China Law Blog

Back when the media was getting all hot and heavy (sexual reference intended) on China's plans to require internet filtering software, I did a post, entitled, "Two China Things Of Which We Dare Not Speak (And Sex Is Not One of Them)." In that post, I explained why we virtually never write about proposed laws and why I had not written anything on the filtering software.

I gave the following reasons:

I do not like writing about proposed laws for the following reasons:

1. There are so many laws already on the books and being enforced that need coverage more. Laws on the books will impact you right now. Proposed laws may or may not ever come into being.

2. China has a very real habit of saying it will institute a new law and then never doing so. It floats new laws to gauge reaction. If the reaction is negative, the law oftentimes never comes into being.

3. China has a very real habit of instituting new laws and then never enforcing them. This often happens when the new law is negatively received.

Today, China officially backed down (no surprise). Or, in the words of the immortal Gilda Radner, Never mind.

China is billing it as a delay, but I can virtually guarantee this software will never be heard from again. I say this for two reasons. One, the people did not like it and Beijing does NOT want to go against the people on something like this. Since there is absolutely no reason to believe the people will ever start liking something like this, there is absolutely no reason to believe the software will return. Two, I know movement has been slow, and I know it has been in fits and starts, but if we were to draw a straight line through the rises and falls, freedom is on a fairly inexorable march in China.

We now return you to our regularly scheduled programming....

UPDATE: E-Commerce Times interviewed me on this last week and quotes me in their story today, entitled, "China Wobbles on Green Dam:"

It was never really clear whether or not Beijing would enforce the edict, according to Dan Harris, a partner in international law firm Harris & Moure and an expert on China.

"What they're doing is floating an idea and seeing what the reaction is," he told the E-Commerce Times. "In the last five years, there probably have been thousands of laws China said it's going to enact and hasn't. Or it has enacted them but hasn't implemented them."

FURTHER UPDATE: Sky Canaves has a great post up on the WSJ China Journal, entitled, "Green Dam and the Politics of Consent," discussing how popular "consent" plays a huge role in China's governance. This post nails it completely.

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Got a call last week from the HR officer of a US company. She was looking for my firm to assist her on a labor law issue. The US company's China WFOE had laid off a female employee who had come back saying she was entitled to ten months pregnancy pay. The employee gave three legitimate sounding reasons for this entitlement.

I learned that this employee's yearly salary was about $3600 and that the WFOE was in Shenzhen. I also learned that this employee did not have a written contract and that the WFOE did not have an employee manual. I told the HR officer that for us to research whether this ex-employee was entitled to what she is seeking, we would need to research the laws of China, of Guangdong province and of Shenzhen. I then told her that the cost of our doing that would be so close to what the employee was seeking and that I was very dubious that our research would reveal any cost savings (particularly because this employee had no written contract and this WFOE had no employee manual) that it would almost certainly not make sense for us to take on the matter.

But I also told her that if the WFOE chose to pay this ex-employee her ten months salary that it needed to have her sign an appropriate release, in Chinese, making it so that she would not be able to sue the company and win, even after receiving payment. I told her that from what we have been hearing, foreign companies lose pretty much every time in these sorts of employee disputes and they usually lose a lot more than just the one case. I told her that what happens is that the company loses the one case, all the other employees hear about it and then they sue as well. I stressed again the need to contain the problems stemming from this one employee right away by means of a well-crafted written agreement in Chinese.

She is to get back to me this week, after she talks with the company owners.

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I actually began my legal career as an antitrust lawyer and I though there has so far been no call for it on our China matters, I have very much tried to keep up with China's slowly developing antitrust laws. So I was delighted to sit down (metaphorically speaking) with Josh Gartner Managing Editor of Publications for AmCham China for an interview on recent developments in China's anti-monopoly law. This interview can be heard as an iTunes podcast here and on AmCham's site (gosh, I'm right there with Nancy Pelosi and John Kerry) here.

Or you can read the transcription below, stripped of all my overly long pauses and interminable "uhmmms."

Welcome to China Brief Insight. This is Josh Gartner of AmCham China. I’m very excited today to be joined by Dan Harris of Harris & Moure law firm. Dan is a very well-respected lawyer. He is also well-known in China for China Law Blog, which he writes together with Steve Dickinson, who is also with his firm based out of Qingdao.

Today, Dan and I are going to talk a little bit about the MOFCOM [Ministry of Commerce] decision to block the Coca Cola purchase of Huiyuan. Huiyuan, as you know, is one of the biggest Chinese producers of juice. This case was pretty widely watched because it is one of the first tests of China’s anti-monopoly law.

JG: Dan, how are you?

DH: Good. How are you Josh?

JG: Good. Welcome to the Podcast.

DH: Thank you for having me.

JG: Alright. We are going to talk about the anti-monopoly law today. And specifically China is coming up on the one-year anniversary of the implementation. In the year since China has formally put the anti-monopoly law into place, what have we learned about it? How is China using it?

DH: Well, they are not using it all that often. The case that everyone talks about is the Coca Cola-Huiyuan purchase or the attempted purchase. And in that instance, China used the anti-monopoly law to prevent Coke from purchasing a large juice manufacturer.

JG: And when that ruling came out and the purchase was blocked, you wrote on China Law Blog that you had been anticipating that result for awhile. Why were you so convinced that was going to be the final result?

DH: Because the brand that Coca Cola was trying to buy was simply too big, and we felt that China would not allow it to go forward because that sort of purchase would be viewed as not being in China’s national interest.

JG: So are you saying that it was not on the traditional grounds that people would view monopoly cases? Or is it a combination of the monopoly law and some national sentiment as well?

DH: I’m saying that it is difficult to know. The thing about monopoly is – and this is true of many instances of the law – there are a lot of ways to look at numbers, a lot of ways to look at market share. In fact, just the other day I was at a party and somebody said the local cable company is a monopoly, and I said “no,” that it was not a monopoly because there are various ways that you can get a signal to your television. And this other person kept insisting that it was a monopoly because it was the only cable company. So a lot depends on how you define the market. The reality is that I would think most countries would not have stopped Coke’s purchase on antitrust grounds, on anti-monopoly grounds, for various reasons. First, the company Coke was buying was in the juice business. I believe that the combination of Coke and that company would have – I can’t remember exactly the numbers – it would not have increased Coca Cola’s percentage. Huiyuan, I believe, had something like 40 percent of the market, and Coca Cola had a very small percentage of the juice market, so the combination would not have led to that much of an increase in market share in the juice market alone. I also think that a lot of countries would not have confined it to just the juice market. Maybe they would have looked at it more specifically and said what about grape juice, what about orange juice, what about water, what about soda, etc. A lot has to do with the concept of elasticity of demand. If orange juice all of sudden doubles in price, people are not necessarily going to continue buying orange juice. They might switch to something like grape juice, so gaining monopoly power in something like orange juice might be very difficult because you have to deal with more than just who else is in orange juice, but also grape juice, cherry juice, soda, water, etc. So I think very few countries would have acted the same way China did with respect to the Coke deal, and I think a lot had to do with China’s overall policies regarding foreign investment.

JG: Are there any ways other than, specifically a monopoly on juice or a monopoly on specific type of juice, that a merger like this could create any specific monopolistic concerns?

DH: No, not really. The monopoly would come from Coke having such a large share of the market that it would be able to essentially price the product in a monopolistic way. And what that means is that it would have so much pricing power that it could raise prices and people would still have to, need to, or want to continue buying the product. There is another aspect to the purchase that we should talk about and that’s another reason why I think that it was denied, and that is the brand name. The fact is that Huiyuan is such a big brand name in China. I think that Beijing was concerned with appearing to cave in to foreigners by allowing foreigners to take over such a well-known Chinese brand name. And again that has to do with nationalistic sentiment. One thing I want to make clear here is – and you and I have talked about this previously – and that is this idea of decisions being made based on nationalism is very common throughout the world. It is not confined to China, and China could have made a similar argument with respect to some of the decisions made by the United States regarding foreigners purchasing American companies. I think the best example is the attempted purchase of UNOCAL a few years ago, which was denied by – I don’t remember if it was formally denied by the US government – but it was certainly made clear that the US government was not going to tolerate a Chinese company owning UNOCAL, which was viewed as important to national security interests.

JG: And for that particular deal, would you say that national security issues were the most important or was it more general protectionism and nationalism?

DH: My view was that it was protectionism and nationalism.

JG: Looking at more recent deals, particularly since the Huiyuan purchase was blocked, people have looked at the Rio Tinto deal to draw connections to the Huiyuan deal to see if there was some sort of fallout in Australia that even though Australia wasn’t involved in the Coca Cola-Huiyuan deal there were some questions about whether China’s reaction was enough to rouse nationalistic sentiment in Australia to block the purchase of Rio Tinto by a Chinese company. Can you talk a little about that deal?

DH: Yes. Again, there is no way to know what the rationale was for what happened in Australia. But I do think nationalism and protectionism definitely played a part. And I find it very interesting that people talk about the Rio Tinto deal being a bit of backlash from the Coca Cola deal because I don’t really see that. I think that the same thing would have happened had there never been a Coca Cola deal, just like it happened when CNOOC [China National Offshore Oil Corporation] was trying to buy UNOCAL in the United States. I think that Australia was very wary of a Chinese company coming in and taking over, essentially, one of their commodities. Call it national security. Call it protectionism. Call it nationalism. I think that is a fact of life just about everywhere in the world and so what happened in Australia didn’t really surprise me either. I don’t think that the line goes to the Coke deal in China. I think the line goes to nationalist sentiment.

JG: Since the Rio Tinto deal basically fell through there has been a new seller, which is BHP Billiton, and China’s Ministry of Commerce or MOFCOM has begun to make some rumblings about looking into the monopolistic implications of that deal. I guess I have two questions. The first would be: How much of that – from your own personal point of view – is fallout because the Rio Tinto deal with a Chinese company fell through? How normal is it for a third party country to look at the monopolistic implications of a deal involving two foreign companies?

DH: I’m going to answer the second question first. How normal is it? It’s unusual but not unheard of. I think the basis that China is giving for looking at that deal – the BHP-Rio Tinto deal – is legitimate or at least appears legitimate initially and that is that China is saying: “Look, these two companies are going to get together and control a huge portion of the iron ore industry. And we, China, are a huge purchaser of iron ore. Therefore we are entitled to look into this merger from a monopolistic perspective under our antimonopoly laws. Countries do that. The European Union has done that with respect to Microsoft. I can’t think of instances where the US has done that, but I’m sure they have. The justification is sound. I don’t really know enough about the numbers that will result from a BHP-Rio deal, and I don’t know enough about the numbers with respect to Chinese purchases of iron ore to really know whether under antimonopoly law – and when I say under antimonopoly law, I’m just talking in general, not necessarily under China’s antimonopoly law – if there is really something there. I do have no doubt that China is not happy about what has gone on in Australia. They are not happy about Chinalco essentially being pushed out of the deal, and I’m sure that their initial reaction to the BHP-Rio Tinto deal is based on anger, and it will be interesting to see how far they take it and what sort of valid basis they have for doing so.

JG: On the China side, in terms of foreign companies coming in and purchasing Chinese brands, I think the recent history shows that companies are starting to be a little more cautious about it and there is sort of an understanding that in certain cases there may be a backlash. Have you seen any developments recently that show foreign companies taking a different tact in terms of purchasing Chinese companies?

DH: From my own personal perspective, no. I should talk about that briefly. My law firm tends not to represent huge companies. I shouldn’t say “tends not to.” We do not represent huge companies in huge buyouts. We tend to represent small to medium sized companies who go into China either on their own or sometimes they buy Chinese companies. In that marketplace, these antimonopoly laws have never been a big factor, and we have never had to deal with any sort of nationalistic backlash on the scale where…. let’s say the media gets involved. There have been times when there are certain industries where we get the sense that the Chinese government would prefer that our clients not go in, but that’s probably less due to nationalism than other factors because these are not investments where they are going to make the national press in China. So from my own perspective, and that being the perspective of representing small to medium sized companies there has been absolutely no change. What I have also seen, from the perspective of an interested observer, is that there has always been and will likely continue to be the big companies who seem to understand what is going to be allowed in China in terms of purchases and act accordingly. A very recent example of that is KKR -- Kohlberg Kravis and I forget what the R stands for. I was just reading that they invested $150 million in a dairy company in Anhui province. I think they are getting a 20 percent stake in that and the press has talked a bit about how this was allowed and the Coke deal wasn’t, and the reason why is fairly obvious. The reason is that this is the kind of deal has always been allowed in China. (When I say “always,” I am talking about the last five to ten years.) The Chinese government has always pretty much encouraged foreign companies to purchase non-majority interests in Chinese companies where the foreigner coming in can add a benefit to the Chinese company – maybe a transfer of technology, management skills, access to foreign markets. That’s what I see in the KKR purchase. My guess is that China is very happy with this purchase because it views this as an opportunity to bring in foreign expertise to help tighten up the supply chain in the dairy industry.

JG: To clarify KKR is Kohlberg Kravis & Roberts. I won’t pretend that I knew that, but I was able to look it up while you were talking through that. So you’re basically saying that when it’s a smaller stake and the foreign enterprise is able to bring in the expertise and essentially add something to industry and the economy in China that is something that tends to be more welcomed as opposed to something that might be seen as a foreign enterprise coming in and taking over a national company or a famous brand in China.

DH: Absolutely. Yes. In fact, one of the reasons I am willing to take some credit for having foreseen what happened with the Coke purchase is that in the article we wrote we talked about – and I say “we” because it was with one of my partners, Steve Dickinson, who is based in China – the policies that China has with respect to foreign M&A, and we set out what we saw as the kinds of purchases that would be allowed. The Coke purchase did not fit in there. We said that foreign companies would be allowed to purchase small Chinese companies that the central government is not interested in managing and those tend to be the kind of deals in which my law firm is involved -- small companies that frankly the government does not have much interest in. We said that they would be allowed to purchase large state-owned companies that are suffering from financial difficulties, provided that the foreign investor can restructure and save the Chinese company, and thereby save jobs. There were a lot of those purchases going on three or four years ago. That has seemed to die down a bit, but I remember a number of our clients would come back from China and talk about how some government official was telling them about some great company that our client should buy. Our reaction to that was always “If a Chinese government official is telling you about a great company to buy, it’s either because this Chinese government official has some friend who owns it or more likely this company is probably on its deathbed and they are hoping you can save it.” So those deals have always been encouraged by the Chinese government. Another deal that has always been permitted is – like the KKR deal – where a foreign company comes in and buys a non-majority share in a successful Chinese company but will bring some added benefit to it. But the one purchase that has generally not been allowed is – and will not generally be allowed is – buying a majority interest in a large and financially successful Chinese company. Another kind that tends to not be allowed is a smaller company that is financially sound that has what China considers a critical technology or in a really important field like military related or something like that.

