the world. If Party A and Party B each a consensus that a trade is mutually acceptable, and there is no sign of fraud or collusion, why should the President/League Commissioner intervene and try to fix those so-called “terrible” trade deals?

Even those trades perceived to have been lopsided or unfair does not mean that the losing team on the deal needs rescuing or that the deal should be voided or undone. Teams make stupid deals all the time.

Every team hopes to avoid making bad trades, just as reducing the U.S. trade deficit is not wholly a bad idea. But reducing trade deficits by itself will not restore America’s manufacturing jobs any more than avoiding bad trade deals by itself will get teams a championship ring. The effects of a huge trade deficit or a bad trade deal, either in the market place or on the playing field, tend to work themselves out over time because there are so many other factors that go into the country’s economic performance or team’s performance. A good President/League Commissioner would know better than to try to fix every “bad” trade deal or trade deficit he doesn’t like.

Editor’s Note:  If you talk with people who regularly do business with China, especially people with companies that do business in China, they will mostly tell you that what they/we need is not so much higher duties on imports, but more pressure exerted on China to level the playing field for foreign companies doing business in China.

Negotiating with Chinese CompaniesJust read a post over at Andrew Hupert’s ChinaSolved Bog, entitled, 5 Negotiating Lessons from Sec. of State Tillerson’s Beijing Trip. Hupert, who I count among the foremost experts at negotiating with Chinese companies, uses Tillerson’s recent Beijing trip as the springboard for explaining five tips on how foreign companies should negotiate with Chinese companies.

Before I get to the five tips however, I want to highlight what I see as one of the best, one of the most realistic, and — most importantly — one of the most accurate descriptions on what it is like to negotiate with a Chinese company:

We’ve seen it before. The Chinese side raises their glasses of Mao-tai and proposes a long relationship of mutual understanding and joint cooperation. The western side “gambei’s” and then makes their own polite toast about “long term cooperation, success, and prosperity”.

Now, at this point the westerners feel they are done with the preliminary small talk, and are ready to begin the opening phase of the REAL negotiation.

The Chinese side feels they are running the new partnership, co-own the intellectual property, and will make all substantive decisions about operations, hiring, and distribution.

If you for any reason do not believe the above accurately reflects how the typical Chinese company views its dealings with foreign companies you should memorize the above and then in one year of dealing with China ask yourself again whether it is accurate or not, because it just is.

Now on to a some of the Hupert five.

That treacherous opening Chinese toast. Hupert notes how Tillerson, “like many western execs before him, . . . doesn’t seem to understand what the Chinese believe he’s agreed to. This is true. Our China lawyers almost never document a China deal without there being at least one issue on which our Western client believes the China side has agreed to something to which it has not. There are many explanations for why this always seems to be the case, ranging from cultural and language differences to the China-side penchant for agreeing to something to get something in return for that agreement and then retrenching from the previously agreed upon item after it has already succeeded in getting concessions from the Western side.

Manage the agenda, and then focus on individual deal points. Western negotiating protocol is to focus on the key negotiating goals, but Chinese negotiators “always” have a larger agenda. Or as Hupert puts it, “too many western executives fighting internal deadlines and hoping to satisfy their HQ sacrifice big-picture strategy for short-term deliverables.”

Watch the timing mismatch. “Don’t make real concessions now for longer-term promises.”  Western companies too often believe that if they make xyz concession to their Chinese counterparty now, their Chinese counterparty will make the next concession the next time around. Wrong. Where we see this a lot is with Western service companies cutting their rates to Chinese customers to “get into China now”  and “build loyalty, all with the plan to raise their prices later. Problem is that the Chinese company for whom you just cut your prices will view your loss leader pricing as their ceiling, not as a floor and it will move on to another naive Western company for its next contract. Or as Hupert puts it

You’re in the same boat – but who is the captain and who is the crew? Hupert concludes his post by highlighting how different perspectives so often can lead to problems down the road. Hupert uses the example of how it is “relatively easy to get a Chinese negotiator to agree in principle to a cooperative partnership,” but how that “cooperative partnership is viewed by the two sides will be very different. “Both sides tend to walk away thinking that they will have the power and authority to protect their interests and further their positions. In practice, however, Chinese tend to feel that they will call the shots on issues pertaining to China.”

For more on how to negotiate with Chinese companies, check out the following: