China Law Blog - China Law for Business

By: Steve Dickinson

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

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

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

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

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

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

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

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

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

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

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

What do you think?

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

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

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

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

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

More from Dr. Von Wunschheim:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I draw two main conclusions from the above:

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

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

By: Steve Dickinson

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I know I keep reading how China's economy is just fine, but my firm just keeps getting more inquiries and more work relating to shutting down offices and companies in China. 

Of those, the most heartbreaking are coming from Chief Representatives of China Representative Offices who are concerned about their own liabilities when their China Rep Office closes.

Typically, the Chief Representative tells the Rep Office employees that the Rep Office is going to be shutting down. Naturally enough, the employees ask about their getting paid. The Chief Representative usually tells them not to worry, which causes them to worry more and go to their local government. A local government official then comes by and informs the Chief Representative that he or she is PERSONALLY responsible for paying the Rep Office's employee salaries AND all outstanding taxes. 

The Chief Representative then contacts my firm and we tell him or her that he or she does indeed run a very real risk of being on the hook for any and all Representative Office debts and so they had better make sure their home office pays. What can happen to a Chief Representative if the home office refuses to pay? We've heard of all sorts of things, ranging from the Chief Representative being held at a hotel for weeks until all debts are paid, to Chief Representatives sneaking out of town and then out of China, under fear of being put on a list that will prevent them from ever returning.

But what happens when the head office/owner of the China Representative Office files for bankruptcy in the United States?

In those situations, we recommend that the Chief Representative hire a US-based bankruptcy lawyer to file a claim against the bankruptcy estate on his or her own behalf.  The Chief Representative could claim that the US company owes him or her the amount owed to the Chinese employees and the Chinese tax authorities because the Chief Representative assumed that debt on the home office's behalf.  Will this work?  We don't know. Yet. 

Will the bankruptcy court hold that the Chief Representative is owed anything by the home office in bankruptcy? And even if the bankruptcy court does hold that the bankruptcy estate owes the Chief Representatve the amount the Chief Representative (and the estate) owes in China, is there any basis for the Chief Representative to claim entitlement to any higher percentage on his debt than any of the other unsecured creditors? In other words, will the Chief Representative get anything more than the usual pennies on the dollar creditors usually get? I rather doubt either the employees or the tax authorities in China will cut the Chief Representative much slack simply because his or her home office has filed for bankruptcy in the United States.

Quite the ugly situation. Bankruptcy lawyers (and others), what do you know?

At least once a month, I get an email from an English teacher in China wanting to start a language consulting business or school in China. I have a form response that summarizes what it will likely take and likely cost for them to do so legally. Virtually none of them had any idea of the difficulties and costs in starting such businesses.

My law firm represents a good number of existing international schools in China and we are right now working on at least double the number of legal issues as usual for them. Today I saw a Shanghaiist post on "issues" being faced by Shanghai Rego International School. The post entitled, "Shanghai Rego International School now facing forced relocation," details how the school is being forced to move as its facility is being taken over for a public school:

However an official surnamed Hua with the district's Education Bureau said there were no safety issues but said the school probably will have to relocate because the bureau has decided not to lease land and facilities to it anymore.

Hua said the bureau signed a 10-year contract with the school in 2003 for its renting of the facilities, which will expire in January 2013. He said the facilities were built at that time to be a public school, but the area was not sufficiently populated to need such a school. The bureau instead leased the facility to the international school.

"But now a growing number of local residents living in the area are having trouble finding a school for their children, so we have decided that the facilities will be taken back when the contract ends and will be used as a public school," said Hua.

He said the decision was made and announced with no possible alternatives, and the Shanghai Education Commission is now talking with the school over relocation issues.

Because we are right now in the midst of so much work for international schools in China, I hesitate to discuss even broadly the sorts of issues these schools face. But suffice it to say that international schools in China are more subject to the whim of governmental authorities than most foreign businesses and I am starting to think that the whims are shifting. I am hearing all sorts of explanations for this shift, ranging from the value of land to a concerted desire to make it tougher on foreigners staying in China.

What are you seeing out there with respect to the international schools in your area? Are Shanghai Rego's issues a one-off or just one more sign of a broader trend?

Blog post at Letters Blogatory, entitled, "Dueling Translations," expresses surprise/concern over how both parties in an ultra-high stakes international litigation matter "actually submitted dueling certified translations of the Ecuadoran appellate court’s decision (Chevron’s is here, the Lago Agrio plainitffs’ is here)." The post questions this as a waste of time/money:

Really? Dueling translations? I know that Randy Mastro and James Tyrrell are top lawyers at major law firms, and that this is extremely high-stakes litigation, but I would like humbly to suggest that the two of them sit down for a beer summit and see if they can find some way to reduce what has got to be the awe-inspiring litigation budget.

I disagree. He/she who controls the language can control the case. The following spring to mind:

1.  Whenever the other side in a case submits a translated document, I almost always move to strike it unless the translator has attached a declaration/affidavit regarding the translation. Even with that, I virtually always have someone on my side confirm that the translation is accurate. About 85% of the time the translation is "accurate" but about 99% of the time, it has been translated in a way that favors the side doing the translation. This needs to be pointed out to the court. Just by way of example, there are languages where the same word can be translated either as "shall" or as "should." Those are two very different meanings.

2. Finding a good translator for depositions is very difficult. In Seattle, there is a Russian translator who everyone knows is fantastic and it is pretty common for both sides in a case to agree that she will be the only interpreter for the entire case. I know of no such translator in any other language here. I once had a case where the French translator was so bad that I was pretty much able to nullify anything at all harmful my Swiss client said at her deposition, simply by pointing out how bad this translator had done overall. It was not so much that the translator's English was so bad (he was French) it was that it was his first job translating at a deposition and he simply did not know what his role was supposed to be. He did not realize that legal translation means translate, not help with the questions or the answers. 

3. I had another case which involved depositions of around 8-10 witnesses from the PRC. The other side was taking these depositions and they flew all of the witnesses to Hong Kong for deposition. The other side also flew in a court reporter all the way from New Zealand. But their big mistake was using a Hong Kong based interpreter whose first language is Cantonese, not Mandarin. She was terrible.

As I always do for depositions where the deponent speaks a language other than English, I brought along someone both completely fluent in the deponent's language and someone I completely trust to watch over the translating. In this case, it was my co-blogger Steve Dickinson. The other side brought along a Chinese speaking attorney as well. What ended up happening is that both parties essentially reached an agreement that whenever either side had a dispute regarding the translator's interpreting, they could object, at which point Steve and the Chinese lawyer would seek to reach an agreement. If an agreement could be reached, the correct/better translation would go on the record. if no agreement could be reached (which was surprisingly seldom) we would defer the argument for the court. All this meant that each deposition took probably twice as long as it would have taken had the other side brought in a decent interpreter.

I could go on and on, but you probably already have gotten my drift. Bottom line, the translation matters.

What do you think?

For more on the impact of the language/translation chosen, and for why we draft most of the contracts in Chinese for our American clients doing business in China, I urge you to read "China OEM Agreements. Why Ours Are In Chinese. Flat Out." To grossly summarize that post, we figure that if you are going to end up before a Chinese judge you are going to want to give him or her a contract that he or she can understand. If your contract is in English, the Chinese court will use its own translator to translate it into Chinese. This means you are not going to have any influence on what it is going to say nor will you even know what it is going to say until you have sued.

By:  Steve Dickinson

At the end of December, the NDRC issued its long awaited 2011 revision to the Catalog for Guidance for Foreign Investment 外商投资产业指导目录（2011年修订). It is a central policy of the Chinese government that foreign investment must be made in a manner that is consistent with Chinese policy and in a way that will promote China's development. China therefore follows a policy of guided investment, and the Catalog is the guide.

The first Catalog was issued in 1995. This is the fifth revision, replacing the 2007 Catalog. This 2011 version of the Catalog will take effect on January 30, 2012. Foreign invested enterprises approved prior to the effective date will not be effected. However, any changes to existing foreign invested projects that take effect after the effective date must comply with the terms of the new Catalog.

The encouraged category shows where the Chinese government wants foreign investment to go. The restricted and prohibited categories show the sectors that are hands off in China. Even for those who are not considering investment in China, the Catalog is instructive. The encouraged category is quite detailed. For those who are looking for the next sector where China will push for dominance, the Catalog is quite revealing. In the same way, the Catalog can show which sectors the Chinese government has decided to limit or reduce. The Catalog is therefore a model for the development of Chinese industry for the next several years.

In what follows, I will summarize and comment on the official NDRC explanation of the background and policy behind the new Catalog, which can be found here. In a subsequent post, we will provide more detail on the changes introduced in the Catalog.

Foreign Direct Investment (FDI) remains an important element of the Chinese economy. In 2009 and 2010, China remained the number two destination in the world for FDI. Through the end of November, 2011, FDI amounted to $US103.8 billion, an increase of 13.2% over the previous period. It is anticipated that the total for 2011 will be around $US110-120 billion. Even in the face of the world economic crisis, China clearly remains a primary target for foreign investors.

Starting with the 2007 Catalog, China has moved to substantially change the structure of foreign investment in China. The 2011 Catalog follows on this basic program. For the developed Eastern regions of China, the goal of the Catalog is to move foreign investment away from 1) investment in low value added, high labor business, 2) investment in conventional technology, and 3) investment in high pollution and resource intensive technologies. The Catalog is intended to push investment in the East towards high value added and technically advanced manufacturing, strategic technology in both manufacturing and services
and low pollution energy saving technologies. The entire Catalog reflects these goals.

As stated by the NDRC, the new Catalog is intended to reflect the following changes:

1. Continued openness. The continues the trend towards opening up of the economy, consistent with China's WTO commitments and the need to make us of advanced foreign technology.  The basic numbers reflect this. Three items were added to the encouraged category, while seven items were removed from the restricted category and one item was removed from the prohibited category. In addition, where joint ventures are required, the required Chinese share was reduced in eleven cases and was not increased in any case.

2. Modernization and technical advance in the manufacturing sector. Consistent with the 12th Five Year Plan, the Catalog focuses heavily on promotion of the traditional manufacturing sector. In particular, advanced technology in textiles, chemicals and equipment have been added to the encouraged category. The deletions from the encouraged category reflect the government's desire to prevent excessive investment in conventional manufacturing technology, particularly where there is extensive current investment by foreign enterprises. This goal is reflected by the deletion of vehicle manufacturing from the encouraged category. The government also intends to prevent excessive investment in certain "trendy" sectors. This goal is reflected by deletion of mono crystalline silicon and chemical processing of coal from the encouraged category.

3. Promotion of strategic new industries. A central goal of the 12th Five Year Plan is to move China beyond reliance on traditional manufacturing and onto strategic new industries that will mark the
manufacturing world of the next several decades. The following seven such strategic industries have been identified:

-- Alternative fuel cars:hybrid cars and electric cars as well as better fuel-cell batteries;

-- Biotechnology: biomedicines, new vaccines, and advanced medical equipment;

-- Environmental and energy-saving technologies: energy efficiency, pollution control, clean coal, waste-matter recycling and seawater usage;

-- Alternative energy: ext-generation nuclear power plants, solar power, wind power, smart grids and bioenergy;

-- Advanced materials: rare earths, special-usage glass, high-performance steel, high-performance fibres and composites, engineering plastic, nano and superconducting materials;

-- New-generation information technology: cloud computing technology, high-end software, virtual technology and new display systems; and

-- High-end equipment manufacturing: Aircraft, high-speed rail, satellites and offshore oil/gas equipment.

4. Modern service industry. Service businesses that have a direct, practical value to the Chinese people or to China industry will be encouraged. Among the new entries in the encouraged category are:

-- Electric car fueling stations

-- Enterprise start-up consulting

-- Intellectual property consulting

-- Marine oil spill cleanup technology

-- Vocational skill training

In addition, medical enterprises and financial leasing have been removed from the restricted category.

5. Adaptation to differences in regional development. The basic approach of the Catalog is actually concentrated on the development of the already advanced coastal region. The goal of pushing China to high
technology modernization conflicts with the extremely low state of development in the Western, Central and Northeast Regions, where the vast majority of the Chinese people actually live. For development in these regions, the government will need to take a different approach to FDI. For example, low value added, high labor content manufacturing that is strongly discouraged for the East may be permitted or even encouraged in the less advanced Western and Central regions. To date, however, no clear policy has emerged. These matters will therefore be addressed in the proposed revisions to the Catalog for Foreign Investment in the Western and Central Regions (2008) 中西部地区外商投资 优势产业目录, which are expected next year.

The intention of the Chinese government towards foreign investment is clear. Foreign investment is intended to support China's manufacturing sector by providing access to modern advanced technology. There is no longer a focus on job creation and there is little interest in foreign investment in any sector of the economy outside those areas which will help China modernize. Potential foreign investors should take this into account. Investing against the trend in China seldom succeeds.

The following is a guest post by Ted Folkman, the force behind the Letters Blogatory blog, of which I am a long-time fan. Letters Blogatory has a very tight (and for me, very interesting focus). It "covers international judicial assistance in civil and commercial cases," which means the following:

• Service of process abroad, including service under the Hague Service Convention
• Obtaining evidence abroad for use in the United States, including proceedings under the Hague Evidence Convention
• Obtaining evidence in the United States for use abroad, including proceedings under the judicial assistance statute
• Recognition and enforcement of foreign judgments
• Recognition and enforcement of international arbitral awards, including awards under the New York Convention
• Authentication of foreign public documents, including use of the Hague Apostille Convention

I find Ted's blog extremely interesting because it deals essentially with what it really takes to get the job done in international litigation. Ted and I communicate from time to time on the issues above as they relate to China and I thought it would be good to have him write a guest post relating to China. So here goes.

Thanks to Dan for the invitation to post on China Law Blog. Discussions about judicial assistance in China usually focus on the US litigant’s perspective. Often the gist of the discussion is that it’s really hard to get judicial assistance in China. Sometimes it’s conceded that it’s not as hard as it used to be. In this post, I want to look back at 2011 from the perspective of a Chinese litigant. How easy or hard is it to get judicial assistance in the United States? What are some difficulties that Chinese firms have encountered in the US in 2011 that have judicial assistance or private international law implications?

Everyone knows that US judgments are not readily enforceable in China, but the converse is not true, as Hubei Gezhouba Sanlian Indus. Co. v. Robinson Helicopter Co., 425 Fed. Appx. 580 (9th Cir. 2011) shows. Hubei first sued Robinson in Los Angeles, but Robinson, perhaps planning a "boomerang litigation" and thinking that a US court would never enforce a Chinese judgment, successfully sought dismissal on forum non conveniens grounds. But the Chinese court entered a default judgment against Robinson. Robinson appealed, arguing, among other things, that the judgment should not be recognized because China does not recognize US judgments.

The court gave that argument short shrift. Reciprocity or lack of reciprocity simply is not one of the grounds on which a court may refuse recognition or enforcement under the Uniform Foreign Money Judgment Recognition Act or similar statutes. It's noteworthy that neither Robinson nor the court took the view that there were any systematic problems with the Chinese judiciary that precluded recognition of a Chinese judgment. There is a growing recognition in the US of the increasing maturity of the Chinese judiciary. And it’s interesting that neither Robinson nor the US court raised the issues of lack of finality that have caused courts in the Hong Kong SAR to question whether mainland Chinese judgments are entitled to recognition and enforcement.

What about efforts by Chinese firms to resist US pretrial discovery in the United States? The record in 2011 is mixed. Chinese banks in particular had a mixed record in relying on China’s banking secrecy laws to resist efforts to obtain the bank records of depositors who were defendants in US lawsuits, even if the records were located in China rather than in the US. Two internet trademark infringement cases, Tiffany (NJ) LLC v. Qi, 276 F.R.D. 143 (S.D.N.Y. 2011) and Gucci America, Inc. v. Li (S.D.N.Y. 2011), come to opposite conclusions on this point. More troubling, both cases also suggest -- wrongly, I think, in light of US law limitations on the reach of injunctions -- that Chinese banks may be bound by US asset freeze injunctions in such cases, even where they are not named as defendants.

Of course, there were a bunch of other judicial assistance cases involving Chinese parties in 2011 and you can find many of them at Letters Blogatory's China page. As time goes on, there is little question that the volume of these cases will grow. From the American perspective, we can only hope that the US's liberal attitude towards enforcement of judgments, including Chinese judgments, will encourage reciprocity in China.

CHINA LAW BLOG NOTES: My law firm recently took a Chinese judgment and secured its enforcement in the United States, with pretty much no hassle. I have to remain somewhat mum on this because we intend to use that judgment to seize the assets of a Chinese company, but I have always been of the (minority?) view that it really just isn't that tough to get Chinese judgments enforced in the United States, even though the opposite is pretty much impossible.  I have been involved in about a dozen cases involving the enforcement of foreign judgments in the United States -- on both sides of the issue -- and of those cases, the foreign judgment was enforced every single time.  In maybe five of those occasions, the foreign judgment came from Russia. If the US courts will enforce Russian judgments, I just don't see why they won't enforce Chinese judgments as well. 

For more on the enforcement of China/US judgments, check out the following:

• Enforcing Your Judgment In China. We Cop To Ethnocentricism.
• Enforcing Foreign Judgments in China -- Let's Sue Twice
• Chinese Companies Can Say, "So Sue Me."
• Taking Judgments To China (And Korea), Let's Not Sue Twice
• Will Your US Judgment Be Enforced Abroad? Not China, But Maybe
• Why Suing Chinese Companies In The US Is Usually A Waste Of Time
• How To Sue A Chinese Company. Part III. Litigation Strategies And Enforcing Judgments

My law firm does not generally handle visa/work permit matters in China as it typically is not worthwhile to pay lawyer rates for this. The other day, I got an email from a loyal reader I know, asking me how she could go to work for a new China employer, without having to relinquish her existing work permit. I told her that I did not know how to do that and asked her to report back to me if and when she found out.

This morning I got an email from her, very nicely setting out the steps one must go through to switch China employers while hanging on to a China work permit. Neither I nor anyone in my firm has confirmed that these are the right steps, but they certainly sound right to me. Here goes.

The most important factor in keeping your work permit is getting a letter of release from your current/old employer company. Technically, as long as the employee has not violated its contract, the employer company is required to provide this release letter. However, as you can imagine, people often have problems obtaining this letter when they don't have a good relationship with the company they are leaving. I am not sure how it works, but it seems that there are ways that the company can strip you of your permit so you are left with 30 days to leave the country. Other sticky situations include companies that posses employee permits or even passports.

However, assuming there are no serious issues, the process seems relatively straightforward. I spoke with a few visa agents and they provided me with a list of documents that I needed to collect:

1. A release letter from your employer;
2. Transfer or cancel your employment permit;
3. Your original diploma which should show a Bachelor degree or above;
4. A simple CV, preferably in Chinese;
5. A letter from your any of ex-employers certifying that you have more than two years working experience;
6. Passport and four 2 inch white background photos;
7. Residence Registration;
8. The business license of your prospective (new) employer and two copies with chop;
9. Application forms needs to be chopped

All of the visa agents assured me the whole process is usually very easy. I asked for quotes and one person said it would take around two and a half weeks and would cost RMB 2,500, which includes government fees, however much that may be.

This reader ended up not taking a new job because her prospective employer was not authorized to hire foreigners and, "amazingly, they didn't check before offering the job. Apparently this happens a lot." The reader went on to provide the following additional good advice:

The hiring company needs to get a permit as well, which must be presented together with the other documents in order for the permit transfer to succeed. Luckily, I insisted on understanding everything about the permit process before giving notice at my current company. I would strongly advise that for anyone else who is in the same position. 

Makes sense. What do you think?

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

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

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

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

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

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

Thank you.

Here is my response:

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

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

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

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

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

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

Yesterday, I did a post, entitled, "Drafting A China Manufacturing Agreement. Watching The Sausage Get Made," seting out many of the questions we typically ask our clients before we begin drafting their OEM agreements. A reader, Phil,  left us the following comment to that post:

Can I ask about the wording of your agreements in Chinese? A deal I'm involved with has been running into a lot of trouble because the American law firm who wrote our contracts have written them in highly complex legalese, very different to the language of Chinese law and standard Chinese contracts. In the third tier city where we are trying to operate, our partner and potential collaborators are having real trouble just reading and understanding the documents. (I'm a translator, and I'm reasonably sure that both sides are right on this - the contracts are correct, but they really are very difficult to read.)
How does your firm walk the line between the conventions of English (American) legal drafting and Chinese drafting?

Great question.

We write our contracts the modern way. By that I mean that we eschew legalese (and using strange words like "eschew") and we strive to avoid unnecessary boilerplate. This is true of our contracts in both English and in Chinese. Most importantly though, we do not really need to "walk the line between the conventions of English (American) legal drafting and Chinese because of how we draw "the connection" between our English version of a contract and its Chinese version.

When we draft a contract for a client, we first draft it in English. We do this for the benefit of the client and we work with the client using the English language contract. Once we have finished the contract in English, we then move on to re-writing it in Chinese. Notice how I did not say "we then translate it into Chinese." We use lawyers and only lawyers to take the English and re-write it into Chinese and the re-write is not a direct translation. 

Just the other day, in an effort to save a few bucks, a potential client asked me if we would reduce our flat fee on a contract by $300 if he had his own people translate our English version into Chinese. My response was that if we gave such discounts, it would be greater than $300, but that my firm will not do a China contract unless we do both the English and the Chinese. As I wrote in "No China Translation. What Were You Thinking?" and in "Dual Language China Contracts Double Your Chance Of Disaster," we do not write dual-language contracts. The contracts we write have one official language and that language is nearly always Chinese. 

Every few months or so, I see something that reminds me of how important it is to file your trademarks in China before anyone else does. I often tell clients that filing a trademark is about the only China legal no-brainer. Or as I said in a post from earlier this year, entitled, "China: Do Just One Thing. Trademarks," if you do nothing else to protect your company in China, register your trademarks.

Apple Computer is learning the importance of being first to file a trademark in China. Apple just lost a lawsuit in China against Proview Technology over ownership of the iPad name. Proview Technology filed a trademark for the iPad name in China back in 2000 so my initial reaction to the lawsuit was that Apple had zero chance of prevailing. China is a first to file country, which means whoever files for a trademark first (with only a few rare exceptions) gets it. Turns out the case is not so simple in that Apple's claim was actually based on a 2006 contract it had with Proview to buy the iPad name from Proview. So the real question in the case appears to have been one of contract interpretation, not China trademark law.

Every few months, my firm gets a call from someone seeking either to sue someone in China for having "stolen" their trademark or seeking to buy it. I put quotes around the word "stolen" because if someone beats you by filing "your" name as a trademark in China, they have not stolen anything; they have merely beaten you to a name by being the first to file it.

When someone retains us to try to buy a name from a Chinese company that has registered it as a trademark in China, the first thing we do is try to learn more about the company and what it is actually doing with the trademark. That helps us develop our initial offering price. Then we have a Chinese person (NOT a lawyer) call to see about buying the trademark. We would never call the company ourselves because we figure that a foreigner calling drives up the price 100-fold. A Chinese lawyer would have a similar effect.

We are also increasingly getting retained by American companies seeking to register their competitors' trade names in China before their competitors catch on to the need to do so for themselves.

How can you stop a Chinese or a foreign company by beating you to "your" name in China? One simple way, register it before they do. 

For more on China trademarks, check out the following:

• How And Why To Trademark In China
• Hey Sucker, We've Got Your China Trademark And You Are Goin' Down
• Who Should Own Your China IP? Maybe Not You
• China Trademarks. Do you Feel Lucky? Do You?
• China Trademarks. Do You Feel Lucky? Do You? Part II
• China Trademarks. Do You Feel Lucky? Do You? Part III

Just got an email as a cc from co-blogger Steve. It is to a client that is selling/licensing its software through a distributor in China. Steve was responding to a question about the need to register the software licensing agreement. The below is a portion of Steve's response to that question, watered down to remove any identifiers.

I am posting this email because it nicely explains the vagaries of registering license agreements in China and when that is necessary and when it may not be. Here it is:

In general, if a contract is characterized as a "license," payments under that contract are characterized as "royalties." Under Chinese law, to receive royalty payments, the contract must be registered as a foreign technology transfer contract. This can be simple or it can be complex, depending on the district in which the paying party is located.

However, many districts treat software agreements these as normal sale contracts and do not require registration. The decision is made at the foreign exchange bank that will process the payments. If the bank does not require registration, then you do not really have any issues. The way we typically suggest our clients deal with the issue is to have the paying party check with its bank. If the bank will process payments in the ordinary course, then there is no issue. I am sorry to make this so complex, but the issue is quite unsettled in china and so it must be made on a case by case basis.

Note that this goes back to the issue above: who is actually responsible for making payments to you: your distributor or the end user. This matters because it is the bank of the payer that will make the decision, so it is important to get clear about the responsible party. If your software distributor is always the one who is going to be paying you, then you only need to deal with this issue once. If each end user is the payer, then you have to deal with the issue with each end user separately, increasing your burden and risk. I note that if you have already received a payment without having this issue arise, it is probable that the locals are treating your contract as a normal sales contract, which is good for you.

If you like (or even dislike) our blog, please go here and register to vote and then click on "niche" and vote for the China Law Blog. Thanks.

This is the third and final part of a series of posts in which our Beijing-based attorney, Mathew Alderson, is interviewed by CMM-I as part of CMM-I's sector report "Feature Film Co-production in China." In this post, Mathew explores issues relating to the regulations governing foreign involvement in film production in China. Parts I and II of this series can be found here and here.  

CMM-I:   What are China’s regulations governing Sino-foreign co-productions? 

Alderson:   There are several layers of rules and regulations and they include the following:

1. Guiding catalogue for Foreign-Invested Entities 外商投资单位指导目录
2. The Regulations on the Administration of Movies 电影管理条例
3. The State Administration of Radio, Film and Television Interim Provisions on Operation Qualification Access for Movie Enterprises 国家广播电影电视总局对电影企业经营资 格的暂行规定
4. Any applicable treaty, such as The Australia-China Co-production Treaty 中澳合作条 约
5. SARFT circulars 国家广播电影电视总局的通告
6. China Movie Industry Promotion Law (not yet in force) 中国电影产业推广法

CMM-I:   How do current Chinese government regulations impact co-productions? Do they pose a serious barrier? If yes, which regulations pose the greatest barriers?

Alderson:   They don’t so much impact co-productions as mandate them. The regulations prohibit foreigners from producing films in China without some kind of Chinese co-production partner. You might say this is a barrier. Article 18 of the Movie Regulations provides: “No overseas organization or individual may be independently engaged in the activity of producing movies inside the territory of the People's Republic of China.” 第十八条 “境外 组织或者个人不得在中华人民共和国境内独立从事电影片摄制活动。” .

CMM-I:   According to your understanding and experience, what factors influence SARFT’s decision on whether an approval is given or not?

Alderson:   There are stated and unstated factors in the decision-making process. The unstated factors are opaque and will relate to issues or topics periodically considered to be off-limits by higher authorities. Predicting these is impossible, although respecting the approval process and the people charged with implementing it always helps. The officially stated factors that influence decisions are clear enough when you read between the lines. Article 25 of the Movie Regulations prohibits the following kinds of content:

1. That which defies the basic principles determined by the Constitution;
2. That which endangers the unity of the nation, sovereignty or territorial integrity;
3. That which divulges secrets of the State, endangers national security or damages the honor or beliefs of the State;
4. That which incites national hatred or discrimination, undermines the solidarity of the nations, or infringes upon national customs or habits;
5. That which propagates evil cults or superstition;
6. That which disturbs the public order or destroys public stability;
7. That which propagates obscenity, gambling, violence or instigates crimes;
8. That which insults or slanders others, or infringes upon the lawful rights and interests of others;
9. That which endangers public ethics or cultural traditions;
10. Other content prohibited by the laws, regulations or provisions of the State.

By Rachel Buker

Rachel is an attorney at Harris & Moure whose practice focuses mostly on intellectual property. 

Trademark infringement with respect to domain names is a very common problem, particularly for those who do business with China or even just manufacture their product there. It is unsurprising that many in China are quick to register domain names similar to those of the foreign companies they see.

We frequently see the following sorts of domain name thefts, oftentimes by Chinese companies seeking to hone in on a well-known brand name:

• Domain names that intentionally contain a common typo of a known trademark.

• Domain names that take a known trademark and attach a generic word like “outlet” or a word descriptive of the product, such as “shoes." 

• Domain names that are exactly the same as a known trademark’s domain name, but with a different extension.  For example, abc.net, instead of abc.com.  

Companies confronted with domain name theft oftentimes do not realize how relatively easy it can be to put a stop to it, even when it is a Chinese company that is using the name. The Internet Corporation for Assigned Names and Numbers (“ICANN”) developed The Uniform Domain Name Resolution Policy (“UDRP”) to resolve domain name disputes, and international arbitration of disputes under UDRP is administered by a list of ICANN approved dispute resolution service providers. 

Anyone who registers a domain name is agreeing to the registrar’s terms and conditions, including making a commitment to be bound by the UDRP.  The UDRP’s purpose is to prevent cybersquatting, which is defined “as registering, trafficking in, or using, a domain name with bad faith intent to profit from the goodwill of atrademark belonging to someone else.”  Tenneco Automotive Operating Company Inc. v. Naushad Dhukka / SoftDot Technologies, LLC,NAF, FA1104001384326 (May 31, 2011). 

When a complainant demonstrates that another party is using a domain name in “bad faith,” the UDRP will either transfer or cancel the offending domain name at the request of the complainant.  We almost always recommend that the domain name be transferred to our clients so nobody else can grab it at some later date and force our client to go through the same UDRP domain name arbitration again.

Companies need to be proactive in locating and excising “bad faith” websites as soon as they are discovered because those offending sites can not only damage a company's online presence, they infringe upon and can ultimately dilute legitimate trademark rights.

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

 Forming a WFOE in China typically requires the following:

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

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

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

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

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

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

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

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

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

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

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

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

I am often asked usually right after I quote our fee) whether a China contract I am proposing to write "is even enforceable in China." I always give the same answer, which is more or less the following.

There are three reasons why it makes sense to have a contract with your Chinese counter-party, and only one of those reasons is enforceability in court.

1.  Clarity. The first is to achieve clarity. To make sure you and the Chinese company are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 20 days, it will say "yes" pretty much every time. But if you put in your contract that the product needs to ship in 20 days AND for every day it is late, the Chinese company must pay you 10% of the value of the order, there is a great chance the Chinese company will get honest with you and tell you that 20 days is impossible. At that point, you and the Chinese company can figure out what is realistic and then you know what to expect, realistically, going forward. Needless to say, I can give countless examples of this sort of thing, but this is yet another reason why we advocate putting your contract in Chinese. Clarity before you start the relationship. It is more important than you think. 

2.  Stricture.  The second benefit of having a contract with your Chinese counter-party is that it will likely bring that company to heel. By this I mean that just having a well written contract that is at least potentially enforceable means that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well. Let's use the 20 day example as the example here as well. If your Chinese manufacturer makes widgets for 25 foreign companies and 5 of those have very clear time deadlines with a very clear liquidated damages provision, and the Chinese company starts falling behind on production, to which companies will the Chinese manufacturer give production priority? Of course it will put the five companies with a good contract at the front of the line.

3.  Enforceability.  Here's the funny thing. My firm has written hundreds and hundreds of China contracts and we have never once been called on to litigate any of them nor am I aware of any of them having been litigated. I attribute this to reasons #1 and #2 above, but I have to admit that this also means I cannot stand up and scream that Chinese courts enforce well written contracts. Even better though, I can stand up and scream that they do certainly seem to prevent problems. Even though I cannot speak regarding the enforcement of my firm's contracts, I can say that where my firm has sued or threatened to sue or arbitrated or threatened to arbitrate on contracts written by others, we have felt that China does enforce contracts. More importantly, however, the World Bank feels the same way, ranking China 16th among 183  countries in terms of enforcing contracts.

And that is a lot of the point. If your Chinese counter-party believes your contract will be enforced or even if it just believes it may be enforced, it is likely to act accordingly.

China contracts worth doing? If done right, you'd better believe it.

What do you think?

We have been handling way more than the usual number of disputes between our clients and Chinese companies. In a number of these cases, our clients paid money to Chinese factories with whom they had been doing business for years and the Chinese factories simply refused to send over any product. These Chinese companies claimed that our clients owed money for previous deliveries (in which the costs supposedly went up) or for Chinese taxes/duties for which our client is supposedly responsible. These cases (and others like it) are no doubt due to the increasing number of Chinese factories facing economic difficulties. In none of these cases did our client have a good OEM Agreement in place, which gave the Chinese companies at least some basis for their claims. 

Be that as it may, the Chinese companies (pretty much without exception) threatened to sue our clients and one of them threatened to freeze our client's China trademarks, copyrights and/or patents and then take that IP once they prevail. In the case with the IP threat, our client's only China asset was its registered intellectual property so the risk was very real.

A recent Chinese case allowed a Chinese plaintiff to "freeze" a Chinese trademark belonging to a foreign company, Castel. The Re:Marks on Copyright and Trademark Blog wrote of this case in a post entitled, "French CASTEL (卡斯代尔) Company Frozen out of China?" and noted the following risk stemming from this case:

[T]he decision is of particular note for foreign entities who do not have significant assets in China.  Typically, such entities may have considered themselves insulated from the risk of litigation in China due to a lack of assets in China.  However, even foreign entities without significant assets in China very often have trademarks in China.  Those trademarks are now in the firing line if the foreign entity ever gets sued, whether for trademark infringement or for other causes of action, particularly where the foreign entity has limited assets in China.  Of course, this equally applies to foreign plaintiffs who seek to recover damages against Chinese defendants.

How can you prevent your Chinese IP from being taken from you? Probably the best way is not to put your China IP in the name of a company that does business in or with China. Instead, you should think about creating a new company (it can be based in the United States or anywhere else) to own "your" IP in China. In turn, that new special purpose company can then license its China IP to your company that does business in or with China. That way, one of your companies will still own the IP in China, but if your company that does business in or with China encounters legal problems with a Chinese company, the Chinese company will not be able to just seize that company's China-based IP.

If your IP is already in the name of a company that does business in or with China, you should consider assigning that IP to another company and then licensing it back. Doing this is not going to be without its complications and costs, but it beats losing your China IP.

What do you think?

Fascinating article up on the Wall Street Journal, written by Geoff Nairn and entitled, "Patents are a Virtue," and subtitled, "China is a land of opportunity for business, but it is also a land of counterfeiting and intellectual property theft." The article is on counterfeiting in China and the various innovative ways companies act to prevent it. 

The article has a sidebar, entitled, "An ABC to Losing Your IP," that lists out three things companies often do to cause them to lose their intellectual property in China. The Journal attributes this list to our blog, but because it has been so modified for the article, I am not even sure from what post(s) they came. In any event, I love the list, so here goes:

A: Failing to use employee invention agreements. These specify that any invention made using the company's time, material or facilities belongs to the company, not to the employee.

B: Thinking that patents are the only IP that matters. Western companies underestimate the importance and value of trademarks and trade-secret agreements in China.

C. Neglecting the three Ns. Non-disclosure agreements stop suppliers disclosing IP to third parties. Non-use agreements stop Chinese contract manufacturers setting up as your competitors. Non-circumvention accords stop contractors selling direct to your customers.

What do you think?

In both the United States and in China, one need not actually register one's copyright to have one. This oftentimes leads companies not to bother registering their copyrights.

The problem with not registering your copyright in China is that it is nearly impossible to prevail in a copyright lawsuit unless and until your copyright has been registered. American companies too often think this is no big deal, figuring that if anyone infringes on their copyright, they will simply register it and then sue. However, the problem with this thinking is that securing the actual copyright registration in China typically takes from 12-18 months.

If a Chinese company is violating your copyright and you cannot sue for another year, it becomes very difficult to stop the Chinese company from infringing. You can write a cease and desist letter, of course, but it will not be all that powerful because you will not be able to cite to any registered copyright and the infringing company will figure it has at least another year or so before it really need worry much. This delay is particularly problematic for gaming companies because by the time they can sue for a copyright violation of their game, that game may no longer even exist in its previous incarnation.

Registering copyrights for video games in China is very much like doing so in the United States. Because of this, when we do such registrations, we usually just track what has already been done in the U.S. Registering video games in China consists of the following:

• Registering the source code using China's special software registration rules.

• Registering the artwork as a work of art. The normal strategy for video games is to treat each character as a work of art. If there are special locations, these are also treated as a work of art. All the artwork is then collected into a bundle and is registered in one filing. The exact physical item that is sent to the registration authority depends on the nature of the work. Registration is not expensive and it is better to register too much rather than too little.

By: Steve Dickinson

China continues to bar foreigners from ownership those sectors of the economy China considers particularly sensitive from the standpoint of national security. The Internet is one such sector where direct foreign ownership is prohibited. Yet it is well known that virtually the entire Internet sector has been funded by foreign IPOs, making foreign investors the owners of this sensitive sector in violation of the of the law. New regulations recently promulgated by MOFCOM (China's Ministry of Commerce) appear to have ended this unusual situation.  

Foreign companies have managed to "own" companies in China's Internet sector by using what is known in the United States as a Variable Interest Entity (“VIE”). Under a VIE structure, a Chinese Internet provider is effectively owned by a foreign entity through a complex set of contractual arrangements, rather than through ownership of stock.  The control by the foreign entity is so total and complete that the arrangement is considered the equivalent of ownership under U.S. accounting rules. However, by there being no actual foreign ownership of stock, these VIE structures have managed to operate in China, evading the clear rules restricting foreign ownership.

New Regulations recently issued by MOFCOM appear to spell the end of VIEs. On September 1, the Regulation of the Ministry of Commerce on the National Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (Regulations) became effective. The Regulations provide the long-awaited procedures for national security review for foreign related M&A activity that is required under the recently promulgated PRC Anti-Monopoly Law. To the surprise of many, the Regulations also took direct aim at the VIE procedure.

The provisions are deceptively simple. Article 9 of the Regulations provides that using “contractual controls” to evade the requirements of Chinese law that would otherwise restrict or prohibit foreign investment in a sensitive sector is prohibited. This is a clear prohibition against the use of VIE structures. The whole goal of the use of VIEs is to hide the fact of foreign investment from the Chinese regulators. Thus, it is likely that the use of a VIE will not be caught by national security review at the outset of the investment. To deal with this issue, Article 10 of the Regulations provides that where such contractual controls are used but not reported to the Chinese regulators, the parties involved have the independent duty to immediately terminate the offending conduct. If the parties do not take action on their own, the regulators have the authority to order the immediate termination of the offending investment by whatever means are necessary.

What does this mean for the future of foreign investment in China? Many foreign investors contend that existing VIE structures are sound and that VIE arrangements can safely be used in the future. I disagree.

The following has been occurring of late in the VIE arena:

• In the Internet sector, IPOs continue to be proposed that rely explicitly on a VIE structure. Such IPOs are clearly under a cloud and are quite properly being delayed or cancelled. 

• Many investors have proposed expanding the VIE structure for foreign IPOs in other restricted sectors of the Chinese economy, such as the telecom and medical services sector. It is now clear that this proposed expanded use of the of the VIE structure in China will not succeed.

• The new regulations only reaffirm that existing foreign investment in the Internet sector is built on a shaky foundation and the that the Chinese regulators are essentially only one phone call away from steppng in and ordering all of these investments be terminated. Even if the Chinese regulators doe not take this drastic step, it is now clear that the contractual arrangements on which the various VIEs are based are in clear violation of Chinese law. This renders the contracts unenforceable and makes existing VIE structures essentially meaningless.

None of this is actually new. These risks have long been known. However, the clarity of the Regulations means it is now nearly impossible to claim that Chinese law on these issues is ambiguous or unclear. Where Chinese law says that ownership by foreigners is restricted or prohibited, the law means what it says.  Foreigners who invest in violation of the law are making a bet that the violation will be ignored. This is extremely unlikely in today’s China. Such bets are sucker’s bets and should avoided at all costs.

We have been speaking out against VIEs for years and just about every time we do so, someone says that if they are illegal, why have so many large law firms, large accounting firms, and large companies gone along with them? The answer is simple. Money. Big money. Really big money. Now, some of these same law firms and accounting firms and companies are denying that anything has changed. And why is that? Again, money. Only this time they are taking positions not so much to make more money going forward, but to avoid losing through lawsuits the money they have already made.

We have written extensively on the perils of VIEs and if you want to read more, I urge you to check out the following:

• China VIE Structures, The Podcast. Money....So Money
• Who Owns China's Internet? Why Even Ask That?
• Crouching Tiger, Hidden Fraud. Clear Speaking On VIEs.
• China Law: Don't Blame It On The Gray.
• Gigamedia And The Perils Of VIEs. Dude, Where's My Chop?
• China. Where Everything Is Local. Until It's Not.
• Variable Interest Entities (VIE) In China. What Would The Buddha (Steel) Say?

What do you think?

It should go without saying that the applications to register trademarks in China are 100% in Chinese. The applications themselves are entirely in Chinese, as are everything oen puts on the application to complete them for filing. I always find it strange when clients and potential clients express surprise at this and I usually respond by noting how the trademark applications in the United States are entirely in English.

The fact that the applications are entirely in Chinese means that your company name goes into Chinese as well. This is not usually a big deal, but it can be when things get confusing down the road. When we do a trademark application for a company that already has its own entity in China or at least enough of a presence to have already translated its English name into Chinese, there is usually no issue. If the client wants its Chinese entity to hold the trademark, we put the trademark in the name of the Chinese entity and no translation is necessary. Similarly, if the client wants the trademark to go into its United States entity, and that entity already has a Chinese translation, we use that.

But oftentimes, we register trademarks in China for companies that have no real direct interest in China and because of that, they have no Chinese name. For instance, we recently did a number of trademarks for a large company that wanted its names trademarked in China becuase it "probably will go there eventually."

In those situations, it can be important to choose the right translation (and to stick with it) so as to avoid confusion down the road on who owns your mark.

China is trying to deal with the potential for confusion by allowing for a Roman script version of the applicant name and address to be included in the application. Though the Chinese language version of the company name is treated as controlling, the Roman script version is used for assistance in searching and for prevention of confusion. As one would expect, no attempt is being made to accommodate other languages and scripts. For languages that use a non-Roman script, translation into English or some other European language (French usually) is required.

Whenever I speak at law schools, I always emphasize the growing need for international lawyers. There is a particular need for this in the individual (as opposed to corporate) arena. As people more and more live and marry and buy houses and die outside their home countries, the need grows for lawyers who understand the international legal issues that can arise from these life events.

Divorces with international ramifications are now becoming common. When an expat married to a Chinese citizen contacts us for help on their China divorce, I suggest they first get a divorce lawyer in China and, if necessary, also get an additional divorce lawyer in their home country. Then, if those lawyers need assistance on any cross-border issues, they can call my firm. We virtually never get these calls, simply because not many people can afford three sets of lawyers on one divorce.

The response I usually get to this is a request for me to reccomend a Chiense divorce lawyer in whatever city it is in which they are located.  I then usually have to tell them that I have no referrals in their particular city. Lately though, I have been mentioning that they check out the Divorce in China blog, which is written in English by Ann Lee, a Shanghai based Chinese licensed lawyer. Ms. Lee does a nice job talking about China's divorce laws, particularly as they apply to expat divorces. I know of no other comparable English language resource and these people going through divorce in China seem pleased to have a place where they can read more about it. 

If you want/need information on China's divorce laws, I suggest you too check it out.  

Every few months we get a call from someone wanting to shut down their China WOFE (Wholly Owned Foreign Entity a/k/a WFOE or Wholly Foreign Owned Enterprise). Interestingly, these calls usually come from companies who have been in China for a long time (average time, maybe ten years). Their reasons for seeking to leave China are all over the map but usually involve a decision relating to their China operations lack of profitability or lack of cost-effectiveness. Surprisingly often, they say that they might return to China in three to five years. And that is the problem.

If both you (and I will define that later in this post) and your company will never ever again be returning to China AND if both you and every other foreigner in your company will never again be returning to China, closing down is easy. Essentially, just close down.

A friend of mine who does business in China found himself not being allowed to go out of the country because of a lawsuit filed against him by a Chinese company. They are saying that he owes them money while all the while they have been cheating him (cutting corners on products, using low quality materials instead of the good quality materials agreed upon, late shipments which causes cancellation of orders). He was not notified beforehand of this lawsuit against him before he came and only found out about it when he
was about to return home and was stopped at the border crossing. Is there a way he can be allowed to leave China while the case is pending?

We have written about this same thing numerous other times:

• China Hostage Situation. Now IS A Good Time To Pay Your Debts
• China, We Have A Problem. A Mostly True Story.
• How Not To Get Kidnapped In China
• Shutting Down A China Rep Office Without Going To Jail

If you have any foreigners in China and you want to shut down your business, either get all of those foreigners out and have them never again return, or shut down your business correctly.

How then does one shut down a Chinese business correctly?

There are essentially three ways.

1.  Formally dissolving the company.  This is done by paying all existing debts, including especially all debts to employees and to the government. Doing this correctly (and complying with China's myriad labor laws) involves going through a long drawn out government audit and typically takes at least a year and is far more complicated and time consuming than you would think. The advantage to shutting down this way, however, is that in the end you satisfy the government and both your company and its employees could return to China the next day (or whenever) and legally open a new business. Without a formal dissolution, there is a good chance that neither your company, nor any of its employees of whom the Chinese government is aware, will be able to return to China problem-free.

2.  Filing for bankruptcy liquidation. if your company does not have the funds/assets to pay its debts, it may liquidate under China's bankruptcy laws. We have many times looked at this option for our clients and many times we have been of the view that this option would have been a legally viable one. However, none of our clients have yet to pursue this option because in every instance it was determined that it would be cheaper and easier to go through a formal dissolution per the above. I am not even aware of a foreign owned Chinese company that has pursued bankruptcy in China. Are you?  

3.  An informal petering out.  Due to the time and costs involved in the two scenarios mapped out above, we have "created" a third option for our clients. This option makes the most sense for those companies that really do think they will be back in China within the next few years. This option involves the compamy doing the following, at minimum:

1. Terminating all Chinese employees with an agreed upon severance package and a signed release of any and all claims they might have against the company. It is critical that this be done pursuant to China's labor laws.
2. Either buying out any lease(s) or letting any existing lease(s) expire. We have generally found that Chinese landlords are not terribly willing to give decent discounts for one time lease termination payments. 
3. Paying all government taxes, pensions, etc. and remaining current on the same.

After completing the above, the WOFE still exists, but is essentially dormant. At this point, it must still pay its taxes (which should be minimal) and still comply with any and all government reporting requirements.This is at best a temporary solution because doing this does not stop the cost meter from running entirely and there will almost certainly come a point where the government will either start imputing higher taxes or demand a formal shutdown. The biggest benefit of this method is that it is fairly cheap and if you really are uncertain as to whether to stay or go, it will buy you time while at the same time, clearing off your books so that any subsequent formal shutdown ought to go just a bit quicker and easier. The beauty of this option is that if you do eventually decide to revive your China operations, there is already an existing company in place by which to do so.

What do you think?

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

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

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

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

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

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

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

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

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

What do you think? 

Today I am going to be speaking at Grinnell College, my undergraduate alma mater. I am going to be talking to students about what it takes to practice international law. I know this sounds geeky, but I love speaking before students because I enjoy talking with people who are excited/energized about what they will be doing. I also love their willingness to ask the tough questions.

I also enjoy how these talks force me to examine what I do and how that differs from other legal areas. When you get right down to it though, practicing international law is not so different from practicing domestic law and the attributes of a good lawyer in both arenas are pretty much the same: hard work, a competetive nature, good analytical skills, and an ability to connect with people. In both domestic and international matters, the goal is usually to analyze and structure a matter to best serve your client's interests. International law is in many respects domestic law with additional issues that happen to be international.

I see the greatest differences between international lawyering and domestic lawyering on the psychological level. If you are going to practice international law well, it is absolutely crucial that you keep an open mind and not get too wedded to doing things "the American way." When I was just starting out as a lawyer, I wrote an article on the basics of doing business in emerging market countries. In that article, I talked about how important it is to keep an open mind:

Doing business in an emerging market means taking nothing for granted. I have a mantra for my own legal work in these countries that translates well to the business world: "Assume nothing, but assume that you are assuming things without even realizing you are doing so."

Things will be different. Very different. Things you take for granted in your home country might not exist in the emerging market country. Things you take for granted in your home country might be the exact opposite in the emerging market country. Things you think will be totally different in the emerging market country may be exactly the same. Things you thought you knew about emerging market countries based on what you know from another emerging market country may be completely different in a neighboring country, or even in another region within the same country.

Though it sounds like a cliché, I think keeping an open mind is maybe the biggest difference between the practice of international law and the practice of domestic law. Though keeping an open mind is obviously important in a domestic context, it is absolutely essential when operating internationally.

What do you think?

We did a post a little while back, entitled, "Making Films in China. You Talkin' To Me?" (please tell me you all got the Taxi Driver reference!). That post was written by Mathew Alderson, who though he has been practicing China law for about a decade, still expressed surprise at a commenter publicly boasting of having made an illegal film in China.

The point of the post was not to excoriate the commenter, but to make clear two things. One, there are repercussions to acting illegally in China and we, as lawyers, see those repercussions all the time. And two, our posts are directed to those who want to follow the law in China, not to those who want to break it.

A few commenters took us to task for our not siding with the law-breaker. 

The best comment opposing us (by far, actually) was the following: 

For what it's worth, I completely agree with the dissenters. I don't think any moral laws are broken in making a film in china that hasn't been approved by the Chinese censors. It's just a business risk, you might end up in jail or with a hefty bill, but that's a risk some people will take, and good luck to them. No one has ever achieved anything in business without taking risks.

I've read this blog for several years, and whilst its advice is very valuable I can't help noticing that it is increasingly geared towards established businesses with large amounts of capital behind them, where compliance is a major issue and they have resources to deal with it from the outset. It's worth bearing in mind that a lot of people have built up businesses in china from nothing, dealing with regulatory issues as the businesses have expanded. In fact, thats how most businesses grow, rightly or wrongly, wherever in the world they are located.

Here is my response:

We do not disagree regarding morality. Nobody inculcated immorality into the discussion. I am a huge and unwavering fan of both the First Amendment and of guerilla filmmaking so, as Bill Clinton would say, I feel your pain. 

We also do not disagree regarding how operating in China illegally can be seen as just a business risk. That really was the point of the post:  here are the risks. Now you know the risks and can operate accordingly. If you want to operate illegally, that's fine, but the odds are tremendous that you will incur real problems by doing so. 

I also plead guilty as charged to our focusing more on businesses with more capital. Things have really changed on this since we started and that change has been driven 100% by the Chinese government, not by us.

When we started this blog back in early 2006, it was relatively easy to operate "off the gird" in China and many foreign companies were doing exactly that. Taxes were pretty low back then and tax collection was pretty spotty at best. Many legal business were not paying their taxes. All that has changed.

This change started out gradually, but then accelerated rapidly with the Great Recission. Though China's economy weathered that time well, the Chinese language blogs were nonetheless rife with complaints by Chinese citizens about how foreign companies were taking jobs from Chinese citizens. The Chinese government responded to this by markedly stepping up its legal and tax enforcement against foreign companies and it has never stopped.

The Chinese tax authorities have been told in no uncertain terms to raise their tax collections and they see foreign companies as the easiest way to achieve their higher collection goals. On January 1, 2010 I listed out "China's Top Five Business Law Trends for 2010" and my first three dealt with stepped-up legal enforcement against foreigners:

I see the following five key things happening on China’s business law front in 2010:

1. China will step up even further its crackdown on foreigners in China violating its visa/immigration laws. If you lack an employee visa, you may be at risk.

2. China will increase its efforts to root out and shut down illegal and unregistered foreign businesses. I have seen ample evidence of this already happening in the last 3-6 months and I have no doubt this will continue. Providing jobs to Chinese citizens does not let you off the hook.

3. China will increase its tax collection efforts. This has been going on at a rapidly accelerating pace over the last six months or so. If your China operations are not making a healthy profit, do not be surprised if the government imputes healthy profits to it. In particular, the government will look very closely at your transfer pricing and in many cases it will not like what it sees.

I see my role on this blog to be to tell it like it is, not to tell it like some of our readers wish it could be. And if that means that I have to say things that reflect the increasingly expensive reality for companies that want to operate in China, then so be it.

China right now is much more interested in preservation and harmony than in money and foreign investment. China realizes that it must comply with various international trade rules (or at least appear to be doing so), but at the same time, it rightly sees foreign investment as generally working at cross purposes with preservation and harmony. The effect of this view is that it is doing what it can to increase the expenses for legitmate foreign businesses (the new social insurance laws are great proof of that) and to extirpate those operating on the fringe.

If your business conflicts with China's core interests you have a problem.

I sincerely wish it were otherwise, but my wishes do not reality make. Trust me when I tell you that I take no pleasure in saying that if you do not have the funds to do things legally in China, you are probably better off not doing things in China at all.

What do you think?

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

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

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

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

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

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

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

This is even more true today than then. 

What do you think?

By Mathew Alderson

I was fortunate enough to have been invited to attend a recent session in Beijing convened by Nancy E. Kremers, the Senior IP Attaché to the US Embassy here.

The purpose of the session was for intellectual property lawyers from US firms, together with representatives of IP-dependent US companies, to brief the Attaché on current IP issues in China. It was also a chance for the attendees to get up to speed on the many US Government initiatives in this area.

One of the biggest concerns voiced at the session was the ongoing problem of "bad faith" in Chinese trademark law. I am not going to get into that too much here because others have already covered it adequately. Suffice it to say that there is a big problem in China with "pirates" or "squatters" who register in China a brand they have simply ripped off from the West. Restrictions against this sort of thing are tougher in most other countries, but in China it is extremely difficult, if not impossible, to get rid of someone who registers first, even if they do it in bad faith. This is what we were referring to in our earlier post on Chinese trademark law, entitled, Do you Feel Lucky? Do You?

One of the challenges faced by the U.S. and by other Western countries that try to plug the "bad faith" loophole or simply push to improve IP protection in China generally, is that many Chinese perceive this is being done for essentially selfish reasons, with little or no benefit for China. The fact that the Chinese are, at least during their current stage of economic development, net importers, or even copiers, of Western IP tends to underlie this perception. This state of affairs provides little incentive for improving protection on the part of the Chinese.

Anyway, the point I tried to make at the Attaché’s session was not about trademarks. What I conveyed was that the argument for improved copyright protection in China might be easier to get across in the context of the film industry. I brought this up because China's domestic film industry suffers from piracy just as much as, if not more than, Hollywood.  Couple that with the abundance of Chinese producers, cast and crew wanting to work more with foreigners and you have a pretty good argument for lifting the barriers to foreign films as well.

In other words, not only would the local Chinese film industry benefit from better protection against piracy in China, it would also benefit from the general increase in local production that is likely to occur if the market opened up to foreigners.  Sure, strictly speaking that is also a trade issue, but it certainly is an IP-related trade issue nonetheless.

It is not the local Chinese film industry that wants to stop foreign films. Far from it. Barriers to entry such as China's twenty foreign film quota, and the requirement that foreigners shoot their films in China as Chinese co-productions, are there to stem the invasion of Hollywood's "corrupting" influences, which the  Chinese government sees as US propaganda or soft power. These barriers really have more to do with the government's desire to preserve what it deems important than in protecting the local Chinese film industry.

All of this means that the foreign and the Chinese film industry should be able to work together to advance the film industry in China by expanding those who can make the films and by blocking those who seek to copy them.

For more on the legal issues foreign filmmakers confront in China, check out the following:

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

What do you think?

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

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

I responded as follows:

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

Hope this helps.

What do you know?

Someone called KAS just left us the following comment:

We have a pretty blatant patent infringement where the Chinese manufacturing company (with whom we have a contract) has sold the product to Australia. Our goal is to shut down the sales in countries outside of China, e.g. Australia. Under these circumstances, would it make any sense to sue? We are just starting down this path and I do not want to waste my client's money. Thank you for your informative posts.

For various reasons, we virtually never answer comments seeking legal advise. The main reason we demure is simply because there is usually no way to give a real answer without knowing all of the facts and without going into great depth as to the additional facts needed. And that is definitely true here as well.

This comment raises such an interesting question and it so well highlights the sort of initial analysis that goes into answering these sorts of fairly typical questions, that I am going to venture an email like response (without a "yes" or a "no") as though this comment had just come to me via email from a potential client.

Dear KAS,

For us to be able to know whether it would "make any sense to sue," we would need to gather up all sorts of additional information from you and then conduct our own research regarding various aspects of it. At this point, I am going to give you a taste of just some of what more we would need to know and if you wish to continue the discussion, I would urge you to answer the questions below and then we should follow that up over the telephone. 

For us to have any sense at all regarding whether you should sue or not, we would want to know the following:

1. Is there really a patent infringement?  You say it is pretty blatant, but what do you mean by that? We would first need to see your patent and then see exactly what it is you say is infringing it.
2. Where do you have this patent? If, for instance, you have this patent in the United States and nowhere else, your case is not looking so good. This is because for you to assert patent infringement against a company that is manufacturing your product in China and selling it in Australia, you almost certainly (note how lawyers always hedge a bit) will need to have a patent in either China or in Australia.
3. Where do you propose suing this Chinese company? if you propose suing the Chinese company for violating your Australian patent, you probably (yes I know I am hedging again, but without conducting the specific research, I am always hesitant to say that anything too strongly) can only sue in Australia. If this Chinese company does not have any assets in Australia, there will probably be no point in suing it in Australia unless you can then take your Australian court judgment to China and enforce it there. i know that Chinese courts do not enforce US judgments but I do not know whether or not they enforce Australian ones. It is possible that they do and that is something it may end up making sense for us to research.
4. Alternatively, if you have a Chinese patent, then your best bet may end up being to sue the Chinese company in China.
5. What are your damages? Patent lawsuits anywhere are expensive and so if this Chinese company is not hurting your profits all that much, it may not be worth suing it. Of course, the fact that it may not be hurting your profits all that much right now does not necessarily mean that things may not get a lot worse and you may determine that it is critical for your business that you sue to stop the infringement. This is something we will need to discuss.
6. Do you really have a valid patent? I hate to pose this question, but I must. Patent boards are notorious for being easy in granting of patents that courts then hold should never have been granted in the first place. We will certainly need to look at this issue.
7. You say that the Chinese company infringing on your patent is (or at least was) your own manufacturer. Do you have a contract with that manufacturer?  I can tell you that when my law firm writes a China manufacturing agreement for our clients, we almost always put in provisions forbidding the Chinese company from copying our client's product for itself or for others. I am very much hoping your contract has something similar and that it also provides for you to be able to sue the Chinese manufacturer in China and to receive liquidated damages for contract breaches. If all those things are true, you may very well have a good case against this Chinese manufacturer in China. Please send me the contract so I can review that. I am also hoping that your contract is in Chinese as that will make things go a lot smoother in any lawsuit in China. 

Once we get answers to the above, we will have a better sense of whether it will make sense for you to pursue litigation (or anything else) against the Chinese company. At that point, we will also be in a much better position to give you suggestions on how best to proceed and the estimated costs of the various options.  In the meantime, please don't hesitate to contact me if you have any further questions.

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

Here's Steve's email:

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

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

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

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

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

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

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

What do you think?

The other day I received an email from a college student looking to form a business that would buy product from China and sell it in the United States. The email asked about the steps to take to get such a business going. Here is that email (modified slightly to maintain the anonymity of its sender):

I am an American college student studying International Business and Chinese at ______ University. This past semester while studying abroad at in China a friend of mine, _______ (who met you in Chengdu), turned me on to the China Law Blog.

A few friends and I have decided to start a company soon after graduating next May. The company will produce and sell product X, starting in the U.S. and then moving to China and elsewhere abroad. Right now my friend's father is developing the prototype product X, which is coming along with great success. In the meantime, we our trying to structure the company and figure out the logistics of the start-up.
 
I'm seeking your advice because we want to manufacture product X in China but don't know how to get started. I have often read your articles describing the risks/dangers of manufacturing there, and I want our company to approach the production of our product in a smart, cautious way. Once the prototype is complete, how do we go about finding reliable manufacturers in China for our product? I know about the importance of protecting IP rights and (some of) the differences between contracting in China vs. America, but I want to know: what is the next step after the our prototype is complete and we have buyers? Where should we go from here??

Thanks a lot for your time and consideration! I hope to hear from you soon.

I responded as follows:

Thanks for writing and thanks for the loyal reading.

1.  Form a US company (probably an LLC) and have a good member agreement drawn up among the owners.  Hire a local lawyer for this.

2.  Make sure your IP is protected in your primary selling market (the United States?).  I doubt you will have anything that can be patented, but that should be a consideration.  Patents are very expensive, however.  If you are going to call your product, product X (that sounds good to me), you should trademark that in the United States. 

3.  Now find the manufacturer. There are many ways you can go about this. The best and usually the cheapest is to do tons of internet research and then narrow it down to 4-5 and then fly to China and meet with those factories. If you are going to be doing something really different than other people making this product, you should require the factories sign a Non Disclosure (NDA) Agreement (read about these on the blog) before you show them anything.  This should be in Chinese and in English. The alternative is to hire a sourcing company to find the right factory for you and to negotiate on your behalf. If you choose that route, we can give you names of the people we know and trust who do this. These people can also usually help with things like shipping as well.  

4.  Then have a really good agreement with the manufacturer and you need to trademark your product name in China and you should be good to go (assuming your product does not call for a China patent). This agreement with the manufacturer is called an OEM Agreement, a Manufacturing Agreement or a Supplier Agreement and this should be in Chinese and in English as well.

I am sure I have left  out a few things, but the above are the basics.

Good luck.

What do you think?

Got an unusual phone call from a client yesterday.

The client is an American company that conducts business with China, not in China. This means that there is absolutely no legal requirement that it have a Chinese entity such as a WFOE or a Joint Venture or a Rep Office. What it does with China is 100% legal and above board. None of this can or has been disputed.

One of China's largest newspapers had written a very positive article on our client but before they could run it, they needed to see our client's China company registration. Because our client is not registered in China (and again, this is wholly proper), it could not produce such a registration and so the story did not run.

This is the first I have ever heard of such a thing. Is this new or has it always been the case? Is it yet another example of China's strong intent to crack down on illegal foreign businesses?

I just recieved the following e-mail, which I quote in its entirety:

Legal remedies now abound for companies victimized by Chinese counterfeit stores

China, widely considered the world capital of counterfeit and knock-off consumer goods, has created a buzz in recent weeks with reports that entire U.S. stores, including the iconic Apple store, Ikea, and Dairy Queen, are now being counterfeited with startling accuracy. While much has been made of this phenomenon, very little has been written about the legal remedies that U.S. companies may have against the Chinese infringers that may be damaging their brands. Mark Zolno, chair of the Customs and International Trade Practice at Katten Muchin Rosenman LLP in Chicago, notes that while at one time, partnering with an IP law firm in China to file suit against the infringer was an exercise in futility, in the last few years, Chinese courts have begin enforcing domestic IP sanctions against Chinese nationals.

"In addition to seeking remedies in Chinese courts,such conduct also violates the WTO agreement and China is a WTO member," Mr. Zolno says. This would allow a U.S. copyright or trademark holder to file a complaint with the U.S. Trade Representative's office under section 301 of the Trade Act. The USTR would contact the Chinese government and press it to take action the Chinese infringer to cease such activities. If the Chinese government refused to act in response to the USTR's complaint, sanctions against Chinese exports to the U.S. could be imposed, such as additional duties or quotas on select Chinese products.  The additional duties or quantitative restrictions would be enforced by U.S. Customs and Border Protection.

Mr. Zolno is available for comment on the current counterfeiting situation in China and legal remedies available to U.S. companies. Please let me know if you would like to speak with him.

Best,
Jason

Jason Milch
Vice President, Public Reputation Services, Jaffe PR
808 Woodbine Lane, Northbrook, IL 60062

jmilch@jaffepr.com
Direct: 312-379-9406
eFax: 267-545-5679
Twitter: twitter.com/jasonmilch

I responded to Mr. Milch by asking that he remove my name from his email list and noting that the email was "deceptive bull---t." 

It is. 

It may be great in theory, but come on.

How many times has what this email makes out to be easy ever happened? I mean really.

If your store is being copied in China, do you really think it makes economic sense for you to go to the WTO about it? Do you really think that your doing so is going to lead to the Chinese government taking prompt action against the store? Do you really think that the USTR is going to take up a cudgel on your behalf over a routine trademark or copyright infringement in China?

This email is not only unrealistic, it is either overly vague or just plain wrong on the law.

Someone with a U.S. trademark generally has no rights to that trademark in China. In other words, if I own the trademark for Brand X on water bottles in the United States and someone in China starts calling their water bottles "Brand X," there is no law to stop that company from selling Brand X water bottles in China unless I registered "Brand X" in China or Brand X for water bottles is a well-known mark. If I were to go to my U.S. Trade Representative on this, he or she would no doubt tell me to work within the laws to protect my trademark. The odds of the U.S. government using my complaint to start a trade war are about the same of Troy McClure becoming President of the United States tomorrow.

In other words, it just ain't gonna happen.

Wikipedia does a nice job setting out the way things really are under Section Mr. Zolno's beloved Section 301:

Section 301 authorizes the President to take all appropriate action, including retaliation, to obtain the removal of any act, policy, or practice of a foreign government that violates an international trade agreement or is unjustified, unreasonable, or discriminatory, and that burdens or restricts U.S. commerce.  The law does not require that the U.S. government wait until it receives authorization from the World Trade Organization (WTO) to take enforcement actions, but the U.S. has committed itself to pursuing the resolution of disputes under WTO agreements through the WTO dispute settlement mechanism, which has its own timetable.

We typically handle our China IP theft matters by sending out cease and desist letters and then suing if those do not work. From now on I think I'll just call President Obama and hand them over to him. Yeah right. That's the ticket.

Oh, and last time I checked, Ikea was Swedish, not American, but hey, if US laws are going to rule the world, we might as well just take over all the big stores as well.

I give Jason Milch a Zilch and Mark Zolno a NoGo.

What do you think?

I was sitting around the other day with a client/friend who has been doing business in China since forever. This person has spent probably 90% of the last thirty years of his life in China and despite his being an American, his knowledge of China business definitely surpasses his knowledge of business in the United States. He was complaining about judges in China and his comment was that about half of them were incompetent.

My response was to tell him that was not so bad.

I have to be really careful here because lawyers talking bad about judges is never a good idea, so let me say that much of what I am going to say has nothing to do with what I have seen, but of what I have heard from my lawyer friends around the United States. Since nearly all of my firm's work has an international component, we almost always find ourselves in Federal court. Federal court judges are appointed and they are paid pretty well and they typically have two really good clerks assisting them. I cannot remember hearing a lawyer complain about the quality of the Federal judges in our area.

in much of the United States, however, judges are elected and these elections are oftentimes determined based on politics, not quality. When lawyers sit around and talk about judges, we almost never complain about a judge's politics. What does politics have to do with a breach of contract lawsuit anyway? No, we complain about competence. 

My never-reticent, Ohio-burdend and sometimes correct friend, Dan Hull, did a post on his What About Clients? blog on  U.S. state court judges, provocatively entitled, Get off your knees: Say something and do something about state elected judiciary. Dan put a picture of Mae West on the post and subtitled it, "Is that a county judge in your pocket? Or are you just hugely happy to see me?"

Hull is characteristically blunt about the inherent problems with elected judges:

Two lousy messages: Judges, like mayors and congressmen, have "constituents". Justice, like real estate or widgets, is "for sale".

Think of it like this: Good Crops, Motherhood, the Flag, Andy Griffith, puppies, selflessness, courage (Mae West, above, had lots of it), beauty, truth, a thin Marie Osmond, sweetness, light, replacing state judicial elections with merit-based selection in 39 American states.

As NYC trial lawyer Scott Greenfield and maybe others worry that writers at this site are getting soft and even, well, flitty, we will reach and try here to be frank, and forthright:

The popular election of state judges is beneath:

(a) you,

(b) your law firm,

(c) your family's dog, and

(d) especially your clients, and especially if you act for businesses who trade nationally or globally.

That institution, favored in a vast majority of states in some form, makes states that still conduct them appear insular and potentially unfair to both American litigants and to non-Americans and their businesses abroad.

*   *   *   *

But elected benches are by nature glaringly "fishy" (i.e., "...dang, Nadine, the campaign money to the judge last year...just don't seem right...the dog don't hunt...") to even the most casual observer in the Midwest or South, and wherever else American horse sense abounds.

Merit-based selection is not perfect. However, it has worked very well for two centuries in American federal courts with a minimum of bad appointments and embarrassments--even if you adjust for the fact that state judges outnumber federal judges (who are appointed for life) by a factor of over 10 to 1.

Generally county-based, American litigation at a state level is already frustratingly local and provincial for "outsider defendants"--businesses from other U.S. states and other nations sued in local state courts--who cannot remove to federal courts, the forums where federal judges can and should protect them from local prejudice.*

American states that still hang on to electoral systems look increasingly provincial, classless, and silly from a global perspective. Merit selection is not perfect--and also poses risks--but it is far better than what most American states currently have in place. It's time for American states to grow up.

Hull is absolutely right and it would be tough to find a good American lawyer who disagrees with him. Well over half of American judges are competent, but every year state court budgets seem to get reduced and the gap between judge's salaries and what they could be earning as practicing lawyers seems to widen. This does not bode well for U.S. state courts.

Does China have work to do to improve its judiciary?  Heck yes it does. But if you are an American looking at it, please do not compare our courts with theirs as though absolutely everything in the United States is just fine. Because it isn't.

If you are doing business in or with China you should give serious thought to registering your trademarks in China. In particular, you should consider a China trademark registration for your trade-name, your logo and your service marks. Brand identity is critical for success in China (as it is just about everywhere) and if you are going to protect your trademarks in China, you must register them. This is especially true in China where if you do not register your trademarks, someone is almost certain to try to appropriate them.  If you have not taken the necessary steps to protect your brand, this theft will succeed. 

This post explains why trademarks are so important for creating your brand in China. Your trademark is what conveys who you are.

No matter what the drink, if it has Coca Cola's name on it, you know that the odds are overwhelming that it will have been well made and be safe. Westin on a building tells you before you go in that it is a nice hotel. Think how damaging it would be to Coca Cola or to Westin if everybody could use those two names on their products, be they drinks or hotels. None of this is any different in China.

Unlike the United States, however, China employs a "first to file" system for trademark registration. This means that China does not recognize unregistered trade mark rights. So you must register your trademark to have any trademark protection. Without trademark protection, someone else can register "your" trademark and then prevent you from using it. This is true even if you are not conducting any sales in China. Even if all you are doing is manufacturing product in China, someone else can (and probably will) register "your" trademark and then stop you from exporting anything from China with that trademark on it unless you pay a licensing fee. This happens all the time and it mostly happens to companies from common law "first to use" trademark registration systems. It happens less often to European companies because they usually know better because they come from a first to file system.  

All of this means that you should register your trademark or service mark before someone else beats you to it. In other words, you should register your trademark or your logo before you first start using it in China. If you know you will be using your trademark or logo in China, there is no benefit (other than cost delay) in waiting. 

The first to file an application in China for a particular trademark gets priority to that trademark, but it can take years for the Chinese trademark office to actually issue your trademark. In the meantime, nobody can stop you from using the trademark for which you applied, but you cannot stop anyone else from using it either. So if you are planning to sell a trademarked product or service in China at some point in the future, there are real benefits to going ahead and registering for the trademark right away. That way you will either have it when you start selling or very soon thereafter.

Even if you are just manufacturing a product in China and are not selling it there, you must register your trademarks on that product before anyone else. This is because if someone beats you to "your" trademark, they will be able to stop you from using it in China at all and block your product (with the offending trademark) from leaving China's ports. 

But what exactly should you trademark and how?

You should trademark anything that identifies your company or your brand or your product or your service that you can. If your company is Premier and your product is Alpha and your logo is a giant A and you sell a special sort of cloth headband, you should at least consider registering the following trademarks:

• The word "Premier" in Roman script
• The word "First" in Chinese characters
• The Mandarin word that sounds closest to "Premier"
• The logo

If you do not choose a name in Chinese and register it, the Chinese consumer will almost certainly choose a Chinese name for you and you may find you do not like that Chinese name one bit or that the trademark on it has already been taken.

There are essentially three methods for picking your Chinese name. You can translate your English or other foreign name directly into Chinese. Registering the word "first" in Chinese characters is an example of that. The disadvantage of a literal translation is that you will essentially have two different names for your same product or company and this can cause confusion in the market. The second option is to use a Chinese character name that sounds like your foreign name. If you go with a phonetic version of your foreign name, you must make sure that you know what the Chinese characters you are using actually mean in Mandarin and Cantonese. Otherwise, you might find yourself with a Chinese name that means something you really do not want to be saying. Oftentimes, the best solution is to choose a phonetic version of your name that also conveys something you wish to convey.  Coca Cola is the classic example of this. Its name sounds like  "Ke Kou Ke Le," which means "delicious" and "happy." 

You will also need to consider in what category(s) to register whatever trademarks you deem necessary from the above. Returning to the example of the headband, there are at least two categories that make sense: hair accessories and clothing. If you register your trademarks in just one, you leave a massive opening for a competitor to step in and register the your same trademarks on the same product in the category you did not choose. If that happens, both of you will be able to sell the headband using the same trademarks. Not choosing all of the right categories for your trademarks can be as bad as not registering your trademarks at all.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I then concluded that post with the following:

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

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

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

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

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

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

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

Get legal now.

We are frequently requested to write demand letters to Chinese companies that owe money to our American clients. These letters are very different from what we would write were we seeking to collect from an American company.

Demand letters to American companies are typically fairly long. They usually spend considerably space setting out the facts and the relevant law. They then usually conclude by stating what we would expect to get from a jury and then it concludes by talking of how it is in everyone's interest to seek resolution and towards that end, we will accept something less than what the jury would give us.

The other side usually responds by pointing out the holes in our case and emphasizing how difficult and expensive it will be for us to collect anything. Something over 95% of U.S. business law cases settle.

China is different.

David Dayton of the Silk Road International Blog has a post that explains some of this difference. The post is entitled, "When Your Supplier is not Arguing to Win," and it posits that Chinese companies simply do not care about arguing towards a logical conclusion:

Americans tend to argue to resolve specific points (words, dates, statistics, etc.).  Ideally those individual points will be acknowledged and eventually the argument will reach a “logical” conclusion—each side’s specific points have been resolved to some mutual agreeable level.  I guess you can say that you “win” an argument by getting as many of your specific concerns resolved to your satisfaction as possible (without giving up too many to the other side).  This interpretation doesn't preclude win/win either—you still want to get as many of your personal issues resolved as you possibly can, you’re just going about it by allowing the other side the same goal in the hope that it’ll actually get both of you a better resolution in the end.

But in 12 years in China, I can honestly say that I’ve only had this progressing-to-a-logical-conclusion type of argument a couple of times (and no, I’ve NEVER had a win/win type factory relationship—even when we’ve consciously tried to structure it—there just isn’t enough mutual trust on either side).  It seems to me that both the point of and the process of arguing is completely different in China.

David has worked with hundreds (thousands?) of Chinese factories and so i tend to believe him on this. Believe him or not, we have found that the most effective demand letters to Chinese companies usually consist of one to two pages and they dispense pretty much entirely with the law and they are light on the facts as well. Our demand letters (always in Chinese) typically set out as fact (without any explanation) that the Chinese company owes our client X dollars from its failure to do Y. We then let the Chinese company know in no uncertain terms how miserable and expensive we will make their lives if it does not pay our client and pay it fast.

The Chinese company typically then contacts us and tells us it will not pay anything. The Chinese company usually gives some sort of vague reason for not paying, like "your client is a liar" or "your client promised it would make another order from us" or "your client does not understand China." We then reiterate the horrible things that we previously described would happen to the Chinese company if it does not pay and fast and then things move on (or not) from there.

What have you seen out there?

Chinese Law Professor has an excellent post, entitled, "Who Owns The Chinese Internet," seeking to answer that very question. The post is in reference to this article [in Chinese] by Jing Linbo and Wang Xuefeng from the Chinese Academy of Social Sciences, asserting "(a) that foreigners (“foreign capital”) in the article’s terminology) have come to control the Chinese Internet, and (b) that this is a bad thing."

Chinese Law Professor analyses whether or not foreigners do control China's Internet and he concludes they do not. In fact, he persuasively argues that many of the Variable Interest Entities (VIEs) to which the Linbo/Xuefeng article cites, are actually controlled by Chinese, not foreigners:

• Take Baidu (the Cayman Islands company listed on the NYSE), for example. 52% of the voting power is owned by Robin Li, either directly or through a BVI company he owns and controls. Another 16% is owned by his wife. Except for a Scottish partnership that holds 2.49%, the rest of the voting power appears to be widely held. In other words, foreign capital is helping out Robin Li, but exercises no control. Robin Li, to the best of my knowledge a patriotic citizen of China, controls the offshore company and the money.

• Sina.com presents a third model. The president and CEO, Charles Chao, is of PRC origin. (I don’t know if he is still a citizen.) He appears to be the largest single shareholder, controlling over 8.66% of voting rights. Only one other shareholder holds more than 5% of the voting rights. In other words, the shareholding is largely dispersed and there is no controlling shareholder. Since Jing and Wang admit in their 2009 article that Sina.com has no controlling shareholder, how then can they claim at the same time (as they do) that the company is “controlled by international capital”? They state that ownership of more than 50% of the shares constitutes absolute control, but this means that some unified will – a single person or a unified group – has to control all those shares. In grammatical terms, the subject of the verb “to own” has to be an entity capable of thinking and expressing a will. “International capital” is not a person with a unified will. The authors appear to believe that in a 10,000,000-share company, if 5,000,001 foreigners each own one share, that is “foreign control” just as much as if one foreigner holds 5,000,001 shares. It is not. One can always identify a group of random and unconnected shareholders in any company whose holdings add up to more than 50%; that does that mean that they control the company. When a company has no controlling shareholder, who does control it? The answer is: management. And in the case of Sina.com, management appears to be predominantly in the hands of Chinese nationals.

• Dangdang presents another model of control. In this case, the Chinese entrepreneurs – Li Guoqing and Peggy Yu – don’t have absolute, majority control. They do, however, control more than 45% of the company’s voting power and occupy the top management and board positions. This doesn’t look very much like control by foreign capital.

To which I say so what? To me the big question is not who owns China's Internet? I know the answer to that and if you define it by who actually controls the content or who actually has final say over the overwhelming bulk of Internet companies, it is the Chinese. I mean, come on. Chinese law effectively precludes foreign involvement and though there are foreign companies involved in China's Internet through VIEs and other patchwork solutions, those companies are always going to be at least somewhat beholden to their Chinese "partners."

The better question is who is perceived in China, by Chinese, to "own" China's Internet? 

if the perception in China becomes that foreigners control China's Internet, that perception will lead to repercussions for those entities that are perceived to be foreign and perceived to control China's Internet. Or as the China Accounting Blog put it in its post, "Communist Party School on VIEs:"

We have already seen regulatory challenges to VIEs, leading to Yahoo losing its interest in Alipay, and alleged theft of a VIE.  Now we can add political risk.  I think it is time to again ask the question whether VIEs are a going concern.  I started this series suggesting that the VIE could be compared to the fable of the Emperor's new suit - not really doing what people are told they do.   My recommendations to clean up this sector remain valid. 

The China Real Time Report blog of the Wall Street Journal has picked up this story. There is also a good analysis of it at China Finance Blog.   An interesting read on the legal theories at play here was posted by Professor Clarke at the Chinese Law Prof Blog.  I like his conclusion:  "I think we all agree that these structures are OK until they are not OK."  Are we there yet?

China Finance blog is more blunt. In its post, "China IT Just Got Even Riskier,' it starts out noting that the Linbo/Xuefeng article has deemed China's Internet to already be controlled by foreigners and that this does not bode well:

The piece doesn’t just brand the obviously foreign companies as being controlled by foreign capital, but includes almost every Chinese internet company in this group. As such the risk of increased scrutiny of VIE structures (explained at lengths in the article), and any dealings between foreign and domestic players in the sensitive IT market has gone up significantly.

China Finance Blog then goes on to note that no matter how accurate the article is or is not regarding foreign control of China's Internet, the "bigger picture" is what is going to matter:

Although I think the report misses the mark on some issues, the details are unlikely to matter too much, the bigger picture will sell it.

One of my disagreements with the article lies for instance in that the Alipay case to some extent demonstrates the power that VIE structures can give the Chinese government over the IT-companies, rather than highlight the dangers of foreign investment.

That this issue is being discussed in this detail, at this level, at this point in time, should give everyone reason to take this quite seriously, indeed.

The last time I wrote on VIEs, Paul Gillis of the China Accounting Blog left the following comment:

What about all the lawyers who have given clean opinions to the use of these structures for the past decade?

What about all those lawyers? Don't cry for them. Any lawyer worth his or her salt that was involved in a VIE structure wrote a lengthy CYA letter making crystal clear that VIEs were risky, that the whole purpose of VIEs is to usurp/circumvent Chinese law, that Chinese law is itself risky, and that nobody really knows what will happen to VIEs or for how long they will be allowed to exist.

China Hearsay spoke to this as well, in its post, "Gray Areas in China Law: A Vote For Legal Realism:"

I think what this comes down to is that Dan Harris and I are looking at this [VIE structures] as practitioners. If a client wants to do a deal in a restricted area by setting up a structure that has never been shut down by the government in 25 years, I still can’t tell that client that this is a “gray area.” I just can’t do it as a lawyer, for basic liability reasons.

What I can say is that it is technically illegal, and then explain the history of enforcement (or lack thereof). If the client then wants to proceed, then (in some cases), I will stay on board and help facilitate the transaction (in some cases, I will beg off).

I think I might add something along the following lines: VIES. They were risky yesterday and they are even riskier today. They are okay right now and will be okay until they are deemed not okay. I have no idea when or if that will ever happen, nor does anyone else, but hey, you are big boys and it's your money, so you make the call.

What do you think?

If it seems we have been obsessed of late regarding Variable Interest Entities (VIEs), it is because we are. We are obsessed with them because we have spent massive amounts of time over the last few months working with investment companies (and others) investigating publicly traded Chinese companies that use VIE structures.

This work has led us to read pretty much whatever we can on VIEs and it led me to read a very clearly written article by Ballard Spahr lawyers Norman Goldberger and Laura Krabill.

One additional risk factor in investing in Chinese companies is that the use of a reverse merger is often accompanied by the creation of a variable interest entity (“VIE”). VIEs allow the public company to gain control of a private Chinese company and its assets through a series of contractual arrangements, rather than through a strict parent-subsidiary relationship or direct ownership of the operating Chinese company or its assets. The VIE structure is used to avoid Chinese regulations prohibiting foreign ownership of Chinese companies and assets. The VIE arrangement, however, creates further risk and complication for U.S. investors of public companies whose assets and operations are in China.

In particular, the contractual arrangements providing for control by the public company are only as strong as the enforcement mechanisms that can be effectively used — generally Chinese law and Chinese courts. There may be incentives for the Chinese company
or its insiders or their friends and family (who are likely the other parties to the VIE contracts) to simply renege on the contracts, and it might be impossible for the contracts to be enforced in China. Or, despite their best efforts to perform under the contracts, the VIE contracts could be nullified as a result of intervention by the Chinese government. Whatever the reason, the fact that VIE contractual arrangements may ultimately be unenforceable
creates a substantial risk that investors in a public company whose only assets arise from VIE arrangements will be left with nothing.

For more on the risks of VIEs, check out the following:

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

To Vie or not to Vie, that is the question. What do you think?

By Steve Dickinson

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

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

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

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

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

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

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

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

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

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

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

Be careful out there.

China's nominal per-capita GDP stands close to $4500. This is about a third of the way towards a developmental milestone INSEAD economists Antonio Fatas and Ilian Mihov have dubbed "The Great Wall." Fatas and Mihov have given this name to attaining over $15,000 in per-capita GDP because over the past thirty years middle income countries have consistently failed at climbing over it into the ranks of advanced nations.

In a recent Wall Street Journal article, entitled, "Is Mexico China's Future," Bob Davis also talks of the difficulty emerging countries have in reaching developed status and notes that "Singapore and South Korea are nearly alone in having made the transition." Nearly everyone else gets stuck in a sort of Mexican purgatory where continued growth is dependent on continued reform of governmental and financial institutions:

Most every other poor nation — whether one calls them “third world,” “developing” or “emerging” — gets stuck in second-tier, Mexican-style status.

“Absent continuing reforms,” the economists argue, “Chinese growth is likely to slow down sharply, perhaps leaving China at a level less than Mexico’s” — an outcome that would be a hard slap to the China-as-future crowd.

While Mexico and China seem very different, the economists point out a number of similarities. On the positive side, the two nations focused on foreign trade as a growth engine and they eased central government control of the economy. On the negative side, their financial systems are inefficient, their non-tradable industries (communications, transportation and the like) lack competition; and their rigid labor rules discourage employers from adding full-time workers.

The thinking on this is that it is relatively easy for developing nations to make big yearly moves in their per-capita, but only up to a certain, Mexico-like point. After that, top tier governing and financial reform becomes necessary to become Denmark-like:

Once that catch-up period is over, however, the countries need to continue to reform institutions and policies to produce a well-functioning government an efficient financial system and a steady increase in knowledge so it can continue to grow smartly. Few countries manage that transition, which leaves them well behind the U.S. and Europe.

In its post, "China’s $10,000-12,000 Question, the China Bystander blog (a superb blog, by the way) posits that China will not reach developed status without some serious changes: 

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.” As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China Bystander himself adds that poor quality in China is linked to set of very specific problems and that China's ability to get past The Great Wall will depend on its ability not only to reform, but to reform quickly enough:

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

China Bystander sees SOEs as another potential impediment:

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes.

China Bystander also thinks China's demographics bode ill for it climbing over the Wall:

China has already reaped the benefits of a demographic dividend, which is believed to have played a role in the country's economic breakthrough, having enjoyed the advantage of abundant cheap labor for decades.

"Wage increases are the most direct response to labor shortages. That will definitely squeeze the profit margin for some low value-added manufacturers," Zhang said.

What will China do and what will China's economic future be? I have heard many say they think the Chinese government will be fine with the $12,000-$15,000 wall, preferring to stop there than to reform "too much."  i personally think it is too early to judge. I mean, who knew Korea and Singapore would keep growing while Malaysia, Indonesia, and Thailand would fail to keep pace? What is the difference between Korea and Singapore and Chile (whose economy has done amazingly well over the last ten years) on the one hand, and Malaysia, Indonesia, Mexico and Thailand on the other? And if you answer better governance, then you have to explain why Singapore and Korea got it and the other three did not? Same if your answer focuses on corruption. So really, which way will China go? Korea/Singapore or Malaysia/Thailand/Mexico?

What do you think will happen? Will China climb over the wall, merely bang against it or never get close? Why?

For years I have been fighting against those who claim Chinese laws are gray. China's business laws are generally as well written or as clear as any other country's. My contention has always been that those who claim China's laws are grey are usually just saying that to excuse their own failure to abide by them.

I wrote on this way back in 2007, in the post, "China Company Formation Law Is Clear -- WFOEs Are Easy," where I talked of how the so-called lack of clarity in China's laws on forming companies arises from those who have not actually read them or from those who benefit from propagating this idea:

We recently took on three new WFOE formation matters for U.S. lawyers. Two of these matters are for lawyers working on behalf of their clients and one is for a lawyer who owns the (non-law related) business. All three of these lawyers told me they had spoken with company formation firms and had grown frustrated with the information they were being given. They relayed that these firms were not giving clear answers to many of their questions, but were instead responding by saying China's WFOE laws were "vague" and/or "ever changing."

What these company formation firms are saying is just not true.

Chinese law on WFOE formations is actually quite clear and I suspect these company formation firms were claiming otherwise only because the laws are vague to them. Near as I can tell, these company formation firms typically consist of a foreign voice or two (oftentimes in Hong Kong) who takes in the work and then farms it out to a Chinese lawyer in a low cost city to do the work. The people on the phone or at the other end of the e-mail at these firms have never read China's laws on WFOE formation and so, not unexpectedly, those laws are vague to them.

As for "ever changing," on January 1, 2006, there was a sea change in China company formation laws for foreign companies, but they have remained static since then.

By far the biggest source of confusion/frustration for these lawyers seeking information on forming a China WFOE is the minimum registered capital requirement.

The law on minimum registered capital is clear, but the amount of capital that will be required does vary, depending mostly on the nature of the business of the company to be formed and on the city in which it is going to be registered.

I wrote on this again in 2009, in a post entitled, "China's Business Laws. Ignore Them At Your Peril." In that post, I reiterated that China's business laws are just fine:

But what about the grey areas in China's laws? China's laws are simply not that grey. They were grey five years ago, but their business laws are now, for the most part, pretty clear, particularly as they apply to issues important to foreigners.

I really do not see much more gray in China's business laws than in those in the US.

In the post, "Rationalizing Risk: Phantom Gray Areas in Chinese Law," China lawyer Stan Abrams seems to concur. Stan's post is on VIEs and he gets all nicely worked up by those who attribute the problems that arise from them to gray areas in China's laws. Stan starts out by talking of how the media (and others) have been chalking up Yahoo's problems with Alibaba to "gray areas in Chinese law" and Stan ain't buying it:

It sounds comforting, but I think it’s a rationalization employed by those responsible for making risky moves in the first place. When the Board of Directors is staring you down and asking “How the f#@% did this happen?” you tend to shift the blame elsewhere.

Bloomberg ran an article on the Yahoo/Alibaba case, written by Debra Mao in Hong Kong, in which the dispute was explained away, for the most part, as the result of uncertainty due to legal gray areas. (The title of the piece was “Yahoo's Alibaba Spinoff Losses Show Dangers of China's Legal Gray Areas.”)

For my take on Yahoo/Alibaba/Alipay, check out "Yahoo/Alibaba/Alipay/Jack Ma/Carol Bratz: What Really Happened And What It All Means."

Stan goes on to extoll a quote from Pillsbury Winthrop’s Tom Shoesmith:

Western businesses come into China and they want to know what the rules are, Shoesmith said. There's the technically correct answer, there's the practical answer, and then the third one is, "Who cares anyway?" Sometimes the answer is "Who cares anyway?" until you get busted.

Stan sees Shoesmith as saying "that his clients sometimes flaunt risk entirely, hoping that they won’t get caught. This isn’t about whether the system here is transparent, or unclear, or if gray areas exist. This is about understanding risk and plowing ahead anyway."

I 100% agree. Just as my firm always makes very clear in writing the fact that VIE structures are inherently risky and are of questionable legality in China, I am quite certain that every other legitimate law firm does the exact same thing. That being the case, no company can claim that it had no idea of the potential problems with VIEs and no company that does a VIE structure in China can claim a "gray area" excuse. Or as Stan puts it, gray areas in Chinese law "does not explain Yahoo/Alibaba, and it doesn't mesh with what Shoesmith was saying."

And lest anyone out there think that the VIE structures are gray, Stan emphatically tells us that they are not; at minimum, they clearly go against the spirit of Chinese law:

Remember the fundamental problem with the so-called “Sina Structure” or “VIE” that I've talked so much about recently? If you recall, the government restricts foreign companies from investing in certain industries, yet some of those sectors are so attractive that foreign investors will pretty much do anything to get in anyway.

So what happens? An elaborate structure is cobbled together that includes offshore holding companies, onshore subsidiaries, and a series of exclusive commercial agreements. This is done to approximate, as much as possible, a direct investment.

Here’s the crux of the matter. Is this kind of structure an example of a legal gray area under Chinese law? News Flash: this isn't a gray area at all; it’s obviously improper, designed to circumvent Chinese foreign investment law.

Yeah, I really said that. It’s rather obvious. All those folks out there, including many of the top Internet firms in China that received foreign money, who set things up to skirt legal restrictions, are violating the spirit of the law.

Stan then points out that the real issue with VIEs is not their legality, it is simply whether the Chinese government will continue to look the other way and allow them to continue:

To be clear, I’m not suggesting that legal uncertainty doesn't exist. Indeed, when I counsel these guys, the discussion is not “Hey, you know you’re violating the spirit of the law?” They already know that. What they really want to know is the likelihood that: a) their structures will be enforceable, and b) will the government swoop down on them at some point and force them to restructure (e.g. Yahoo/Alibaba).

So yes, there is uncertainty here with respect to enforcement of these structures and their related commercial agreements. Moreover, the authorities here are aware of these “spirit of the law” violations and generally allow them to exist (at least until they decide otherwise).

That’s a far cry, however, from suggesting that the structures themselves occupy a gray area under Chinese law. They don’t. That’s wishful thinking and a rationalization.

But I understand what’s going on here, at least psychologically. If there is a gray area, then the investor and his lawyer are off the hook, at least to a certain extent. Instead of telling the Board of Directors “I knew it was illegal, but since everyone is doing it, we decided to go for it and hope for the best,” a more respectable “The legality of the structure is unclear, so we moved forward as carefully as possible” can be used instead.

So true.

In fact, I am going to go a step further and say that the Chinese government generally does not crack down on foreign companies unless their violations of Chinese law are clear. So the next time a foreign company claims its Chinese legal problems were due to "gray areas" at least make them explain the law being discussed.

I also like Law Professor Donald Clarke's post, "Phantom gray areas in Chinese law." Professor Clarke also notes how "gray areas" are used as an excuse for contravening what was actually quite clear:

I want to recommend this post from China Hearsay on what the author (Stan Abrams) calls "phantom gray areas" in Chinese law. These are areas where the law really isn't uncertain at all, but people for various reasons like to pretend it is. Sometimes it's just because they don't like the rule; sometimes it's so that they can blame unpredictable government policy instead of themselves when things go wrong. Stan's example is that of the use of contractually-based Variable Interest Entities to attempt to get around Chinese restrictions on foreign ownership in various industries.

One favorite area of mine is the uncertainty I often heard alleged about what would happen to long-term land-use rights under the Urban Real Estate Administration Law when their term expired. (This is before the Property Law injected real uncertainty into the process.) Well, the answer was always quite clear: everything goes back to the state, including all buildings on the land, without any further compensation. But holders of LURs didn't like this result - they would conjure up pictures of granny being thrown out onto the street as year 70 expired. (As if the LUR holder hadn't had a full 70 years' advance notice that this was going to happen!)

Where's the gray?

What do you think? 

This post is part I of what is going to be a multi-part, somewhat irregular series on protecting your IP in China. This part I and tomorrow's part II, were written by Steve Dickinson, and are based in large part on a talk Steve gave last week in Qingdao. Over the last couple of years, "creative services" have been probably the greatest growth area for our firm and so our intellectual property and licensing work has only continued to grow in importance.

For pretty much all of our creative services clients (these are companies mostly in the software, gaming, entertainment, media, art and film industries) intellectual property makes up the overwhelming bulk of the value of their business. Therefore, it is always a surprise to us how many of them seem to treat their intellectual property in China is an optional or secondary matter when it really should be the first issue they consider when approaching the China market. Though IP is usually of somewhat less importance for our clients not in creative services, they too tend to undervalue its importance. 

This series is intended to emphasize the importance of protecting IP in China and to set out a program for for creating, protecting and monetizing intellectual property. Without a clear program on this issue, disaster is certain to follow in China.

The first step is to get clear what we are talking about when we use the term “intellectual property.” IP is not patents, trademarks, copyright etc. These are simply tools for protecting intangible assets. It is the same for real property: a deed is not land, it is a tool used to establish and protect an ownership interest in land.

So what is intellectual property?

• A better term is intangible property or intangible assets. This includes everything about your business that has value that cannot be reduced to a physical asset or to a monetary cash flow.
• For creative industries, IP can include virtually all of the assets of the business:
  • Music
  • Film
  • Books and magazines
  • Research and analysis
  • Design of any kind: interior design, clothing design, product design
  • Architecture and engineering
  • Software of all kinds: industrial, retail, video games, phone “apps”
• For traditional industrial firms, it includes
  • Inventions
  • Formulas
  • Industrial processes and know how
• For all businesses, it includes:
  • Brand and image
  • Business planning and corporate strategy
  • Pricing plans

For most modern businesses, intangible property forms a major portion of their value. For many businesses, such as those in creative services, it forms the core of the value of the company. Consider the stars of the modern business world: Apple, Microsoft, IBM, Boeing, Siemens, Nestle, General Electric, Dow Chemical, Starbucks, Amazon, SAP. Is their value in their real estate holdings? In their factories and office buildings? No, the value of these companies is almost entirely in their intangible assets.

However, even for hard asset, resource based companies, IP is still a major component in their company value. Take the mining companies that have dealt with China for the past ten years. A major portion of their value lies in their pricing plans, their internal data on their resources, their techniques of extraction and transport, their future exploitation plans and the like. This explains why the primary battle between these companies and the Chinese over the past several years has centered on the attempts of both sides to acquire data to aid in the struggle over control of the market.

The message is obvious: active and careful cultivation of your intangible assets is mandatory to survive in the modern business world. This means taking the steps necessary to secure the rights, to protect the rights, and then to secure the rights for your own use or to package those rights for monetization.

Most businesses are constrained by the traditional categories for intellectual property and do not effectively consider the tools that available to protect intangible assets. There is much more to IP protection than the traditional IP tools.

The traditional intellectual property tools are:

1. Patents
2. Trademarks
3. Copyrights
4. Trade Secrets

Though these tools are essential in the IP world, there is a far wider set of techniques that can be used, including the following:

1. Secrecy and refusal to disclose
2. Licensing and trade secrecy agreements: limited and controlled disclosure
3. Trade secrecy and related agreements with employees and joint venture partners
4. Physical techniques such as encryption and related data protection techniques

Many companies believe that since they have done what is necessary to secure their rights in North America and Europe, there is nothing special they need to do in China. This is a mistake.

The key concept is that all IP protection is local. You cannot rely on what you have done elsewhere. You must deal with your IP by making use of the Chinese system. You must act within China for both creation of rights, enforcement of rights and monetary exploitation of rights. You must deal with China the way it is, rather than hoping to rely on a perhaps more perfect system that simply does not exist in China.

Since all IP protection is based on local law and practice, you must adopt an effective and realistic protection program for the country in which you are operating. If you are in China, you must consider the situation in China. The fact is that China is currently the most dangerous country in the world with respect to protection of intangible assets does not mean you can afford to throw up your hands and do nothing. China's IP risks can be managed, if 1) you assess the risks in a realistic way and 2) you take practical steps for protection.

Tomorrow, we discuss specifics.

I have been speaking fairly frequently of late regarding litigating and arbitrating against Chinese companies. One of the things I always hear when I give one of these talks is how difficult it is to serve Chinese companies with complaints. In fact, much of the time, some lawyer will proclaim to me that it is impossible.

This is flat out wrong. My law firm has never once failed to effect service on a Chinese company. If you follow all of the rules you will succeed. The following are the rules as they apply to serving Chinese companies in a United States Court. I presume the rules will be similar for other country's courts.

China is party to the Hague Convention on Service Abroad of Judicial and Extrajudicial Documents in
Civil and Commercial Matters. Therefore, service on a Chinese company must fully comply with this
Convention. Service under the Hague Convention on Service is effected through the designated Chinese Central Authority in Beijing, which is the Bureau of International Judicial Assistance, Ministry of Justice
of the People's Republic of China.

The U.S. company must submit the following to the Ministry of Justice: (1) a completed United States Marshall Form USM‐94; (2) the original English version of the documents to be served (the summons must have the issuing court's seal); (3) the Chinese translation of all documents to be served (although China did not make a specific reservation regarding translations when it acceded to the Hague Convention on service, China's Central Authority has advised the U.S. Embassy in Beijing that documents

to be served in China must be translated into Mandarin Chinese. Since it is China's Central Authority that effects service of process, the best approach is to comply with its requirements); and (4) a photocopy
of each of these documents. Note that because the USM‐94 will not be served, a translation of that document is not necessary.

In addition to the documents, a payment of approximately US$100 by an international payment order must be sent with the service request, payable to the Supreme People's Court of the People's Republic of China.
The Ministry of Justice will then send the service documents to the appropriate local court, and that
court will finally effect service.

In our experience, Chinese courts are often fairly slow to send out service. If the Chinese company being sued is a powerful local entity, the service may be even slower. However, repeatedly calling and emailing

both the court itself and the Ministry of Justice can often expedite service. Service normally takes around one to three months.

Service on a Chinese company by mail is not effective and U.S. courts have held that China's formal objection to service by mail under Article 10(a) of the Convention is valid.

Chinese companies will oftentimes "refuse" service. In these circumstances, you draft an affidavit or declaration explaining to the U.S. Court what transpired and the U.S. court invariably will deem service to have occurred. 

Tomorrow, I will discuss why it oftentimes makes no sense to sue Chinese companies in U.S. courts, but also set forth some situations where it makes all the sense in the world.

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

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

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

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

Bottom Line: It pays to operate legally. 

A bit late on this I know, but I will be speaking today (it is not yet even 6 am here) at The Offshore Investment Conference Shanghai 2011. My topic (a bit different than noted on the program) will be "Avoiding and Winning China Disputes. I will be speaking at 4:30 pm and then I will be part of a panel at 5:15 pm. The conference is at the Shangri-La Hotel in Pudong.

The difference between my new title (created yesterday) and that on the program is subtle, but important. The title on the program makes the thrust of my tallk to be how to avoid Chinese courts. Implicit in that is the idea that one should always strive to avoid Chinese courts, at all cost. I vehemently disagree with that, as I think there are many instances where the only sensible way to resolve a dispute with a Chinese company is in a Chinese court. As regular readers of this blog well know, we are always stressing that getting a court judgment against a Chinese company in New York or in London will almost certainly be of no value if the Chinese company against whom you have secured the judgment has no assets in those cities. We are also always emphasizing that if you want to stop your Chinese counterpart from doing something (let's say, continuing to manufacture your product after you have terminated them), your best bet will almost certainly be to get an order/injunction from a Chinese court.

So if I am not going to be telling the audience how bad Chinese courts are and how to avoid them at any cost, on what will I be speaking?

I am going to be talking about what it takes to avoid disputes with your Chinese counterpart anywhere. And that really is the goal, is it not?  And also, as part of that, how to set up your contract/relationship so as to maximize your chances of prevailing in any dispute at a low cost. And to get a little circular on you, I will note how a contract/relationship in which your chances of winning at a low cost are high will be the kind of contract/relationship that your Chinese counterpart is not going to want to "mess with" and that too reduces the chances of your ever getting enmeshed in a dispute.  

I will put my PowerPoint on here after I have completed my speech. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What do you think?

Not sure if it is cynicism or realism, but I am getting increasingly willing to blame "the victim" of China business problems. I am convinced that nine times out of ten when bad things happen to good people who do business internationally (that includes in or with China) it is the "good person's" fault. Like all lawyers who work with China, I have a ready set of horror stories, which I rotate depending on the occasion, but usually include one or more of the following (modified slightly to protect the guilty):

1. The guy who "invested" $500,000 into a China business because the owner of the Chinese business was allegedly the son of a five star general. Co-blogger Steve Dickinson suggested to this investor that instead of investing this money into the Chinese company, that he use the money to fly him and Steve to Vegas (this was before Macao got so big) and put the money on red because, as Steve put it, the chances of his not losing his money were much greater this way and it would be a lot more enjoyable. This guy went ahead and invested the $500,000 and lost every bit of it. He then wanted us to sue the "son of the general" on a contingency fee basis, but we would not have taken on that case for a 150% contingency.

2. The guy who bought a million dollar condo in Shanghai in the name of his girlfriend because he believed foreigners were not allowed to own real property in China. His girlfriend then left him and claimed he had given her the condo as a gift. The guy wanted us to sue the girlfriend but we demurred, saying that we just did not like a case where our client would need to stand in front of a Chinese judge and explain the deal by starting out saying that he had put the condo in his girlfriend's name so as to avoid the Chinese law that says.... And here's the kicker. When he bought this condo for his girlfriend, he could have purchased it in his name, no problem! His girlfriend had lied to him about Chinese real property ownership laws.

3. The countless people who call my firm after having sent tens of thousands of dollars (sometimes hundreds of thousands of dollars) to someone in China for a product that never arrives. Eventually the person and "company" to whom they sent the money disappears. We have never taken one of these cases because we deem them pretty much hopeless. 

4. The US company that used the local Chinese lawyer of its joint venture partner (what was this company thinking?) who drafted up agreements that involved the American company giving its critical technology to the joint venture permenantly without getting any real influence or control in it (this is an amalgamation of probably half a dozen poorly formed joint ventures in which we have been called in). For more on this type of joint venture deal, check out, When in China Trust Everyone.

I could easily go on and on.

So what can a foreign investor do?

A lot.

Here goes.

In Seven Rules Of China Due Diligence, I set out the following seven rules to analzye a Chinese company with which you are doing business, taking the first six from an article by Muddy Waters entitled, "The Six Rules of China Due Diligence": 

Approach the company as a potential customer does. "You want to see what the China side customers see. Fraudulent companies have far less confidence that they can fool a Chinese company in their industry than they do about fooling a starched shirt analyst. Moreover, they’re usually less willing to take legal risks in their home market (China) than they are in the United States." In other words, look to see how the Chinese company with whom you are interested is treated by other Chinese companies.

Take all company-provided introductions with a grain of salt. "When companies set up meetings or conversations between you and their suppliers or customers, take them with a grain of salt....In a country where a lot of managers earn less than $500 per month, it’s not hard for an unscrupulous company to buy someone’s loyalty for the duration of a meeting or phone call. You should instead rely on your own networks to help you understand the company and industry. If you don’t have those networks, you unfortunately shouldn’t be making investment decisions in China by yourself." I completely agree. 

Try to construct your own fraud scenario. "At some point in evaluating every investment, you should stop and ask yourself how you could have staged everything you’ve been shown or done with the company. It’s good for American investors to practice this mentality because it makes us less credulous. More importantly, this kind of thinking makes clear how surprisingly simple measures (e.g., switching factory signs before you arrive, painting old machinery) can be so effective in fooling the credulous investor." I absolutely love this advice and I urge everyone to follow it.

Forget about the paper. Focus on the operations. "In today’s world where you can buy a competent color printer for less than $200, it’s hard to understand why investors place so much faith in bank statements, invoices, and contracts. China’s deal making world abounds with stories of forged bank statements and other documents leading to disastrous deals. Unfortunately, most auditors apply the US audit playbook in China – reviewing and taking documents at face value....Instead, you have to look at the operation itself. How much does the output seem to be, how much material is moving into and out of the factory, does the office seem to be a hive of activity, how many employees can you count, what is the square footage of the facilities? These are all basic questions one should concern themselves with during site visits. And it pays to visit two to three (or more) times – a good fraudster can put on a show, but they’re unlikely to be able to do it the same way each time. Watch for the subtle differences. Ultimately if you cannot find a good way to measure the company’s sales or productivity (as in the case of a service company), you should think carefully about proceeding with the investment." I completely agree with the advice to put the Chinese company's operations under a microscope, but I completely disagree with the advice to ignore the paper, as I discuss more fully below. I advocate putting the paper under a microscope as well. 

Always speak with competitors. "Competitors with real businesses can usually tell you one of two things about a fraudulent competitor – either that it’s obscure (sometimes the “competitor” is hearing about the company for the first time); or, that they know it’s a fraud. Many competitors will be reluctant to speak openly at first about a fraudulent competitor if they know you’re a potential investor in the fraudulent company. However, if you’re a potential customer who is shopping around for a vendor, it can be a different story." This is excellent advice, but one should also take the views of competitors with at least a bit of salt.

Do not delegate. "A lot of experienced China investors have stories about subordinates who colluded with a target company to attempt (and sometimes succeed) to defraud the investor. Be attuned to the dichotomy between the investment funds at stake and the income/wealth of the people on whom you rely for judgment." Very true. At least half the time when my firm has been brought into a fraud situation, we have to ask ourselves whether the "trusted subordinate" was incredibly stupid or in on the fraud.

The seventh rule (my added rule) is to put the documents you receive under a microscope because the fraudulent company will nearly always make some mistake in its documents. In my career, I have caught the following, all of which threw up massive red flags:

Company claimed to have a multi-million dollar account at a non-existent bank;

Company documents showed a subsidiary in the Marshall Islands, yet always spelled the country as Marshal Island. It had no such subsidiary;

Company claimed to have a branch office in a particular city, yet its documents on that branch office (including supposed government documents) put that city in the wrong province;

Company claimed to be bringing in twice as much product as physically possible on a particular ship;

Company claimed to have been shipping out product on a particular ship that did not exist during the first few years when the product was allegedly being shipped;

Company claimed to have won an IP lawsuit in a country's Supreme Court (they produced the Supreme Court's decision and everything), but there had never been such a case.

Bill Bishop at DigiCha just did a post entitled, "Do You Know Where Your China Stock CFO Lives?" setting out China company (mostly publicly traded) warning signs. The post talks about how two Chinese companies Longtop Financial and Sino-Forest, that publicly trade in the United States and have recently been under scrutiny for alleged improprieties both have Canada-based CFOs even though the bulk of their operations are in China. Bishop posits that these companies may have hired foreign-based CFOs as "China fraud beards." 

Bishop then goes on to quote from an iChinaStock post, entitled, 5 Warning Signs That A Chinese Stock May Be a Fraud, listing out the following warning signs:

1. Company went public through an OTCBB Transfer or other ways of back-door listing;
2. Company name starts with “China” [unless they are state-owned they can not register a company in China starting the word "China"];
3. The products are sold in China, but there is minimal Chinese-language information about those products;
4. The business defies common sense;
5. The underwriter, audit firm and accounting firm are second tier and/or have a track record of missing frauds (like Deloitte China).

Bishop adds a sixth item to the list, that "the CFO does not live in the same city as corporate HQ and is not a regular presence there."

I like Bishop's admonition not to invest in a business that defies common sense. Yes, that is pretty basic, but in many ways it is the key. It is not too disimilar from the advice I gave in the When in China Trust Everyone post mentioned above:

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

One more thing to do before you invest or, in some cases, even do business with a Chinese company: get their official corporate records from the official Chinese government sources. We have of late been doing this rather frequently for our clients and though it is not at all inexpensive or easy, it can be incredibly enlightening and it goes far beyond the information provided by the basic company search firms. 

The China company search firms typically provide only a fairly basic list of information, such as the names, and addresses of those involved with the company and its registered capital. in addition to not being terribly complete, the information from these search firms is of dubious provenance. How did they get the information? Can we be sure they looked at the entire file? We know the files are only supposed to be open to lawyers. How did they obtain access? When did they review review the documents? Last year's documents may be of no help at all.

We strongly suggest that you seek out the full SAIC (State Administration for Industry and Commerce) file on the Chinese company about whom you are seeking information.

In our experience, the SAIC only opens its file to licensed Chinese attorneys. Everyone else is turned down. The Chinese licensed attorney must go in person to the SAIC office, review the file, and make copies in the office. So far, no Chinese licensed attorney with whom we have worked has ever been denied access. It is our understanding that the Chinese companies investigated through the SAIC will know they are being investigated. Like I said, we have so far always been able to get the file, but there could come a day when a local SAIC in an outlying province will block access to the file of a powerful company within its purview.

These SAIC forays usually give us a massive amounts of documents in Chinese, which we then either translate for our clients or, more typically, summarize.

The hot topic in this arena right now is this: the parent company does an IPO in Hong Kong or the U.S. The parent claims the IPO proceeds were injected into a WFOE in China. Was the money injected into the WFOE or not. If so, when? If not, what is the most recent record on the registered capital status of the WFOE. For a WFOE that receives an injection of capital from an IPO, there is typically at least six months of advance work in increasing the registered capital amount. All of this is public and can normally be found in the SAIC file. In addition, the annual audit will show an injection of capital. But the audit is of the previous year. So for recent injections of capital, we have to rely on the approval for the increase in the registered capital.

For more on these issues, check out the following:

• Beware the Potemkin Chinese Company
• Giving China Due Diligence Its Due.
• Giving China Due Diligence Its Due, Part II. Don't Be A Sucker.

What do you think?

Recently, we were called upon to review a commercial lease for one of our regular clients. This client had been working with a local Chinese attorney on the lease, but wanted us to "double-check" to make sure everything was okay. The following is co-blogger Steve Dickinson's email to our client, stripped of any identifiers:

I have reviewed the lease. My comments are as follows. 

1. I assume that this lease is NOT required for the formation of your Chinese WFOE? Is this correct. If it IS part of the documentation required for the WFOE, then it may not be acceptable for two reasons. First, the landlord is not in the formal leasing business. Second, the lease will not be registered with the local real estate registry as is required by law. 

2. You should check carefully to determine that the landlord has the right to lease the premises. I assume that the local attorney has done this.

3. The lease does not set out the the permitted uses for the premises. In that case, you are permitted to use the premises in any way consistent with the zoning. You should ensure that the zoning does in fact permit you to make use of the premises in the manner that you are planning.

4. Note carefully Article ___ of the lease. The translation is NOT correct. What this says is that if you want a receipt for tax purposes (fa piao), then you must pay the tax that will be imposed by the government on the amount of the income received by the landlord. That is, you will pay the landlord's tax on the landlord's behalf. This means that the landlord 1) does not plan to register the lease as required and 2) the landlord does not plan to pay tax on the rental income. Both are common and both are a violation of Chinese law. Since you will certainly want a receipt (fa piao), I would recommend that you face this issue directly. The lease should state: the landlord will provide tenant with a tax receipt (fa piao) corresponding to each payment. Tenant will pay additional rent in an amount equal to the tax imposed on that payment. With respect to registration, note that the registration requirement protects you. For example, it 1) ensures that the local authorities agree that the landlord has the right to rent and 2) it provides notice to the world so that the landlord will not rent to someone else and 3) it provides notice to any buyer of the property that your lease is in effect and must be honored upon a purchase. For this reason, I would also revise the lease to require that the lease be registered. You should be aware that many landlords object to registration. Usually the reason is that they 1) are evading tax or 2) there is some problem with the status of the property that they do not want to disclose. No matter what the reason, you as a tenant are much better off with a registered lease. 

5. You should ensure that sufficient electricity will be provided. There is a major electricity shortage in the ___________ area. The local electricity utility needs to be contacted to ensure that you will be able to obtain sufficient electricity at a price you can bear during the term of the lease. Many local utilities are imposing complex schemes for electricity usage and rationing. You need to be aware of how this will affect your operation. Since I do not know the use for this building, I do not know whether this will be a major issue for your company or not. For normal warehouse use, it probably is not an issue. But, if you will do any assembly or manufacturing, the issue could be significant.

6. It is usually best to state the condition in which the premises must be returned to the landlord in order to avoid disputes on the termination of the lease. Such disputes are extremely common in China. 

Please contact me if you have any other questions on this matter.

We are always writing on how because Chinese courts will not enforce U.S. court judgments it is usually pointless to pursue litigation against a Chinese company in the United States if the Chinese company's only assets are in China. So if you have an agreement with a Chinese company that requires litigation take place in your own United States city you are likely to face problems if you ever need to sue. Here are some of our posts on this:

• Enforcing Foreign Judgments in China -- Let's Sue Twice
• Chinese Companies Can Say, "So Sue Me."
• Taking Judgments To China (And Korea), Let's Not Sue Twice
• Will Your US Judgment Be Enforced Abroad? Not China, But Maybe
• Why Suing Chinese Companies In The US Is Usually A Waste Of Time
• How To Sue A Chinese Company. Part III. Litigation Strategies And Enforcing Judgments

So today when a client called to discuss suing a Chinese company, I started talking about how China does not enforce U.S. judgments. The client then reminded me that it was a Canadian company. Wait just a second. Canada is a separate country with its own international treaties. Is it in a treaty with China under which the two countries enforce each other's court judgments? 

I did some quick research and discovered that China does not enforce Canadian judgments but it does enforce the judgments from the following surprisingly large (and somewhat diverse) list of countries:

• Belarus
• Brazil
• Bulgaria
• Cuba
• Cyprus
• Egypt
• France
• Greece
• Hungary
• Italy
• Kazakhstan
• Kuwait
• Kyrgyzstan
• Laos
• Lithuania
• Mongolia
• Morocco
• North Korea
• Poland
• Romania
• Russia
• Spain
• Tajikistan
• Tunisia
• Turkey
• Ukraine
• United Arab Emirates (U.A.E.)
• Uzbekistan
• Vietnam

From now on, whenever I write about the enforcement of judgments in China from now on, I am going to strive to point out that what China does with U.S. judgments may not be the same thing it does with other country's judgments. 

Anyone out there ever taken a judgment from a foreign country and had it enforced in China?

New Zealand Trade and Enterprise, an NZ governmental agency tasked with helping NZ companies grow internationally is out with an excellent 80 page primer for small and medium businesses looking to make it in China (h/t Dragon Business Network Blog). It really covers the field of what SMEs need to know about China, and though it is nominally aimed at NZ businesses, virtually all of what it says apply to businesses from just about any country.

The whole thing is worth a read, but I particularly liked its short and clear recitation of how companies should deal with protecting their intellectual property in China. On that topic, the primer had this to say:  

It is advised that you seek professional legal advice before seeking enforcement of your IP rights. In order to protect your IP rights you should:

• Consider which products need to be trademarked, not only now, but in the future.
• Protect your Chinese-Language marks in addition to your New Zealand marks.
• Defensive registrations may be needed for similar sounding marks as well as in other product categories and classes.
• Be aware that a mark registered under the food class will not be able to stop someone from using that mark on a clothing product.
• Do not be too trusting with pictures and drawings of your product and do not put detailed descriptions on your website.
• Keep all IP documents safe to ensure a complete audit trail if litigation is required.
• When entering into collaborations with Chinese partners or agents, ensure you have signed contracts that protect your rights and ensure there is a written agreement as to who owns what.
• Ensure confidentiality agreements are in place as well as non-competition clauses in employment contracts.
• Register all of the rights that you can – patents, trademarks, and copyrights.
• Remember - the cost of registering is far cheaper than the cost of litigation.

You also need to be aware that China’s IP laws are different to New Zealand’s IP laws in that China’s system is based on a ‘first to file’ principle rather than the ‘first to use’ or ‘first to invent’ principle. Your rights are not recognised if they are not registered. New Zealand businesses need to be cautious and aware of this difference as people may have already set up your trademark and then try and sell it to you. It is also important to note that you cannot submit trademark applications directly. You must use a designated agent to file for you.

Do not let the potential threat of IP rights violations deter you from entering the Chinese market. China is continually improving the law and application of the law in this area. To manage these risks, we recommend seeking professional advice on specific circumstances before entering the Chinese market.

Do check it out and let us know what you think.

Got the following question regarding FICE (Foreign Invested Commercial Enterprise) today that I worth answering via a post:

As a company we have been planning how we step things up in China for several years and your comments have had a major influence on our thinking. I do have a question. I have heard about a corporate structure that you never seem to mention. FICE, Foreign Investment Corporate Entity I believe does not allow for manufacturing but does allow for multiple sites, whereas WOFEs are I believe single site operations. Does it truly exist? Why is it never mentioned as an option? Appreciate the info.

A FICE is a WFOE that is authorized to engage in wholesale and/or retail trade. The approval requirements for these sorts of entities tend to be much stricter than for a manufacturing or service WFOE. Additionally, approval of a FICE usually must come at the provincial level, not the local level. There are some provinces that do not even accept applications for a FICE. Shanghai and Beijing have the authority to approve the establishment of a FICE and most FICE operations are formed in those two cities for that reason.

Foreign Invested Enterprises (FIEs) mostly consist of Wholly Foreign Owned Entities (WFOEs) and Joint Ventures (JVs). All Foreign Invested Enterprises must set out the nature of their business during the licensing phase of the entity registration process. There are all sorts of possible categories, including Regional Headquarters, Service, Purchasing Center, Research and Development Center, Investment/Holding Company, Service Company, Manufacturing Company and Foreign Invested Commercial Enterprise (FICE).

In the end though, a FICE is nothing more or less than a type of WFOE or JV.  

A few weeks ago, a client asked my law firm to handle a relatively routine domestic matter for them. We told them we do not handle such matters and we gave them a short list of excellent attorneys that do. The client expressed surprise at our unwillingness to take on their matter and remarked on how this area of law is "so easy." I told them that it is "easy" 90% of the time, but difficult the other 10% of the time and that we only knew enough to be able to know half the time when we would be delving into the other 10%. In other words, we would probably have a 5% error rate and that precluded us from taking on such matters.

Yesterday, the client called to thank us because its matter was one of the five percent. Though both the client and I had assumed the client needed A, it turned out that it was actually in the 1% that actually would be much better off going with B.

The percentages above are guesstimates used to prove the point is that many things lawyers do appear to be and in fact are fairly routine But for any given project there is usually the ten percent and it is that ten percent that can cause the problem. 

Law firms tend to see large number of the ten percent because we virtually never get calls from someone saying, "I just did this and it all worked out fine, can you help me?" Our typical call is more along the lines of "the Chinese government just did this to me, is there any way you can help me?" 

Forming a WFOE or a Rep Office in China is an excellent example of the 90-10 rule, both because many people are not aware of the 10% and because the problems that arise from this lack of awareness can be absolutely huge.

Ninety percent of the time (a guesstimate), forming a WFOE or an RO in China is not all that complex. But it is the ten percent that will kill you.  

Here are some of the ten percent issues relating to China company formation on which we have been called:

• American company that had been locally approved for its WFOE to do X was being shut down by Beijing 15 months after its formation because X cannot be done by WFOEs in China. The "funny" thing about what this American company was doing was that had it actually defined it a bit differently in its WFOE application, it would have been legal and it almost certainly would not have been shut down.  For more on how important it is to get the right scope when applying to form a WFOE, check out "How To Form a China WFOE. Scope Really Really Matters."

• An American company that had formed an Representative Office in China and then was told around three months later that it was operating completely illegally and would need to shut down. The American company explained to me what it was doing in China and without any doubt what they were doing was absolutely illegal for Rep Offices. I asked why this company had opened the RO in the first place and their response was that they had done so because it was cheaper than opening a WFOE. They had never consulted an attorney on the differences between Rep Offices and WFOEs; they had simply gone to an entity formation company with the instructions to form a Rep Office. For some very basic information on the differences between Rep Offices and WFOEs, check out "The China Representative Office (RO). Got WFOE" and "How To Form a Representative Office In China."

• Then there are the countless calls we have received from companies who have had their WFOE or RO application declined or stuck in the system. We consider these people lucky because what has happened to them beats getting approved locally and then getting shut down by Beijing. For them we formulate a plan either to reinvigorate their existing application or to start all over. Once a company starts having approval problems, a red flag gets attached to them and so even if they completely clean up their act, they will likely be subject to increased scrutiny. For this reason, we often recommend starting all over, using a new foreign company as the ownership entity. We cannot usually do this with Rep Offices because they require ownership by a company that has been existence for at least two years.

Are you the ten percent? How do you know? 

In deleting old emails over the weekend, I came across one from co-blogger Steve Dickinson to a client looking to lease a factory in China and use those operations as the basis for forming a Wholly Foreign Owned Entity (WFOE or WOFE). I am reproducing Steve's email below because this is obviously not an uncommon desire and the tie-in between leasing space and forming a WFOE is frequently either misunderstood or just plain ignored. The bottom line is that to form any sort of WFOE in China, one must have an appropriate space (be it an office, warehouse, factory, or whatever) that can qualify for WFOE formation.  

Here's Steve's email:

The only way a foreign company can rent and operate a factory in China is to create a Wholly Foreign Owned Entity (WFOE or WOFE). Creation of a WFOE is a standard process. The factory lease is a separate matter from WFOE formation and it can range from easy (typically the case if you are renting from an industrial zone with substantial experience renting space to foreigners) to difficult.

The main problem our clients encounter is that they often try to rent factory space that cannot be used for a WFOE. For factory space to work for a potential WFOE, it must be legally owned by the landlord, it must have all proper documentation and the landlord must be willing to register your lease with the local government real estate office. Though this sounds simple, it is not uncommon, especially with cheap space, for there to be problems with the documentation that make use of a particular space not possible for a WFOE.

What do you think?

About a year ago we started a China Law Blog Group on Linkedin with the goal of creating a spam-free source for China networking, information and discussion. We now have well over 3,000 members and, more importanly, a number of lively discussions. 

We have had approximately 200 discussions, generated by more than 150 members. We have had some absolutely terrific discussions, both based on the numbers (a number of the discussions have received around 100 comments and some have gone over 200) and on their substance. Our discussions have ranged from practical (such as, how do I open a China bank account or what are the best practices for a China Joint Venture) to deep think (such as, what is the future of rule of law in China?).

I am most proud of how (at least as far as I know) no spam item has yet lasted on the site for anything approaching 24 hours.

If you want to learn more about China law or business, if you want to discuss China law or business, or if you want to network with others doing China law or business, I suggest you check out our China Law Blog Group on Linkedin and join up. The more people in our group, the better the discussions. 

Click here and join us.

In going through old emails, I came across a couple from co-blogger Steve Dickinson to a client that was going to have its relatively complicated product manufactured in China. This company was engaging in outsourcing for the first time and we were assisting with the contract. 

Steve's first email was the following:

Generally, a production agreement (also known as an OEM Agreement or a Manufacturing Agreement) involves the following:

a. U.S. side provides the design. 

b. Chinese side manufactures the product.

c. Chinese side agrees not to manufacture the same product for themselves or for someone else.  

d. Chinese side agrees not to circumvent and sell directly to U.S. final customers.

e. Chinese side agrees not to steal intellectual property.

f. U.S. side purchases product and then does whatever it wants to do with product.

There is generally no talk about anything else. In particular, there is no notion of acting as though the parties are in a joint venture. At its core, the relationship should be viewed as adversarial. You are trying to get the best product at the lowest price and your manufacturer is trying to give you as little as possible at the highest price. I am not saying that the two of you cannot and should not establish a cooperative relationship, because you most certainly should. But I am saying that from a contractual perspective, you need to think of your relationship as essentially adversarial.  

Here are some other key issues: 

a. Will the agreement be exclusive? If yes, for both sides or for only one side? 

b. How will you deal with start up tooling and prototype manufacture expenses? 

c. Pricing is always a big issue with these agreements. Normally, the Chinese side ultimately agrees to some price. However, that is just the start. There are two ways to go from there:

i. The Chinese side is absolutely obligated to provide the product during the term of the agreement at the agreement price. Most Chinese manufacturers will only agree to this with two conditions: First, the U.S. side agrees to purchase a minimum amount per year and second, the Chinese side has the right to adjust price if there are significant changes in material costs, exchange rate, labor costs or fixed costs such as utilities. As you can imagine, this all can be extraordinarily complex. 

ii. The Chinese side is only obligated to perform on price, quantity and delivery date for accepted purchase orders. This relieves you of a commitment to purchase but it also leaves you with substantial cost risk. The risk is that you will work for a long time with the manufacturer to develop the product, then the manufacturer increases the price or balks on quantity or delivery date. Since the manufacturer has the right to reject any purchase order, you are left with no recourse but to go to find a new manufacturer and start the process all over again. 

This is a very difficult issue that must be confronted right from the start. Far too many U.S. companies sourcing from China fail to address this issue in even the most basic way and this usually puts them totally at the mercy of their Chinese manufacturer and the results of this are usually not pretty. 

d. Will molds be involved? Will other tooling be involved? If yes, you need to determine how the tooling will be paid for, who will own the tooling, and how the tooling will be dealt with when the production contract is terminated. Our general approach is on this is as follows:

i. U.S. side pays for tooling.

ii. U.S. side owns all of the tooling that it has paid for. 

iii. If the Chinese side refuses to return the tooling on contract termination, the Chinese side owes a sum certain. This is what is known as a liquidated damage provision. 

iv. I assume you will be able to do whatever you want to do with the product after you purchase it, correct?  

v. Do you have any specific plans on quality control? What happens if defective product is discovered? Where will inspection occur?  

vi. What are your proposed payment terms? How do those terms link with inspection of product for defects?

vii. How will you work with the Chinese manufacturer in terms of specification for the product? There are generally three ways to proceed:

-- You have done all of the design and production work for the product. You provide the manufacturer with the prototype, CAD drawings and related. You simply tell the manufacturer: make this. 

-- You develop the prototype, CAD drawings and related with the manufacturer. You maintain the lead in engineering. 

-- You provide a general idea of what you want to the manufacturer and the manufacturer takes the lead in engineering and development of drawings and production technique.

Steve's second email was the following:

Enclosed is our first draft of your China manufacturing agreement. As you will see, there is very much of this agreement that is subject to change depending on the specific situation. I urge you to review this very carefully and then we should set up a time to discuss it. My basic strategy is to push the highly variable, transaction specific items to the exhibits. The things you will never want to change are in the basic agreement. However, the line between the two is never perfectly clear. What I have here is a pretty strict agreement, with much in the agreement that may ultimately be subject to intense negotiation. 

1. Note that this does not obligate the manufacturer on price, quantity, etc. That is, the manufacturer is not obligated to perform until after it accepts your purchase order. The alternative is to force the manufacturer to perform upon receipt of a purchase order. This is extremely difficult to pull off in practice. If you want to go this route, you will almost certainly need to commit to purchasing a specific amount of product at a specific price for a specific period of time. If you are willing to do that, we can revise the agreement to work this way. This is how Walmart and Nike and other big buyers operate. They get the very low prices and good payment terms in exchange for agreeing to purchase a specific amount of product during a specific period of time. I find that small buyers are seldom willing to make this kind of commitment. Please consider and let me know how you wish to proceed. 

2. Exhibit 3 will include payment terms. This includes: price, delivery terms (free carrier designated port, I suppose), deposit (if any), final payment, inspection and any related terms. This is usually a contentious area of negotiation and I find it is best to put it all into a single exhibit that can change over time.

3. I include several separate exhibits related to manufacturing standards and quality control. These can be combined if you find it too cumbersome. The critical issues are: 1) when and where will you inspect, 2) what happens if the inspection reveals a defect? Many small manufacturers inspect in the U.S. This is fine if you have not paid before the product arrives in the United States, but it can be a big problem if you have paid. Disposition of defective product is always a major issue. Product must be destroyed and not sold to third parties. The Chinese hate to do this. The best approach, of course, is to inspect in China and to catch all obvious defects before shipment. The warranty can apply then to latent defects.  

4. For enforcement, the agreement currently contemplates enforcement to occur in the Chinese courts. This is what I prefer, though a number of our clients prefer arbitration. If you would like to discuss the alternatives, please let me know.

If you had told me ten years ago that I would some day be writing on transfer pricing, I would never have believed it. Heck, if you had told me ten years ago that I would one day be writing on transfer pricing, I might have considered going into a different field. Even three years ago I would have just laughed. 

I am not laughing right now and believe me when I tell you that I am writing this post only because I deem it absolutely necessary. Too many companies are missing the boat when it comes to transfer pricing and by doing so they are costing themselves a lot of money.

So to minimize my pain, I am going to get right down to business by listing the three things you need to know about transfer pricing as related to your China business. Spoiler alert: If you are just buying product from or selling product to China, you can (mercifully) leave now; this post relates only to those who are actually doing business in China.

1. Definition of Transfer Pricing. Wikipedia very nicely defines transfer pricing as follows:

Transfer pricing refers to the pricing of contributions (assets, tangible and intangible, services, and funds) transferred within an organization. For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary. Since the prices are set within an organisation (i.e., controlled), the typical market mechanisms that establish prices for such transactions between third parties may not apply. The choice of the transfer price will affect the allocation of the total profit among the parts of the company. This is a major concern for fiscal authorities who worry that multi-national entities may set transfer prices on cross-border transactions to reduce taxable profits in their jurisdiction. This has led to the rise of transfer pricing regulations and enforcement, making transfer pricing a major tax compliance issue for multi-national companies.

Transfer pricing comes into play in China for transactions between related companies. KMPG provides a good definition of what constitutes a related or associated company in China:

Twenty-five percent ownership, be it direct or indirect ownership, or control. This applies whether one party owns another or two parties are owned by a third party. The formula for calculating indirect shareholding percentage has been changed: 25 percent ownership is now counted as 100 percent when multiplying the shareholding percentages of each level of indirect shareholdings. Other criteria including loans, control of management, or other types of control can also be taken into account.

2. Why Transfer Pricing Matters. NOW. I could write pages and pages as to why it is imperative that you deal with transfer pricing now and why these issues have come to the fore all of a sudden in China. But I won't. What I will tell you is that China has over the last year or so been cracking down on transfer pricing and that crackdown just keeps accelerating. China is striving to increase its tax revenues (that's a given) and transfer pricing is a great way for it to do so by tapping foreigners for money. 

3. What Must You Do About China Transfer Pricing. NOW. Again, I could write pages and pages on this. But I won't. I will just say that if you have or will have a related Chinese entity you should look at your prices between your foreign entity and your Chinese entity because if those prices are not reasonable enough to get past the Chinese tax authorities, you will likely be facing serious problems. Just a few examples. If your Chinese entity (let's say it's a WFOE) is buying $1 widgets from the home entity back in the United States or England or wherever and paying $50 for those widgets so that the profits from sales will go to the United States or England and not to China, the Chinese tax authorities will probably step in and re-calculate your Chinese taxes as though you paid $1 for the widgets. You also face penalties. On the flip side, if your Chinese entity's profits is only $10,000 from making $100 million in product for the home entity, the Chinese tax authorities will probably impute much higher profits (than the $10,000) to your Chinese entity. It will then tax the Chinese entity on the imputed profits and you will be facing potential penalties as well.

But the main thing you need to know about transfer pricing in China (or anywhere) is that it is very complicated and the rules relating to it and the levels of enforcement seem to be perpetually toughening. So if you are doing business with a related or associated company in China, you should be working with accountants experienced with China's transfer pricing laws and you should be doing so before you have a problem.

If you wish to learn more about China transfer pricing, I urge you to read any or all of the following reports from the Big Four: Deloitte, Ernst & Young KMPG, PwC.

What do you think?

Got an email the other day from a friend whose company is getting ready to source from China. The email asked me what the company needed to know "to protect their butts in China." I told them they needed to know/do the following four things.

1.  Choose a good factory. This is the sine quo non of China sourcing. I am always saying that I can write the world's best contract, but if the party on the other side is a thief, the contract will have no value. How do you pick a good factory? The first thing you do is make sure that you have actually picked a factory, and not a broker claiming to be a factory. The best way to pick a good factory is to go and look at it yourself. The second best way is to have a qualified person you trust go and look at it. The third best way is to rely on the views of others.   

2.  Use an OEM Agreement suited for your situation.  You need a good written contract between you and your supplier, the official version of which should be in Chinese. For more on this, check out "China OEM Agreements. Why Ours Are In Chinese. Flat Out." This agreement is the road map between you and your Chinese supplier. It will do at least three things for you:

• It will make clear to both you and your Chinese supplier the terms and conditions of your relationship.
• It will let your Chinese supplier know exactly what it must do to comply with your requirements and to stay within the law. By doing so, it will greatly decrease the likelihood of your having problems with your Chinese supplier.
• It will position you well should problems arise.

3.  Set up a Quality Control System.  Even with a good supplier and a good contract, you will almost certainly still face at least some quality control problems. The big question is when will you discover them. If feasible, check for quality before you pay for you product and before your product is shipped.

4.  Register your trademark in China. When it comes to trademarks, China is a first to file country. This means that, with very few exceptions, whoever files for a particular trademark in a particular category gets it. So if the name of your company is XYZ and you make widgets and you have been manufacturing your widgets in China for the last three years and someone registers the XYZ trademark for widgets, that other company gets the trademark for widgets. And then, armed with that trademark, that company has every right to stop your XYZ widgets from leaving China because your widgets violate that other company's trademark. Trust me when I say that many foreign companies have incurred massive damages by failing to take the simple and inexpensive step of registering their trademark in China.

If you abide by the above, you almost certainly will do just fine.

What do you think?

Clients (particularly those involved with Human Resources) and law students are always asking me what English language books I recommend for learning about Chinese law. Many years ago, I would tell them there were none. Now I usually respond with the following four:

1.  The Legal System of the People's Republic of China in a Nutshell. Yes, this is part of West's Nutshell series, but before you law students and lawyers start keeling over in laughter, let me explain. I am always telling law students that they should read "the nutshell" of their course before they go to their first class in any given subject. I suggest they read the nutshell book from cover to cover as though they are reading a novel. In other words, they should not stress too much over the points they do not understand and they should not worry about retaining anything.

I advocate reading nutshell books because they are a superb and fast and relatively painless way to get a big picture view of a topic. Getting the big picture view first then allows you to put the pieces you learn later into their proper place. 

The China nutshell (I read a previous edition a long long time ago) does a great job of giving its readers a feel for Chinese law and a quick read of it will help you immeasurably in thinking like a Chinese lawyer. Will it tell you what you need to do to get from point A to point E in forming a China WFOE? No, but that should not be why you read it. You should read it because it is a very good first introduction to Chinese law.

It is written by Daniel C.K. Chow, a law professor at Ohio State University who is eminently capable of publishing more weighty works on Chinese law as well. 

2.   Chinese Commercial Law: A Practical Guide. This book was written by Maarten Roos, a Holland trained lawyer who practices in Shanghai. I find this book very useful as a good first source on Chinese legal issues. It does a good job touching on the major legal issues foreign investors typically face in China. Its Amazon page accurately describes it as follows: 

He clearly describes the opportunities and pitfalls exposed as a foreign investor engages with such elements of business in China as the following:

• negotiating a detailed written contract;
• performing a legal and commercial due diligence on a prospective partner;
• resolving disputes through negotiation, arbitration or litigation;
• establishing and enforcing trademarks, patents and other intellectual property rights;
• investing in China;
• considering the joint venture structure;
• expanding through a merger or acquisition;
• restructuring or liquidating an operation;
• designing and implementing effective corporate governance;
• retaining, managing and terminating employees;
• arranging funds into and out of China;
• ensuring both tax efficiency and tax compliance; and
• avoiding criminal liabilities in the course of doing business.

I agree and I think this book makes for a great nuts and bolts introduction to the various topics it covers and it also serves as a great initial legal reference as well.

3.  Understanding Labor and Employment Law in China. I gave a very favorable review of this book when it first came out and my appreciation for it has only grown. This is what i said then:

I am three-quarters of the way through the book, Understanding Labor and Employment Law in China, by Ronald C. Brown. Brown is a Professor of Law and the Chair of the Pacific-Asian Legal Studies Committee at University of Hawaii Law School and can confidently state that it is a great book.

But it is not for those seeking merely a light dusting on Chinese labor and employment law. Not at all.

It is 332 page exposition on the current state of China's labor laws. It was just published so it is quite current. Its appendix consists of translations of the key Chinese laws relating to labor and employment.

Who should read this book?

-- Academics interested in China labor laws? Check.

-- Private practice lawyers seeking a deeper understanding of China's labor laws? Check.

-- In-house lawyers wanting to better understand China's labor laws? Check.

-- HR personnel with businesses operating in China? Probably check.

-- Lawyers who actually practice labor law in China? Maybe check.

-- The general businessperson doing business in China? Maybe check.

Let me explain my maybes.

Any lawyer actually doing employment law in China must be able to speak and read Mandarin fluently and so that lawyer probably does not have much need for a book like this, written in English. If you are going to be writing employee manuals and employment contracts in China or giving advice regarding China's labor laws, you absolutely must know how to read and write Mandarin. You have to know how to read it because so many of the employment laws are local, rather than national, and because there is no substitute for reading a law in its original language. You have to know how to write in Mandarin because your employee manuals and your employment contracts pretty much have to be in Chinese if you have any Chinese employees.

This book is probably too intense, too thorough, too long, too deep, and too complicated for the typical businessperson seeking a general background on Chinese employment law and I do not think it was ever intended for that purpose.

If you are looking for an English language book that really details China's labor and employment laws, this is the book.

I am now of the view that HR personnel should buy this book, so long as they realize that it is just a first step towards deciding what to do in each individual instance. I have come to this view after having recommended it to a number of HR people with whom my firm works and seeing how they use the book. I have come to believe this book is a great resource for HR people because they are using it to help determine whether they might have a legal issue in doing such things as firing someone who is pregnant, reducing vacation time, asking someone to work a weekend out of town, etc., rather than using it for the definitive answer to their very specific situation.

4. China Law Deskbook, A Legal Guide for Foreign-invested Enterprises. This book is by James Zimmerman, a very respected China lawyer. I do not own and I have not read this book. I nonetheless list it here because many lawyers and clients tell me how much they like it and how helpful they have found it to be and many consider this to be the definitive practical guidebook for Chinese law.

What do you think?  

Le Monde has a series of captioned pictures documenting beatings inflicted on Shanghai residents who developers wanted cleared out (h/t Shanghaiist). The police were called but never came.

Beyond the fact that this sort of treatment is morally objectionable, here is why you should care: 

1. Though China is relatively safe, one should absolutely not write off the possibility of violence in one's business dealings in China. My law firm has been called in at least a half dozen times where violence was either threatened or occurred. We tell our clients that if they owe money to a Chinese company or are involved in any sort of dispute with anyone in China (partner, employee, etc.), they should avoid meeting to discuss the dispute/problem anywhere other than in a neutral, very public place in the day time. A high end hotel lobby in Shanghai or Beijing is a good choice.

2. Know where the land came from on which you are locating your business. Make sure that you will not be hit up for compensation of someone displaced or that some higher-up government authority will not shut you down for the land having been acquired illegally. Do your due diligence on this and even considering putting something in your lease to better protect you. Beijing has been making a lot of noise lately about wanting to make its eminent domain policies fairer and as it does so, you can expect more problems to arise for those on illegally acquired land. There are huge swaths of land in China that were illegally acquired, particularly in third and fourth tier cities.   

What are you seeing out there?

Fascinating article by Matthew Robertson, entitled, "Fellowes, American Stationary Giant, Brought to Its Knees in China." A couple of readers sent me the article and both of them commented on how it further proves what "you are always saying about Chinese joint ventures." I am not so sure it does. 

The article is about Fellowes, one of the leading manufacturers/sellers of paper shredding products, and of its joint venture problems in China:

There are few paper shredders in the world that can rip an A4 piece of paper into 2,000 pieces, and come with functions like SilentShred, SafeSense, and “100% Jam Proof”—and most that do have the name “Fellowes” printed on top. But consumers may soon be able to buy, say, the deluxe Powershred C-480Cx, without the Fellowes brand, because the company’s entire business in China has been stolen by its joint venture partner.

To make a long story short, Fellowes is accusing its joint venture partner, Jiangsu Shinri Machinery Co., Ltd., of having taken over the joint venture facility in China and of continuing to churn out Fellowes product, but without the Fellowes brand name on it.  

According to the article, the joint venture "would continue churning out shredders with the Fellowes’ name, using Fellowes’ proprietary machinery, while Fellowes controlled both those [joint venture] companies because it appointed the management, according to the terms of the joint venture agreements.  

Wait a minute. Wait just a minute. As we are always saying, simply because a joint venture agreement gives the foreign company the right to appoint management does NOT mean the foreign company controls the joint venture. For more on this, check out co-blogger Steve Dickinson's article for AmCham's China Briefing Magazine, entitled, "Avoiding Mistakes in China Joint Ventures." You might also want to check out my Wall Street Journal article, entitled, "Joint Venture Jeopardy." NOTE: If you are not a WSJ subscriber, you can read the entire article here (go way down the page).

According to the article, for years, everything was going very well for Fellowes, but then in 2009, a power struggle ensued at Jiangsu Shinri and one brother took over from another and the "new" brother" "attempted to force through a series of radical changes to the contract, which would have shifted power, control, and profits to the Chinese side." Jiangsu Shinri also illegally seized the joint ventures' "company seal and business license in an effort to force Fellowes to hand over its 100 percent-owned assets to the joint venture, including its production tools, which are the intellectual property of Fellowes." 

Jiangsu Shinru is also said to have engaged in the following:

Zhou [the new brother] also insisted that Fellowes assign to the joint venture other business interests it had in China; he tried to raise the prices on the products by 40 percent; demanded that Fellowes invest an additional $10 million into the business; and he cut a $3 million payment dividend. When Fellowes demurred from carrying out those demands, he escalated the pressure.

The dramatic moment was in early August 2010, when Zhou, under the aegis of Shinri, blocked the gates of the joint venture facility with security guards and trucks, preventing people from going in and goods going out, effectively shutting down production. Shinri expelled and confined the managers, moved funds from the joint venture to a Shinri-controlled bank account, sent packing the 1,600 joint venture employees, and at night, drove a truck into the facility and stole Fellowes-owned injection molding tools, some of them weighing several tons.

The worth of the products already manufactured and blocked—what Fellowes in his testimony said are “feature-rich, IP-protected”—is $100 million. This includes 70,000 completed paper shredders, going to rust in the factory.

Shinri also won’t let Fellowes recover the over 1,000 custom molding tools, the fruit of decades of refinements of engineering designs, worth $10 million. And it is most probable, according to people familiar with the matter, that Zhou intends to obtain these high-value items in a fire sale enforced by the local court that he has influence over.

As one would expect, all of this has been disastorous for the business:

Because the shipments were blocked, the joint venture was unable to pay its suppliers—the 120 odd Chinese businesses that deliver all manner of metals and plastics that are the makings of the shredders. So 80 of these suppliers sued, and the joint venture became insolvent.

The Changzhou Intermediate Court has started proceedings to liquidate the joint venture, auction off all its assets, including the equipment, land, molding tools, and those unshipped shredders, to satisfy the debts of the joint venture accrued as a result of Shinri’s activities.

To counter this, Fellowes has mounted a Congressional letter writing campaign, but this has borne no fruit.

I hate analyzing situations like this based on newspaper articles because in almost all instances, the article fails to answer key questions. For instance, has Fellowes brought suit in China? If not, why not? Is it because what Jiangsu Shinru is doing is legal in China because the agreement(s) between Fellowes and Jiangsu Shinru were not drafted so as to prevent this sort of thing? Why are you painting the Chinese court as being so terrible for seeking to sell the assets of the joint venture at auction? It sounds as though the joint venture is at a stalemate and selling the assets may be the only legal solution at this point. Is that not the case? Why did Fellowes thing bringing in some Congressmen would help them in this situation? And again, why is Fellowes seeking to politicize this rather than handling it in the courts? The article talks of how Jiangsu Shinru is strong locally and implies that the local court does its bidding. Even assuming this is true, is this also going to be true of the appellate courts? If it is so clear that particular equipment belongs to Fellowes, why does Fellowes not at least sue for the return of that? Does Fellowes' contract(s) with Jiangsu Shinru clearly set out the fact that specific equipment belongs to Fellowes? The article implies Jiangsu Shinru is using Fellowes IP. Is that really the case? Is Jiangsu Shinru using IP in a way that violates the joint venture contract(s)?  Is Jiangsu Shinru violating Fellowes IP that is registered in China? 

As regular readers of this blog know, we are not generally fans of China joint ventures. Our view is that if you as a foreign company are not required Chinese law to form a joint venture with a Chinese company in order to accomplish your China plans, you would in most cases (but not all) be better off going it alone. We made our views on Joint Ventures pretty clear in a previous post, entitled, "How We Really Feel About China, Part II: Joint Ventures. We Love Them AND We Hate Them," in which we stated the following:

We have developed quite a reputation for not liking joint ventures and that is not really true. Wary would be a better word for how we feel about them. I am always bothered when a client or potential client calls about their proposed joint venture and starts out by saying "I know you don't like joint ventures." Are we losing business because of this reputation, or maybe we are getting more because people believe that if we give the go-ahead on theirs, it really is as good as they think it is. Of course, we will never know, but we can at least try to clear the air. We like the appropriate and necessary joint ventures; we just think it is a big mistake to consider a joint venture as the default method for entering China.

Of all the China legal work done by my law firm, our work setting up and dismantling joint ventures is probably my favorite and certainly one of the most lucrative. We charge a flat fee for probably 90% of our China work, but for forming joint ventures, we always charge hourly. We charge hourly because setting up a China joint venture can range from fast and easy to difficult and contentious. It is the rare one that is fast and easy.

* * * *

Just to be clear, we love forming joint ventures, but only when they truly do make sense.

We also love taking apart China joint ventures that have gone wrong. And again, we love doing this not for because it is in any way a good thing for our clients, who usually are in dire straits when they come to us with their joint venture problems, but because resolving joint venture disputes is like a chess game, but at our hourly rate.

I am just not sure where exactly to put the Fellowes joint venture in all of this. I need more information. Nonetheless, the article is certainly worth a read as a cautionary tale.

I know I have said this a million times, but what I like so much about practicing law is that I get to work with the same companies for year after year and so i get to see what works and what doesn't. What I have found, maybe not that surprisingly, is that some companies just seem to have it.

I have one client who works in a really tough business. These company supplies a commodity to mostly Russian, Chinese, and Korean companies on credit. I have represented this company for probably ten years and in that time many of its competitors have shut down and yet this one company just keeps on growing. A couple things amaze me about this company. One, the fact that I cannot name even one single person who has left the company since I started representing it. Two, they eventually always get paid, even if it means pursuing litigation around the world.

This company has a formula for success and it never veers from it. It gives its people a lot of responsibility and high pay, closely tied to performance. Good people stay. Customer contact lists and pricing are critical trade secrets in this business and yet this client has never called me with an employee issue surrounding those. My firm has represented other companies in this same industry and they seem to have ongoing problems with this.

This company always gets paid because it uses tried and true contracts and because the word is out that if you do not pay, this company will fight you wherever and however it can to get paid. 

I thought of this company today when I read a really interesting post over at the China Leadership Blog, entitled, "How to Protect Your China IP." The post starts out noting how employees are a leading IP risk to companies and then it lists out the following two ways to lower this risk:

• Hire workers with character who share your values and they will not come to learn your technology and then sell it all away. Workers of character do not do that. They do not download all your secrets and sell them to someone else. If you want IP protection, then you want to focus on worker character. Workers of character also do not leave for a few extra bucks. They seek meaning in their work and stay if they feel valued. Strong cultures will hold them. Are you a most admired company? If you are, then your risks of people leaving at all go way down.

• Retain those workers. Care about workers and notice their achievements. Give them meaningful work and let them do it their way within agreed to top values. Build your IP protection on hiring and retaining workers of character . Good leaders make head hunters irrelevant.  We need that. Good workers are hard to find. What are we doing to make them so happy they will not listen to any head hunter? 

Hard to disagree. What do you think?

My law firm is frequently contacted by American companies seeking our help in pursuing Chinese companies for providing "bad product." We turn down at least 95% of these cases because we do not want to pursue them.