JG: Would that latter category be under anti-monopolistic grounds or national security grounds?

DH: Not monopolistic grounds. Something more along the lines of national security grounds. As far as I know, just about every country has similar grounds. I know the United States does, China does. Countries tend not to like foreign companies buying into their airlines, buying their ports, etc. I know, for instance, in the US there are limits on foreign ownership of airlines. There are even limits on foreign ownership of fishing vessels.

JG: Moving back to the AML. We have had almost a year of the lobbying in place. We had a few landmark cases but not that many yet. Looking ahead, what are the kinds of deals you are looking for in terms of giving you road markers for the future?

DH: What I am looking for is to see somebody bring an action against some giant state-owned entity accusing it of being a monopoly because there are definitely some of those out there, none that immediately come to mind, but it’s very interesting – the idea of having an antimonopoly law in a country where some of the biggest companies are owned by the government, so I’m looking forward to a case like that. There have been some cases brought involving price fixing. I don’t know what the results of any of those cases have been. I’m not sure there have been any results. Based on the facts, and I’m only getting the facts from the media, but based on what I’m getting from the media is that some of those cases are fairly strong. There are some companies in China that have engaged in price fixing. One of things that fascinates me about China’s antimonopoly laws is that it is essentially plopped down as it ought to be, but it was plopped down without there being any history on which lawyers and judges can go on and so that’s always going to make things difficult and what’s also going to make things difficult is that not only is there no body of case law, which will tell people what they can do and what they can’t do, but there can only be very few judges in China who are knowledgeable about antitrust law because how can such judges have been developed when the law wasn’t in existence? I think there is going to be a lot reliance on foreigners in trying to figure out how to handle the law. I personally find that very exciting. I remember many years ago we sent over a first year associate to Sakhalin Island in Russia to represent one of the creditors in a bankruptcy case there, and it was one of the first bankruptcy cases in Russia. Our first year associate was not an experienced lawyer and he was not a bankruptcy lawyer. He had taken one bankruptcy course in law school and all these very experienced Russian lawyers and the judges were asking him how they should handle various things. I can see that same sort of thing happening – to a somewhat lesser extent – but happening in China with respect to the antimonopoly laws.

JG: One last question before we let you go. You just mentioned that you are going to be watching out for cases where some Chinese companies standing as potential monopolies would be challenged. Do you have any predictions of what the outcome of those cases might be?

DH: Tough question. Tough question because I haven’t thought about it much. But I guess the answer is that I suspect that because of the newness of the law and the lack of comfort that the judges will have with the law and perhaps even the fact that they will not necessarily understand the benefits of chopping up a company or preventing a merger…. I would guess, and it’s nothing but a guess, that we are not going to see much enforcement of the antimonopoly laws against domestic companies for another five years.

JG: Alright. Thanks so much for taking the time to talk with us, and as these cases do come to court and do get resolved. We would love to have you back on the podcast to talk about them.

DH: That sounds good to me. Thank you for having me.

JG: Thanks so much for listening to this AmCham China Production.

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Many years ago, a very good client of mine (in a China related business) called me in a panic. The client had gone to its regular US corporate counsel and asked about using a trade name on product it would be importing from China. Its corporate counsel said it saw no problems and my client went ahead and imported the product. This turned out to be a bad move. A very bad move.

As soon as the product hit the US, it was stopped at customs as counterfeit. Within hours, my client received a fax from one of its direct (and probably most hated competitors), saying that the imported product was counterfeit and that if my client did not pay $25,000 and destroy all of the boxes with the trade name on it, it would be facing a lawsuit. For ease of reference, let's call this competitor "the enemy." My client came to me and we met with a top flight local trademark lawyer (that same afternoon) and we all determined that the enemy was absolutely right. My client was using the enemy's trade name and it was almost certainly liable for trademark violations and counterfeiting. In light of this, we advised our client to do exactly as told and to then seek to recoup its costs from its lawyers.

My client paid the enemy $25,000 and then incurred another approximately $150,000 in repackaging its product, along with another approximately $50,000 in costs having to resell the product because its original buyers were unwilling to wait for the repackaging. My client went to its insurance company seeking reimbursement and it was not only denied coverage, but the insurance company raised its premium by approximately $25,000 a year because it had misunderstood my client's product up to that point! In the end, this trademark error ended up costing my client around $250,000, though it was able to recoup a good portion of this from its (former) corporate law firm.

The two page letter "the enemy" wrote my client was so good that I saved it and my firm has since used it (with slight revisions, of course) a few times on opposing parties to very good effect. Within my firm, we even refer to using that letter as "going 'the enemy' on their ass."

Note that it was a law firm that made the mistake in the above case and note also that my firm does NOT handle US trademark matters for reasons that encompass the story above. We refer out US trademark matters or bring in US trademark counsel to assist. We believe US trademark law is best left to those US lawyers who focus on US trademark law.

Yet, with the onset of this recession/near depression, I am seeing more and more companies trying to cut costs by doing their own US trademark work. I see this as a huge mistake and it is a mistake that is starting to impact my firm's China work. Here are two examples as to how:

1. A company contacted us to have us help them with an OEM contract with a Chinese manufacturer and to have us register their US trademark in China. Their US trademark is a pretty common name so I asked them to tell me more about their US trade name registration. They told me that they are the only company using that name to make their particular product, but that someone else had already registered the same trade name to make a similar, but "very different" product. The product sounded way too similar to me and I suggested that before they pay my firm to register their US name as a Chinese trademark, they ought to first make sure their US name is valid. They agreed and we are awaiting the results.

2. Someone from China very recently emailed me saying they had registered their trademark in the United States all by themselves but they had heard that one has to use an agent in China to register a trademark there. They wrote me to see if there is a way to register one's trademark in China "cheaply." I said the cheapest way is to register one's trademark in both the United States and in China correctly and that I worried their US trademark is invalid. If so, registering that same trade name in China will likely be a waste of time and money. More importantly, it could mean this company is starting off with a name that may eventually be taken from it at a cost of hundreds of thousands of dollars when someone goes "'the enemy' on their ass."

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I have been practicing law long enough to have seen my share of product recall disasters. The most recent was a situation involving a food company client. Our client had contracted out with another company for the manufacturing of a particular processed food product. The food product was determined to be tainted with very low levels of a potentially harmful. Our client informed its distributor of the problem and the distributor agreed it would alert the grocery stores at which the product was sold. And it mostly did.

Unfortunately, however, this distributor "forgot" to alert one very large grocery store who went on to sell all of the product before learning of the recall. Needless to say, this very prominent and respected grocery store became very angry at my client upon learning of its not having been alerted to the recall. This grocery store then told other grocery stores of what had happened and our client's reputation precipitously declines and all of its profits disappeared. Things were never the same again.

I mention all this because the issue of product recalls/product safety is so obviously front and center these days in China. Co-blogger Steve Dickinson recently attended a conference on this topic and he has written on it here:

The issue of how to respond to defective products is a hot issue in China. The recent Sanlu Dairy melamine contamination case highlighted that China simply does not have a clear and effective system for recalling dangerous products. Even when a company in good faith seeks to recall a defective product, such a recall is simply not a practical possibility. In response to this issue, the PRC Product Quality Commission released in September of 2008 a set of draft regulations for establishing a nationwide product recall system, the 《缺陷产品召回管理条例（征求意见稿)》Regulations for Management of Defective Product Recall: Comment Draft, which can be found here. This draft regulation is based on the regulations concerning the recall of defective automobiles issued in 2004: 缺陷汽车产品召回管理规定, The Regulations for Recall of Defective Automobiles, which can be found here.

On Sunday, I attended a major conference here in Qingdao, hosted by the Qingdao Office of Consumer Protection and Wincon Law Firm, a Chinese law firm with whom my firm has a formal affiliation. Even though the conference was held on a Sunday, the meeting room was packed with over 100 participants. The participants included government officials, major consumer product companies, consumer advocates and law firms. The various presentations revealed two things. First, there is strong interest in China in using product recall as a tool for confronting the continuing problem of unsafe products within China. Second, China is a long way from developing a comprehensive product recall system.

My own comments on the draft regulations were as follows:

1. The regulations do not provide for creation of a single regulatory body similar to the U.S. Consumer Product Safety Commission. Where there is multiple and overlapping central and local jurisdiction over these kinds of issues, the result is usually chaos, not effective action. This was shown quite clearly in the Sanlu melamine situation. The proposed rules exacerbate this situation rather than improve it.

2. Manufacturers and retailers will only cooperate with product recall if they believe it is to their economic benefit to do so. The proposed regulations rely entirely on administrative sanctions to achieve compliance. However, the proposed fines are too low. Since there are numerous obstacles to product liability litigation in China, there is little to coerce or convince Chinese companies to comply with any regulations that are actually adopted.

3. A major target of the recall system is foreign manufacturers. In several recent cases in China, foreign manufacturers intended to include China in worldwide product recall campaigns. In each case, they abandoned their China recall program because of the lack of any system within China. The Chinese authorities do not want this to happen again. It is clear that the first target for effective implementation of the recall system will be foreign manufacturers, particularly manufacturers of big-ticket items like automobiles.

As foreign manufacturers begin to have increasing success in penetrating the Chinese market, they need to be aware of the extensive and growing body of product safety laws and regulations. The new recall rules are one of many sets of rules that are likely to be enacted and enforced with particular enthusiasm against foreign manufactured products in China.

For more on food safety in China, check out Steve's Wall Street Journal article, "Food Fumble."

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I am paranoid about my clients registering their trademarks in China, pretty much before they do anything else. For a few examples of my feelings on this, check out, "China Trademarks -- Do You Feel Lucky? Do You?" "China Trademark Law: Simple And Effective" and "Trademark Protection In The Global (And China) Marketplace." The bottom line is that if you have a trademark or trade name worth protecting and you are doing any business at all in China, you absolutely must register your trademark at your earliest opportunity.

But lately I have been having my doubts. Just a little.

Not that long ago, a client came to us having reached a tentative agreement to sell millions of dollars of product to a Chinese city government. The deal looked good from all angles and my firm was hired to draft the contract. I discussed with my client the need to register their product's trademark in China before anyone else beat them to it. My client was concerned about this because a number of people knew it would soon be doing a substantial business in China. So it went ahead and registered its trademark in China right away as it continued to negotiate the final terms of its contract with the Chinese city.

To make a long story short, my client was unable to turn its oral agreement with the Chinese city into a written one due to various disputes regarding payment terms and IP protections. Rather than compromise, my client made the decision not to go into China, at least for now. But its China trademark has been bought and paid for and approved for filing and so, in a couple years (yes, it does take that long), it will have a registered Chinese trademark that will only have value for it if it is either selling its product into China or having it manufactured there. In other words, in hindsight, its filing its trademark there came too soon.

I thought of this prior matter this week because I am involved in another situation where I am worried that my client's trademark filing might end up being for naught. This client has a very strong brand name and it is in negotiations with a Chinese manufacturer regarding having one of its products made in China. Interestingly, if my client does not reach agreement with this particular Chinese manufacturer, it will have its product made in another country. So does it register its trademark now, so as to be sure to beat everyone else to it, or does it wait and see whether it can reach agreement with its Chinese manufacturer? Hate to give away the punchline, but this client too chose to go ahead and register its trademark. But what if it had only a very limit amount to spend?

Though the odds of someone "sneaking in" and filing "your" trademark while you are negotiating a contract are low, the cost of missing out on being able to register your trademark are so high, that as a lawyer, I think I have to advise clients to register their trademark every time. But might there be circumstances where a company should take a wait and see approach to registering its trademark?

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This is the second in a series of posts on Chinese contract law by co-blogger Steve Dickinson. The first post, "China Contract Law: Going All Clear On Us Now," discussed recently issued PRC Supreme Court explanations on various aspects of contract law. This post discusses how Chinese law tends to disfavor contractual disclaimers of liability. US courts tend to disfavor them as well, but workarounds are usually possible. This is not the case in China and we are finding that most of our US and European clients (particularly those in the shipping/freight business) do not realize this.

In my recent post concerning the PRC Contract Law, I noted that restrictions on disclaimers of liability in form contracts are a particular concern. As I mentioned, form contracts are often used for cargo and other carriage contracts. The primary function of such contracts is normally to limit the liability of the carrier. This runs directly against the form contract provisions of the Contract Laws, which are designed to prevent such limitation of liability. In this post, I will describe a recent case concerning this issue that clearly illustrates the Chinese approach and the dangers for foreign carriers who intend to operate within China.

The relevant provisions of the Contract Law are as follows:

Article 39 Where standard terms are adopted in concluding a contract, the party which supplies the standard terms shall establish the rights and obligations between the parties in accordance with the principle of equality; shall use reasonable means to clearly identify any provision that limits his own liability or increases the liability of the other party; and upon the request of the other party shall explain such provisions.Standard terms are clauses which are prepared in advance for general and repeated use by one party and which are not negotiated with the other party in concluding a contract.

Article 40 When standard terms fall within the provisions of Article 52 and Article 53 of this Law, or in the case where the party which supplies the standard terms exempts itself from its own liability, or increases the liability of the other party or eliminates the rights of the other party, the terms shall be null and void.

Article 41 If a dispute over the understanding of the standard terms occurs, it shall be interpreted according to general understanding. Where there are two or more possible interpretations, the interpretation unfavorable to the party supplying the standard terms shall be used. Where the standard terms are inconsistent with specifically negotiated terms, the latter shall be adopted.

Article 53 The following exculpatory clauses in a contract shall be null and void:
(1) those that concern personal injury to the other party;
(2) those that concern property damage to the other party as a resulting of intentional acts or gross negligence.