We typically do not want to pursue these claims because the American company's contract with the Chinese company does not clearly specify the quality of product the Chinese company must provide. There are usually other problems with the contract (including, oftentimes, the lack of any contract at all), but this is usually the most glaring. I often explain the following to the American company:

I know you expected the ______ you ordered from ______ [Chinese factory] to work for more than a week, but you have to understand that China has levels of quality many tiers below anything that would be acceptable in the United States. Have you been there? Good, because then you have seen t-shirt people selling t-shirts in the street for 25 cents. Those shirts are of such poor quality that they are ruined after one wash. But nobody complains because they paid 25 cents for them and so they got what they paid for. I hate to say this here, but that is the exact argument your Chinese factory will make against you. That had you wanted your product to work for more than a week, they would have been happy to have provided you with such a product, but then you would have had to pay 50 cents more for it.  

Their response to that is oftentimes to insist that they have an email they sent at some point in the process "making clear" they wanted the product only if it is of "good quality." I typically then point out to them that the term "good quality" in China is pretty much devoid of legal meaning and that even if it were deemed to have meaning, what constitutes "good quality" there is very different from what constitutes good quality here. 

I then sometimes lecture them as well on another difference between US/Canada/Britain contract law and China contract law, which is that Chinese courts rarely, if ever, look outside the four corners of a contract to determine how to rule on a contract dispute. Co-blogger Steve Dickinson recently explained this to a client:

If you think this may be an issue, we can include "complete agreement" language that makes clear that the Agreement documents control and that nothing outside the agreement has any legal effect. Normally, however, this is not done in China. This is because the Chinese look entirely at the written and sealed contract. They routinely ignore everything else (like emails) and they certainly do not include terms that come from a pre-contract writing from either of the parties. 

This is another of the many differences between Chinese (civil) law and U.S./Canadian common law. 

We are constantly getting calls/emails from companies that have contracted with a Chinese company and then get cold feet regarding the validity of their contracts. After we explain to them how it is better to contact us before they sign the contract, we answer their questions. Here are three that epitomize the sorts of questions we get, along with our answers:

Q.  "We recently entered into an agreement to buy product from a Chinese company. I just noticed that the Sales Manager of the Chinese company signed the agreement. Do you see any immediate issues with a Sales Manager lacking authority to bind the Manufacturer?"

A.  The issue is not so much who signed on behalf of the Chinese company, but rather, whether the document was stamped with the Chinese company's seal. If the document was signed by a Sales Manager and stamped with the correct seal, it is binding on the company. If the Chinese company's seal is not on the contract, then you may well face issues down the road.  

Q.  We entered into an English languagea agreement with a Chinese company and I just read that the Chinese courts do not enforce agreements in any language other than Chinese. What should we do?

A.  The courts in China will enforce agreements that are in languages other than Chinese. if you are going to need to resolve your contractual disputes in a Chinese courts, you are better off having your contract in Chinese, but that is not absolutely necessary. For more on this issue, check out "China OEM Agreements. Why Ours Are In Chinese. Flat Out." Short of requesting a new contract, however, there really is not much you can do about this one.  

Q.  The Chinese company had their attorneys review our agreement. Their attorneys used footnotes in Chinese to provide feedback. I asked that the footnotes be removed, which they were, but the footnote numbers remained and one of the footnotes does as well. Does this pose any issues that you can think of (specifically having footnote numbers without corresponding text)?

A.  I doubt the footnotes without corresponding text will have any impact, but the footnote with the Chinese text may now be part of your contract. We would have to review the contract to better assess this. 

Your enemy won't do you no harm Cause you'll know where he's coming from Don't let the handshake and the smile fool ya Take my advice I'm only try' to school ya.  "Smiling Faces," by the Undisputed Truth

Must-read article out today in the Pittsburgh Tribune-Review. The article is entitled, "Apple tries to avoid Motorola's mistakes in China" and it is about how Apple is trying to avoid letting Chinese companies get its secrets. I say it hardly needs to worry and that is one of the reasons I have had a disproportionate amount of my investment assets with Apple for many years.

I will first discuss the article and then explain why Apple, more than perhaps any other computer/gadget company, need not worry too much about China.  

The article does an excellent job describing how Motorola allowed its technology to be compromised in China. I have no idea if the Motorola history set forth in the article is accurate, but it certainly sounds like it is and it certainly fits what I have personally "observed" happen to other companies. The article seeks to explain how Motorola has gone from being the largest foreign company in China (in 2001) to being an also-ran. The following are two absolutely classic quotes from the article: 

• "In China, Motorola thought it found a loyal friend. But clearly, this demanding friend held a different idea of loyalty."
• "We had the majority (ownership) of those ventures. We didn't see it was a problem," Younts [of Motorola] said. "We were probably a little naive."

But the key takeaway of this article (and the reason for the song quote above) is that it is your employees and those closest to you of whom you must be most cautious. The article nicely highlights this: 

"Motorola was used as a training ground for all the competitors in China," Roberson said. "A person might work for you for six months or a year, then go over to a Chinese competitor. ... 

Roberson said the Chinese gained valuable intellectual property because the government insisted Motorola shift more R&D to China. A Chinese engineer would work at Motorola as long as it took to learn the technology, he said, and then would quit to work for a competitor.

"Though the Chinese wanted to be trained by Motorola, they wanted to work for Chinese companies," he said. "Most were small at first, but there were a dozen of them. Then they started to get muscle. And the Chinese government gave them support that the government didn't give Motorola."

*   *   *   *

Chris Jones, principal analyst at Canalys, a high-tech consulting firm, said Motorola "got squeezed. ... Companies that used to be Motorola suppliers are now competitors."

The article then describes the various Chinese companies that have been built with Motorola employees and technology.  

Apple is playing it cool. Apple is doing things right in China and I said this back in 2009, in a post entitled, "Apple In China (Again) And Why SMEs Usually Do Better Faster," back when it was getting all kinds of criticism for moving "too slow" there:

Yesterday I did a post on Apple's alleged iPhone failure in China, entitled, "The iPhone In China: Ain't No Mountain High Enough." I say "alleged," because though iPhone sales have not soared in China, I remain confident Apple will do just fine there.

After I ran that post, I received a couple emails with "inside knowledge" of how Apple is messing up in China, largely because it is trying to do things "its way" in China, rather than the "Chinese way." I also received a fairly large number of comments saying pretty much the same thing, all of which I accidentally deleted (sorry!).

And though those who emailed and commented are probably right to say that Apple has so far not done as well as expected in China, I, even as a shareholder, say (in the largest font I can muster), SO WHAT.

Then in early 2010, I posited that Apple was now doing so well in China because it had refused to bend its core principles for China:

Here's my own, more concise explanation. Apple stuck to its knitting. Let me explain. Just about whenever I speak on China or am on a China panel, and am asked what it takes to succeed in business in China, I emphasize the need to stick to your business's already established principles. To me the key explanations from Paul's post are how Apple refused to go into China with its iPhone unless it would be free to make it a real iPhone in China, just like everywhere else and on how China waited until China's consumers could afford its products, rather than giving them a cheap substitute in the meantime.

Google has come in for a lot of criticism of late from Monday morning quarterbacks (including from the just released book, In the Plex: How Google Thinks, Works, and Shapes Our Lives, but I view these things very differently. I applaud Google and Apple for emphasizing the big picture and for refusing to bend for just one massive country. By not bending, these companies gain respect worldwide, from both consumers and, perhaps more importantly, from their employees. Without naming names, I can tell you that I know of a ton of people from a Google rival who have left that rival for Google or who talk of doing so because they simply do not like working for a company that they see as being willing to make peace with immorality. I even heard that at one point this employee dissatisfaction on this score had reached such a level that there was a committee formed to deal with this one issue.

I see the criticisms of Google as a buy signal.  

I also see Apple as nearly untouchable by China because I do not see any Chinese company as being even close to being able to duplicate Apple. Sure, there are Chinese companies that can duplicate much of what Apple has already achieved by way of technology, but I do not see any Chinese company as being able to stay upp with Apple when it comes to new technology. Apple snarfs up market share not because its technology is so eye-popping, but because it is exactly what the consumer wants. I do not believe there will be a Chinese company even within ten years that will be so good at understanding consumers. I also do not believe there will be a Chinese company within ten years that will be so good at serving consumers or marketing to consumers. And what Apple lover is going to switch from Apple to a Chinese company's rival product?  Come on.

Sure, there have been and will continue to be Chinese companies that make excellent product that people will buy instead of Apple product. And sure, those companies are competing with Apple and if they did not exist Apple would sell even more product. But they are not a worry and they are not going to have much impact on Apple's sales growth going forward.  

A couple more things to note about some of the issues raised by this article.

The first is somewhat paradoxical and that is that even if you are going to get your technology stolen, it usually still makes sense to go into China. First off, you can get your technology stolen from anywhere and the Chinese can steal it from the Internet or from the United States as well. So you might as well make as much money off of it as you can in the meantime, while also always trying to stay ahead. I wrote more on this in a post entitled, "China's Lack Of IP Protection: Overrated. Overrated" and in an article entitled, "In China, Piracy is no Excuse," [go to the bottom of your screen for my article] in which I argue that China's lack of IP protection is usually not a good excuse for not going into China. 

The second is that you are at risk from your employees everywhere, not just in China and not just from your Chinese employees. I have seen probably one hundred times where employees have started rival businesses while still working for my clients or done so right after leaving by using information they garnered from their old employer, but less than a handful of these involved China or Chinese employees. 

There are IP risks to doing business everywhere in the world and those risks vary depending on all sorts of factors. The smart business accounts for these risks and acts accordingly, just as it always has.

What do you think?

Every so often, and for various reasons, the Chinese government mounts a crackdown on foreigners in China without the proper visa. The last really really big such crackdown was right before the Olympics. Things had been pretty quiet since then, with just a few minor crackdowns which were mostly confined to one or two cities. 

I sense we are in for another crackdown and I think one only needs to read or watch the news to be able to guess why this one is happening. I sense it because in the last two weeks I have gotten desperate calls from two people with illegal businesses in China who have been denied entry into China and I had not received one of those calls for what seems like a year.

One of those people had a visa and was denied entry and given the explanation that he had come "too many times too quickly." The other was simply denied a visa, after having received visas for nearly ten years. I always feel bad telling these people there is nothing my firm can do to assist them, beyond maybe forming a WFOE or a Rep Office that will then hire them as an employee and allow them to get a Z visa. But since they want to get into China now, this idea never gets much traction.  

The New York Times, in a very short piece, entitled, "China:Crackdown on Foreigners" reports of this going on in Guangdong:

Guangdong Province in southern China is tightening rules on foreigners living and working in the province as part of what it calls a clampdown on “illegal immigration,” according to the official China Daily. A new regulation that takes effect on May 1 asks people to report “malpractice” involving foreigners, including overstaying visas, illegal entry and working without permits. 

Has a new crackdown begun against foreigners in China illegally? What are you seeing/hearing out there?

NOTE: Just about whenever I write a post like this, one or two people get very angry at me and point out that the United States does the same thing regarding illegal aliens and makes it seem as though I am criticizing the Chinese government for enforcing its laws. Please don't even bother this time as I am not criticizing the Chinese government for enforcing its laws; I am simply pointing out what is happening. If anything, the Chinese government enforcing its laws is good for my law firm's business and only reinforces what I am always saying on this blog about how if you are a foreigner in China, you had better follow its laws. All of them. For more on the need to follow China's laws, check out "China Business. China Jails. China Hostages" and some of the other posts mentioned therein.  

China policy guru Benjamin Shobert has written an excellent article for the Asia Times on IP in China. The article is entitled, "China's IPR thorn still needles West," and it says what we have been saying: IP protection in China is getting better, but it is not there yet.  

Shobert quotes from a recently released US-China Business Council report to back up this position:

Perhaps with this question in mind, the US-China Business Council (USCBC) released a report in mid-February on the question of IPR enforcement in China. The report acknowledged that China deserves to be recognized for the advancements it has made in this area: "The IPR legal framework … has become less of an issue over time … because of China's efforts to build an increasingly comprehensive regulatory framework for IPR … many - but not all - companies report that the overall IPR picture has shown steady improvement, though at a slow pace."

He also quotes me:

Not only does the USCBC see positive adjustments in this realm, but so do American lawyers who specialize in these matters. Dan Harris, a partner at Harris Moure and blogger at the award winning China Law Blog, agrees: "IP protection in China is very slowly improving and that has been true over the last 18-24 months as well."

What I really like about the article though is how Shobert distinguishes between the effectiveness of IP enforcement by region and by industry. He notes that IP enforcement remains "highly uneven across cities and provinces" and how IP protection for software, movies, and music, is particularly problematic.

Shobert concludes the article with advice from Mike Bellamy and from me that foreign companies doing business in China must consider non-legal methods of protecting their IP:

For Mike Bellamy, China operations director at PassageMaker, the answer is to compartmentalize key technologies from one another, and utilize a third party for final assembly.

According to Bellamy, "We call this our 'black box'. Put simply, the black box concept is designed to protect the intellectual property of our clients by having semi-finished or finished products delivered to our facility and then, behind closed doors … do the final branding, final assembly, packaging and inspection." But even this model has its limitations, which Bellamy is quick to point out: "Once the product is in the market place then it is much harder to control who sees the product. But forcing your competition to reverse engineer and wait for your product launch is much better than having your ideas floating around among suppliers and competitors from day one."

Harris, no stranger to IP issues in China, echoes this advice: "As a lawyer, we always do what we can to protect our clients on the legal front, but there is always more that can be done to add IP protection to the operations side."

What are you seeing out there? Is IP protection really getting better in China? 

UPDATE: Michael Lin of Marks & Clerk in Hong Kong has written a very good piece on China IP protection, entitled, "Intellectual Property Protection in China is NOT an Oxymoron," with the theme that IP protection in China is improving.

The always helpful Quality Inspection Blog has a must-read post entitled, "Should you tell your China suppliers about your China price." In the post, Renaud Anjoran, China quality control inspecter, extraordinaire, does a really nice job explaining the steps you should go through in sourcing your product from China (my comments are in italics):

Here is the sequence I advise importers to follow, when they source new suppliers:

Get in touch with at least 10 potential suppliers, and ask some questions (about their main market, their size…) to evaluate if they are good fit for your needs.  I worry about the high number of potential suppliers. For my reasoning, see below.

Request quotations (FOB, in USD) from them, to get a first pricing (without giving any target). Good idea.

Be in touch with them briefly on the phone, if possible. Human contact will show them that you didn’t sent that RFQ to 100 suppliers, and they will be more inclined to give a fast response. Great idea. A client recently told me that some of the better/busier Chinese factories will sometimes not bother responding to fax quotes.

You will likely see several very similar quotes: that’s the “market price”. Eliminate all the “outliers” that gave prices 20% higher or lower than the average. (If you are consciously looking to buy above the market price to get above-average quality, keep the highest quotes). Excellent advice.

If you have a team on the ground and if all candidates are in the same area, this is the best time to visit their factories. If this is not easy, continue discussing via email and phone, and pay for factory audits once you have narrowed your search down to 1 or 2 candidates. Makes good sense to me.

Give more information about your product and your quality requirements to the most interesting candidates. Don’t hesitate to give them your target price if it is very different from what they offer you. Ask them to justify their price level precisely. Makes sense. 

Don’t forget, in China price is very closely tied to quality. If you negotiate a very low price, most suppliers will end up saying yes. Then they will wonder how to make your products. They will probably use the very cheapest materials and subcontract production in a small workshop. You will get what you pay for. So true.

One last piece of advice: if you pay 20% above market price, all you risk is wasting 20% of the money you disbursed for your project (and actually it is closer to 10-15% because the FOB price is only a portion of your total landed cost). If you pay 20% below market price, you risk getting something that can’t be sold at all (which means you risk losing all your investment). Completely agree.

I will add one thing to the above. If you are going to be providing information to Chinese factories before contracting with them to purchase product, you should consider the confidentiality of what you will be providing to them for your quote. If possible, you should avoid providing anything you want to keep confidential, including any tradenames related to the product. If you cannot do that, then you should think about contacting fewer than ten factories and you should require those that you do contact to sign a Non Disclosure Agreement (NDA) or, better yet, what we call an NNN Agreement.

Also, if you will be revealing any of your trademarks or trade names to the Chinese factories and you have not yet registered those trade names in China, do so before the reveal. The most likely people to steal "your" trademark are those who are capable of manufacturing your prouduct and the only sure-fire way to prevent someone from stealing "your" trademark in China is for you to register your trademark in China before anyone else.

It is not at all uncommon for English language publications to write about our posts on here, but it is quite uncommon for Chinese language publications to do so. This only makes sense. So I was both surprised and delighted to learn that Caixan, probably China's best business magazine had written on one of our recent posts. The post is "US-Listed Chinese Companies. Let's Watch The Sausage Get Made" and the Caixin article (in Chinese) can be found here. 

The translated title of the Caixin article is "American Lawyer Analyzes VisionChina Lawsuits against DMG and Its Former Shareholders" and its focus is on how Chinese companies doing business in the United States will be succeptible to lawsuits there if they insist on doing business as though they are in China:

According to Dan Harris, a senior lawyer with Harris & Moure law firm in the U.S., small-time Chinese firms are used to doing business on their own terms, often with little regard to contracts; but the situation is gradually changing with more Chinese companies getting listed in the U.S. And the VisionChina / DMG case will become a case study for other such contract disputes cases in the US.

It then describes the VisionChina/DMG case: 

In October 2009, VisionChina announced that it agreed to buy DMG with US$ 160 million in cash and stock. And according to the Agreement, DMG’s investors would get US$ 100 million in cash and stock at or about when the deal closed, along with two subsequent US$ 30 million cash instalments on each of the first two anniversaries of the closing date.

On December 27th, VisionChina pre-emptively sued former shareholders of DMG claiming fraud, and said VisionChina was led to pay a price higher than DMG was really worth. VisionChina’s claimed in its complaint it received the “E&Y report” on December 24th, 2009, and VisionChina found the “E&Y Report” on DMG financial statement for the first eight months in 2009 did not match the same period covered by the DMG-presented Management Accounts.

Subsequently, former shareholders of DMG countersued VisionChina, claiming VisionChina was not able to deliver the first pay of USD 30 million on time. Former shareholders of DMG requested the Court to force VisionChina to fulfil the Agreement, and make compensations accordingly. 

In the March 17 article, Harris noted that VisionChina apparently released tens of millions of dollars from escrow on January 2, 2010, more than a week after it said it received the E&Y Report. Then five months later, VisionChina released millions more. VisionChina apparently waited more than a year after reading the E&Y Report to bring its case against the DMG investors.

The story concludes with the key point, that Chinese companies listing or doing business in the United States had better start getting used to being sued in the United States

According to Harris, that VisionChina, a Chinese company doing business exclusively in China, chose to sue in New York is a testament in itself to the new calculation for US-listed companies. He says he is “looking forward to watching this case play out.” 

I have written extensively in the past on Glocalization and on how companies that operate internationally must be prepared to meet international standards because what happens in one country does not stay in one country. For more on this, check out "China, Glocalization, And The Specter Of Product Liability And More" and "Toyota And China. It's A Small World After All." And for more on suing Chinese companies, check out the following:

• How To Sue A Chinese Company. Part I. Jurisdiction And Service Of Process.
• How To Sue a Chinese Company, Part II. Discovery.
• How to Sue a Chinese Company. Part III. Litigation Strategies and Enforcing Judgments.
• How to Sue a Chinese Company. Part IV. Arbitration in the U.S. and Suing in China.

UPDATE: I see where China Hearsay just did a post covering another U.S listed Chinese company going through U.S. litigation. China Hearsay writes about China MediaExpress in a post definitely worth checking out, entitled, "The China MediaExpress Saga: Part II -- The Litigation."

I constantly get emails from people asking what my law firm charges for registering trademarks in China and I always respond by quoting our rate for a trademark analysis and stating that we will not "just" register their trademark in the category they tell us. If they want that, they need to retain someone else.

I did that the other day and the person emailed me back to say that our rates were considerably higher than those of a Chinese firm they were putting in competition with us. My response to that was as follows:

We are talking apples and oranges. If all we did was just file the trademark that you told us to file, we would charge the same. That's not at all what we do and much of the time we save our clients considerable money in the process. What we do is consult with our clients regarding their product, their business and their intellectual property (IP). After we do that, we then we formulate a trademark protection plan that will maximize protection while minimizing costs. In the last three months alone we have been contacted on the following matters by companies who had used trademark filers who did nothing more than just file the trademark their client told them to file.

1.  American company used a quick filer who filed one China trademark for them. Turns out that the American company should have filed at least two China trademarks because a Chinese company filed the same trademark for the same product and now there is pretty much nothing the American company can do to stop the Chinese company from using "their" trademark to compete with them. We get about five of these calls a year. You have a clock radio. Do you register the clock or the radio or both? It depends mostly on what you are going to be doing with the clock radio and where you are going to be doing it. Here's a less obvious example: you trademark your lawnmower but not the engine. Someone else trademarks the engine and puts their name in big letters on the engine and starts selling lawnmowers with it. You should have trademarked the engine and the lawnmower. I can go on and on.

2.  Should your trademark be in both English and Mandarin? That really depends again on what you will be doing and where you will be doing it. But if you do not register the Mandarin name, you do not get it. And what about Cantonese? And what will you choose for your Chinese name anyway? 

3.  Should you register your logo separately or with your name or not at all. Again, that really depends. Many times you can do the name and logo together and thereby save money. Other times you cannot.

4.  Are you certain the class you have chosen makes sense in China? Do you know what categories you want within that class?

4.  What if your trademark is not accepted by the Trademark office?  What exactly does your fee with the Chinese firm cover? I assume they will come back to you and just say "too bad."  We work with the trademark office to get them to say yes and if they still do not, then we work with you on what to do and if that involves trying again with a new trademark, we do that too.

In other words, when it comes to registering a trademark in China, just like with everything else, you get what you pay for. 

What do you think?