These provisions were applied in the following case. (Taken from 合同法案例应用版 (2009) pp. 27—29):

Company A is located in Nanjing. On July 21, 2006, it received an order from Company B, located in Nantong, for an IBM notebook computer. Since Nantong is 300 km from Nanjing, company A engaged the services of a package delivery company to make the delivery. Upon accepting the order, the Delivery Company provided a freight bill to Company A, stating the particulars of the transaction and providing for a delivery fee of ten RMB (about $1.50 US). Below the signature line, the freight bill included the following statement: “If this package requires insurance, please provide advance notice.” Below this statement was the further notice: “Before signing this document, please read the explanation on the reverse of this document. Your signature confirms that you understand and accept the provisions of this explanation.”

After signing the document, the delivery company took away the package. Company A notified Company B that the product had been shipped and Company B paid the purchase price of RMB 17,450 (roughly $2,000 US). The package never reached Company B. As a result, Company A shipped a replacement computer to Company B and sued the delivery company to seek compensation for its loss. After investigation, it was determined that an employee of the delivery company had subcontracted the delivery to a third company. An employee of that third company stole the computer before it could be delivered to Company B.

At trial, the delivery company argued that the exclusion provision of the delivery contract limited its liability. Provisions printed on the reverse side of the delivery contract provided the following:

1. In the case of expensive items, the customer is required to state the actual value and to purchase insurance.
2. In the case where the customer has not done the above, the liability of the carrier is limited to 30 times the delivery fee.

In this case, the delivery fee was 10 RMB. The delivery company therefore argued that its liability was limited to 300 RMB.

The court rejected the argument of the delivery company and held that it was liable for the entire damage in the amount of RMB 17,450. The court did not discuss the requirement of prominent disclaimer language or the requirement to explain, as required by Contract Law Article 39. The court instead based its decision on Article 40, which provides that any standard term that limits the liability of a contracting party for its intentional or grossly negligent conduct is simply void. The court held that it was grossly negligent for the delivery company to subcontract to an unsupervised third party and stopped its analysis at this point.

This decision suggests that in the context of form contracts it is not possible for a party to limit its liability for negligent or willful conduct. This is true even if the exculpatory language is clearly stated and even if the other party acknowledges the provision. This issue must be considered carefully. The delivery company in this case charged only a nominal sum (10 RMB) for this delivery. It charged this low price presumably on the assumption that the exculpatory provisions of its contract would limit its liability to no more than 300 RMB. Instead, it was held liable for the entire 17,450 RMB loss, an amount it clearly had not considered in setting its delivery fee.

Many foreign carriers operate within China under the same assumption. They believe their limitation of liability provisions allow them to safely charge a modest freight charge. This case shows that this assumption is misplaced and that far more care in this issue must be taken in delivery, freight and related contracts in China. The Chinese form contract provisions are far different from anything encountered in the common law and they must be considered carefully.

China's tendency not to enforce limitation of liability provisions applies much more broadly than just to freight contracts. They apply in any warranty situation where a seller or service provider seeks to limit liability. The normal waiver of warranty in bold print does not appear to be a viable solution in China. The entire issue of disclaimer of warranty/disclaimer of liability must therefore be approached with extreme care in China, particularly when using a form contract.

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China's Supreme Court recently confirmed what my firm has always been telling its clients: if you want to protect your trademark in China, you absolutely must register it in China. We have always said that because the likelihood is so slim of being able to prove that a trademark is a well known mark and the cost of trying to do so is so much higher than actually filing, that unless you are as well known as Coca Cola, you should just go ahead and register. China's Supreme Court just came out with an explanation saying essentially the same thing. Co-blogger Steve Dickinson explains this new explanation below.

PRC Supreme Court Explanation of Legal Issues Concerning Well Known Trademarks
by: Steve Dickinson

The issue of protection of “well known” foreign trademarks is a continuing area of dispute in China. In an attempt to clarify some of the issues, the PRC Supreme Court recently issued an explanation of the issues arising in disputes relating to well known marks. This is 最高人民法院关于审理涉及驰名商标保护的民事纠纷案件应用法律若干问题的解 (Explanation of the Supreme People’s Court Concerning Some Questions Arising from the Application of Law in Civil Legal Disputes Concerning the Protection of Well Known Marks) which can be found here [in Chinese only].
The Court issued this Explanation on April 22 and it officially became effective on May 1.

Among the purposes of the Explanation is to clarify the provisions of Article 13 of the Trademark Law, which provides the following:

13. A trademark which is applied for registration in identical or similar goods shall not be registered or shall be prohibited from using, if it is a reproduction, an imitation or a translation, liable to create confusion, of a well-known mark which is not registered in China.

A trademark which is applied for use in unidentical or dissimilar goods shall not be
registered or shall be prohibited from using if it is a reproduction, an imitation or a translation, misleading the public, of a well-known mark which is registered in China, provided that the interests of the owner of the well-known mark are likely to be damaged by such use.

The translation above is taken from the WIPO standard translation. Note that many translations found on the internet are incorrect and should not be used.

The first article of the Explanation clarifies an important issue. Explanation Article 1 states that the term “well known mark” means a mark generally known by the public within the territory of China. The Explanation thus makes clear two key requirements for a well known mark. First, the mark must be known to the general public, not to a restricted group of experts. Second, the mark must be well known within China. The situation outside China is not relevant.

This second requirement is the source of much confusion for foreign trademark owners. I have read a number of case reports in China where a foreign company went to great lengths to prove that its mark is well known in the United States and Europe and I have had a number of companies tell me they did not think they would need to register their trademark in China because it is a well known mark. The Chinese courts in these cases can do nothing but politely state that though it may be true that the mark is well known outside China, that is irrelevant here in China. What we need to know is whether or not your mark is well known within China. Absent evidence of knowledge of the mark by Chinese consumers, the provisions of Article 13 are of no benefit to the foreign trademark owner. It is essential that the territorial limitation of Article 13 be clearly understood because a failure to understand this and act accordingly will likely lead to much wasted time and money on the part of foreign trademark owners. The clear statement in the Explanation is intended to prevent such misunderstanding.

For the basics on China trademarks, check out this post, entitled, "China Trademark Law: Simple And Effective."

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By Steve Dickinson

One role of China's Supreme Court is to provide guidance on the interpretation of statutes. These interpretations are directed at two fundamental issues. First, Chinese statutes tend to be short and general. Conflicting interpretations of such general wording is possible. Since China has no form of stare decisis, the only way to resolve such conflicts is through guidance from the Supreme Court. Second, most Chinese legislation is quite new and is based on foreign models. Without an historical background in the concepts, lower courts sometimes interpret the legislation in a manner clearly contrary to the intent of the drafter. Guidance from the Supreme Court serves to correct these aberrant interpretations.

In accord with this role, the PRC Supreme Court recently released Some Explanations of Questions Arising Under the PRC Contract Law 中华人民共和国合同法若干问题的解释 (“Explanation”), which became effective on May 13, 2009 and can be found here. The PRC Contract Law arises in virtually every commercial transaction in China. This post will discuss several of the provisions of the Explanation that are of particular importance for foreign companies operating in China.

Explanation 2: The Contract Law at Article 10 provides that contracts can be formed through a writing, orally or through “other means.” The Explanation states that if the conduct of the parties is sufficient to show the parties intended to enter into a contract, then the courts should enforce such contract as a contract formed by “other means.” There are two important points to notice here. First, many of our clients (and many Chinese businesspersons) believe that an oral contract is not enforceable under Chinese law. This is not true. Article 10 of the Contract Law clearly provides that oral contracts are valid and enforceable. Second, there is a general trend in the Chinese courts to limit enforcement of oral contracts. The Supreme Court constantly battles against this trend. This Explanation is an example of this. Lower courts have avoided enforcing contracts arising from conduct, and the Supreme Court is now pushing the courts to expand their jurisdiction to cover such contracts.

Explanation 3: This Explanation provides that if a party announces publicly that it will make a payment to any person who completes a certain task, this is a contract enforceable under the contract law. This provision makes clear that unilateral contracts are enforceable under the Contract Law. This clarifies a difficult issue. The plain wording of the Contract Law suggests that only multi-party contracts fall within the scope of the Contract Law. This Explanation would exclude unilateral contracts of reward or gift. However, such an exclusion is not consistent with other interpretations of the Contract Law and actual judicial practice in China. This Explanation clarifies the matter and makes clear that unilateral contracts are valid under Chinese law. In this regard, note that China follows the German approach to contracts and has no requirement for consideration. Thus, a “naked promise” is enforceable under Chinese law.

Explanation 4: In the case of a written contract, if the parties fail to state the location where the contract was concluded, the court must make this factual determination. As a general rule, the location for the execution of the contract will be the place where the last signature was affixed. Note that this whole issue can (and should) be resolved in the contract by setting out the governing law and the location for dispute resolution.

Explanation 5. In China, when contracting with individuals, it is common for the individual to sign with a fingerprint. This fingerprint is usually taken as the equivalent of a corporate seal used by a legal person. This Explanation states that such a fingerprint will be taken as the equivalent of a signature under seal, even if the party does not actually sign his name.

Explanations 6, 9 and 10: These Explanations are concerned with the issue of form contracts or contracts of adhesion. The Contract Law provides for a series of highly restrictive rules relating to form contracts. Many foreign parties ignore these provisions and then are surprised when their contracts are not enforced by Chinese courts. This often happens even when the contracts provide that they are governed by foreign law, because the Chinese courts take the position that the Chinese form contract rules are a matter of public policy that cannot be waived. Any such waiver will not be enforced by Chinese courts. The form contract rules are similar to consumer contract rules that have been adopted in Europe. However, there is a major difference that causes even Europeans to make mistakes in this area. The European rules protect only consumers. The Chinese rules are much broader and apply to all contracts, regardless of the status of the parties. Since Chinese companies have a strong tendency to use form contracts, these rules are very important within the Chinese system.

The basic form contract rules are as follows:

-- The party making use of the form contract must use reasonable means to clearly identify those provisions of the contract that limit or eliminate its liability to the other party. Upon request, such provisions must be explained.

-- The following provisions of a form contract are void:
* To eliminate one’s own liability.
* To increase the liability of the other party.
* To exclude the important rights of the other party.
* To exclude liability for physical injury to the other party.
* To exclude liability for negligence or intentional damage.
In the event of a dispute in interpretation, form clauses are interpreted against the drafter.

These provisions are contradictory and quite difficult to apply in practice. The Explanation provides some guidance as follows:

Explanation 6: This Explanation states simply that if a form contract meets all of the above requirements, then it is a valid contract. This prevents lower courts from dismissing form contracts out of hand.

Explanation 9: If the party that provides the form contract fails to explain an exculpatory provision and the other party requests that such a provision be invalidated, the court shall comply with such request. This then raises the following question: how is it possible to prove conclusively that an exculpatory provision has been explained? It appears to me that it will be virtually impossible to offer such proof, which suggests that all such provisions should be considered to be voidable under Chinese law. Perhaps the only way to do this would be to provide a written explanation and to require the other party to sign something indicating that it received and read that explanation.

Explanation 10: Any provision of a form contract that fails to comply with the provisions of the Contract Law governing form contracts should be declared void by the court. This applies only to the offending provision, not the entire contract. That is, the obligations remain in place, only the exclusions are voided. Where a party has priced its contract obligations assuming that the form exculpatory provisions will be enforced, the result can be an unexpected and disadvantageous shift in the bargain.

Explanation 19: Debtors in all jurisdictions often seek to avoid collection actions by transferring some or all of their assets to a third party. When this transfer is made at an unfairly low price, this impairs the interest of legitimate creditors. Such a practice in the U.S.is known as a fraudulent conveyance or a fraudulent transfer. Fraudulent conveyance is a common tactic in China and Article 74 of the Contract Law is written to combat such practices. Article 74 provides that if an asset is conveyed to a third party at a “clearly unreasonable price,” the creditor can petition to have the conveyance declared void.

Explanation 19 sets the standard for determining what constitutes a “clearly unreasonable price.” First, the court must determine the market price for the property. This is done based on the government standard price or the price in the local market. Then, any price that is 70% or less than the determined price is “clearly unreasonable”. The creditor needs to prove nothing more regarding the motive for the transfer or the relation of the transferee to the debtor: the proof of an unreasonably low price is sufficient.

Explanation 29: Since it is based on civil law, Chinese contract law is far more flexible with respect to remedies than the common law. China makes no distinction between law and equity. As a result, in addition to money damages, Chinese law provides for specific performance, contract (“liquidated”) damages, deposit, loss of bargain damages and incidental damages. Most importantly, the use of one remedy does not exclude the application of another remedy. For example, if contract damages are not sufficient to compensate for a party’s actual damages, Article 114 of the Contract Law provides that the injured party can request that the court order payment of an amount sufficient to allow for complete relief. However, to prevent abuse, the reverse is also true. Contract Law Article 114 provides that where stipulated contract damages are “excessively higher than actual damages”, the defendant may request a reduction in the amount. Explanation 29 provides that an amount 130% higher than actual damages will generally be considered “excessively high.” However, the burden of proof in establishing the amount of actual damages is on the defendant. In the absence of clear proof, there is a strong tendency for Chinese courts to accept the stipulated contract damage amount.

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China Economic Review recently published an article by CLB's own Steve Dickinson on foreign investors entering into long term leases of Chinese real estate. The article is entitled "Don't play for keeps," and since a paid subscription is required, we will provide the article Steve wrote before the professional editors gussied it all up.

The Chinese real estate market remains a continuing lure to foreign investors. Though many North American and European investors have attempted to enter the market during the last decade, few have achieved solid success. Since China continues to be the strongest economy in the developing world, foreign real estate investors continue to search for the secret that will allow them to crack China's real estate market. One strategy gaining in popularity is to use a long-term lease instead of outright purchase for a development property.

The use of the long-term lease is designed to deal with two major issues. First, since a lease is a contract and not a transfer of an ownership interest in property, approval of long-term leases can be completed at the local level. Local level approval is both more likely and much quicker than approval at the provincial or national level, as required for ownership transfer projects. Second, the long-term lease provides access to properties that simply would not be available for development in a sale context. Throughout China, many desirable urban properties are simply not available for sale to any party, foreign or domestic. For example, in Qingdao where I live, the beautiful historic German buildings from the early 20th Century are desirable targets for upscale retail and boutique hotel development. However, as historic structures, they are not available for sale. The city is, however, quite interested in having these properties developed and they are very much amenable to having foreign investors do this. The long-term lease is the only solution to allow for such development.

Though long-term leases address these issues, their very flexibility creates important legal issues that foreign real estate investors must address. Surprisingly, one of the most common issues is the difficulty in determining the actual property owner for purposes of the lease. Many leased projects are for state owned buildings that have never been converted to ownership by a specific corporation or other legal entity. Though ownership is clearly in the hands of the state, just who is authorized to act on behalf of the state can be quite unclear. The lease is often negotiated by a low-level organization, when in fact only a higher-level agency has the right to lease the property. Many of these higher authorities seldom visited the properties under their purview and when they do go there and discover that they are being leased, they have been known to insist on terminating the lease and ending the project.

The other major concern arises from a lease being a contract and not an interest in real property. A lease therefore achieves no more protection for either party than any other contract under Chinese law. Though Chinese courts are actually quite good at enforcing written contracts, there is always a degree of uncertainty in any contract setting. In a property lease situation, this uncertainty is compounded by two factors. First, since the landlord is often a government agency, it is important that the investor be comfortable that the local courts will faithfully enforce the terms of the lease. Though this should not be much of a concern in major cities like Shanghai and Beijing, it can be a factor in second and third tier cities. Second, since lease law is relatively new in China, it is difficult to predict how the courts will rule on key issues. This makes it critical to address all important issues in writing in the lease as it will rarely be possible to rely on code provisions or customary practice. This results in a long and complex lease, which is not typical in Chinese commercial practice. Landlords frequently resist signing such a complex document, which increases the uncertainty on the part of the tenant.

Much of the uncertainty concerning the validity of a China real property lease can be resolved by formal registering the lease with the local real estate authority. Registration offers a number of benefits to the tenant. Most important, registration provides notice to third parties of the existence of the lease, which should prevent the landlord from leasing the property to a third party, an unfortunate practice that sometimes occurs in China. An additional benefit of seeking to register a lease is that the local authorities will simply refuse to register it if the landlord has no authority or if the terms are invalid. This refusal can prevent the prospective tenant from entering into a facially invalid lease.

Despite the critical importance of registering your lease, many landlords resist such registration. They do so for two primary reasons. First, the purported landlord often knows it lacks authority to enter into the lease. Second, registration of the lease ensures the landlord will be required to pay real estate taxes on the rental income. It is therefore absolutely essential at the very start of any lease negotiation to make clear that the lease must be registered.

The long term lease solves some problems with real estate development in China, but it raises other legal issues. It remains to be seen whether the lease approach will prove to be a viable real estate mechanism in China. Care in due diligence and drafting is therefore essential as foreign investors experiment with this alternative approach.

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Scrap is very much an international business and due to its potential for rapidly changing prices, it is ripe for non-payments and international litigation. Many months ago, I was interviewed by Scrap Magazine regarding Chinese companies failing to pay on their scrap contracts. At that time, a whole slew of Chinese companies were backing out of their contracts to purchase scrap metal from US suppliers because the value of the product they had purchased had fallen precipitously since their date of purchase.

The article is entitled, "Easing Export Concern," and subtitled, "In the aftermath of last fall's economic collapse and the ensuing trade problems, scrap sellers are seeking new measures to protect themselves in agreements with foreign buyers." It was written by Ann C. Logue and it really does a superb job of setting out the risk of not getting paid in all international sales.

It talks about the pros and cons of letters of credit and it rightly concludes that the surest way to ensure payment is to get paid up front. I then talk about the basics of Chinese contract law and protection:

The U.S. and Chinese business cultures are actually more similar than most people think, says Dan Harris, a partner at Harris & Moure (Seattle), a law firm with personnel in China, and keeper of www.chinalawblog.com. "There are some very good businesspeople in China. There are some very poor businesspeople in China. It doesn't take a great businessperson to understand the forward market. … A lot of times, what is ascribed to culture is just circumstances." Harris gives the example of a Chinese buyer with cash flow problems who pays its local suppliers before foreign ones. Most U.S. companies would do the same thing, he says—not out of patriotism, but because the local company can cause trouble much more quickly than an overseas one.

Some Chinese companies do use language and cultural differences to deceive, Harris says, thus due diligence is essential. In one scam, a company assumes the identity of another company, one that has a long history and good reputation. He once represented a toy company [after these problems arose!] that thought it was purchasing from a major Chinese manufacturer. Representatives of the U.S. company even had meetings at the manufacturer's offices and toured the factory. In reality, the toy company was working with an independent broker who was presumably slipping someone at the plant bribes in exchange for tours and meeting space—and who disappeared as soon as the dispute arose. The major manufacturer knew nothing of the deal.

Companies doing business in China should ask for proof that they are dealing with the right parties. "Ask to see the documents," Harris says, and do not fall for the line that "that's not how we do business here." A reputable firm will work to bridge cultural differences, while a bad actor might hide behind them, he says.

Many scrap dealers have the impression that it's impossible for a non-Chinese company to sue and win in China. That's wrong, Harris says. The Chinese do recognize contracts, he says, but they have to be solid contracts, preferably written in Chinese, and calling for resolution in a Chinese court. Other types of contracts, including those implied by a paper trail, can be useless in the Chinese legal system. Harris has what he calls his bike-lock theory of Chinese law: "If there are 30 bikes, and one of them has a really good lock, it's not going to be stolen." Likewise, a seller that has a good contract in place is more likely to get paid, even if that contract is never tested in court. A contract is not a panacea, Harris says, "but you're dead without it." In fact, his firm will not take on a dispute in China unless there's a good-quality written contract in place.

Companies with a Chinese contract that sue in a Chinese court will find the litigation process different from that in the West. First, Harris says, a suit is not a negotiating tool. In the United States, a plaintiff might file a suit to force a settlement without a trial. In China, more than 90 percent of suits filed end up in front of a judge. It's easy to sue, he says, and cases move quickly. But judges tend to look at the fairness of a contract more than its legal language. Chinese judges do not like to see one party take all of the hit, Harris says, so suing for $1 million for scrap that is now worth $500,000 probably won't lead to a $1 million verdict, no matter what the terms of the contract were. That's not a bias against a U.S. company, he says—a Chinese seller would face the same judgment.

Without a contract enforceable in a Chinese court, the seller must look elsewhere to resolve a contract dispute with a Chinese company. The seller might have the option to pursue assets in Hong Kong or in another country, where the courts might be more likely to recognize e-mail messages, telephone records, and invoices as implied contracts, as they might in the United States.

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Fascinating post up over at CNReviews, entitled, "Husband and wife sue mistress for 330,000 yuan in “lover’s fees.” The gist of the case is that a married couple sued the husband's former mistress to require her to return 330,000 RMB the husband had given her during the course of the affair. The court ruled in favor of the married couple.

I will leave the moral lessons for others to analyze, but I love this case for all it can teach about how China's courts (and arbitrators) tend to make their decisions. And though I am relying entirely on CN Reviews for the case analysis, that is fine because the point I will be making is only that Chinese courts rely far more on equity than do Western courts.

Chinese courts tend to give large account to what is "fair," not just to what the law says.
This means that if a Chinese company is late on a contract because its own supplier was late in delivering it a necessary component part, the Chinese court may very well excuse the delay. This means that if the price of a necessary component part jumps precipitously, a Chinese court might very well excuse the Chinese supplier for substituting in a cheaper part. Many times, Westerners ascribe Chinese court rulings to corruption, when they very well might have been due to equity.

If you have a dispute that may be heading to a Chinese court or to arbitration before a Chinese arbitration, think long and hard about the equities involved, not just the law.

UPDATE: This post has spurred a rather funny follow-up post by Dan Hull over at the What About Clients? Blog.

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My firm recently wrapped up a fascinating matter (it is nearly always bad news when your lawyer tells you that you have an interesting or a fascinating case). Even though the matter is nearly over, I am going to have to gloss over certain facts and make up other ones so as not to leave any possible identifiers. The thrust is entirely true and the result is as well and my reason for writing it also remains intact. Here goes.

Young Chinese Child falls from a window in a room in which an American employee of our client is one of the few adults. Child is very badly hurt. Very badly. It now appears his injuries will probably not be permanent, but he also may be in recovery for a year. His medical expenses by US standards were fairly low, but they are astronomical by Chinese standards, particularly for this less than large city. A day later, the parents of the child come with a lawyer to tell this employee that they want six figures (in US dollars, not RMB) from him and from his employer for the injuries that have befallen their child. They also go to the police and make the same request of this employee and his American employer.

The parents make clear to the employee that many in the town are behind them and that things will get much worse if payment is not received. The employer calls us and we immediately spring into action. We determine that the police do not seem to be buying into the parents story of guilt and they have not told this employee or any other employee of our client that they must remain in town or in China as either witnesses or suspects. We learn that our client is not terribly happy with its joint venture partner in this town and that it has no problem with taking its employees out of there and sending them home to sit this whole thing out. Though they feel terrible about the injuries that have befallen the kid, they do not consider themselves responsible. Our research of the facts and the law and our meetings with a cadre of Chinese lawyers we trust all indicate our client is not liable. However, as everyone who has ever been involved in litigation anywhere in the world knows, not being liable and not being subject to an expensive and time consuming lawsuit are two entirely different and only tangentially connected things.

We determine the best course of action is to get the employees out of this town as quickly as possible and on their way back to the United States. We figure that getting them out will change the leverage game entirely, and it does. The employees leave and the settlement claim by the parents immediately plunges. Now we can talk with all parties (the child, the joint venture partner who actually owns and maintains the building from which the child fell) from afar, pretty much stripped of any imminent threats. We agree to pay the parents something towards the medical bills and we (fairly publicly) ask that instead of the Chinese joint venture partner paying our client what it owes, that it instead pay all of that to the family of the injured child. Agreements are signed on all of this and we move on.

And yes, before anyone accuses me of this, I will come right out and admit it. The point of this article is that it pays to bring your lawyers in early in a problem, rather than late. Early is better for the attorneys too, but only because many times when it is too late there is nothing the attorney can do (or charge for) beyond saying, "sorry."

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Got an email this morning from someone I know in China, reporting the following:

Police in Guangzhou are doing very aggressive passport checks to prevent what they call 三非 [the three must prevents]，meaning 非法入境 [illegal entry]，非法居住 [illegal housing]，非法就业 [illegal employment]. In a moment of candor, one very nice police officer admitted it was because of the CPC congress and the upcoming 60th anniversary of the revolution. The police came into Starbucks in a group and basically accosted a group of very well dressed foreigners, who appeared to be from the Middle East. These foreigners could not speak Chinese and the police could speak only a very little pidgin English. The foreigners were hustled off in a paddy wagon. I asked what would happen to them and I was told they would be held at the local police office until their identities can be verified. The police were extremely polite to me and just looked over my passport briefly. The community where I live is also covered with posters and slogans about illegal immigration written in both English and Chinese. I have never seen anything like it, even after living here for more than six years.

I also received a call yesterday from a lawyer here in the United States (calling for a completely separate reason) who told me of a client of his that had just been "raided" by the Chinese police who had been "tipped off" that there were foreigners working there on tourist or business visas. The client claimed this was part of a "general" visa crackdown going on in this particular Chinese city (which I should not reveal).

I ask again, what are you seeing out there regarding visa issues?

The last few times we have done posts like this one, we have received comments and/or emails from people pointing out that China is merely enforcing its laws and that we should not be criticizing China for doing so. I completely agree. The point of these posts is NOT to criticize China, it is to highlight the importance of getting legal on visas. There are countless foreign companies in China right now (including clients of my firm) that are operating there without being registered, employing foreigners (and Chinese) illegally. The point of these posts is that if you are going to do business legally in China, you must register your company in China (in most instances). Once you have registered your business in China, you are then positioned to be able to legally hire foreign employees legally on Z visas.

What are you seeing out there?

UPDATE: Just received this email from a friend of mine in a major China city. He has requested anonymity, so I have stripped his email of any potential identifiers:

Off record about visas... in November they rejected everyone on my team from getting a Z visa.... we were legal 100% and it was actually all renewals. But they gave us a hard time because we are a small company. WE bitched like hell and they ended up renewing us all for one year. In fact, they gave me 3 years!

It seems to me that they are getting easier on the 100% legal Z visas but are cracking down on others. It is not just all the upcoming anniversaries, but also the Shanghai World Expo.

So it seems to me... going the legal route is easier now than last year, but the non-legal route is going to be a real pain.

On an unrelated note, am I the only one who is in awe of the Shanghai Expo's ability to create even worse mascots than those of the 2008 Olympics?

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Stan Abrams over at China Hearsay just did a great post entitled, When Not To File A Trademark (yes, you heard me). It is based on Duncan Bucknell's post, (Five reasons not to file a trademark). They both list the following five reasons not to bother registering a trademark:

1 - your business is only ever going to be confined to a subset of a country (and not extend to the whole country);

2 - you can’t afford it just yet;

3 - you don’t actually care if people use your brand without your permission (there are business models where this makes sense);

4 - you have no real brand, you rely on a descriptive moniker which attracts volume based sales, not brand loyalty;

5 - the product or service is still confidential and you don’t want competitors to be able to get an insight into it by monitoring the trade mark databases.

I am going to analyze these five reasons with respect to China only and I am going to set out a few additional reasons why it does not always make sense to register your trademark in China. Lastly, I am going to talk briefly about two incredibly poor and dangerous reasons often given for not filing a China trademark.

I do not like reason number one for China. The reality is that if you want to protect your trademark anywhere in China, you need to register it. The fact that your business is going to remain confined to a particular region is irrelevant. If you do not register "your" trademark and someone else does, you will no longer be able to use the mark legally.

The second reason makes tremendous sense and it also does not. Yes, if you truly cannot afford to register the trademark, I guess you cannot do so. In some instances, if you are unable to protect what could very well be the most important thing your business has, well then you likely have business problems that extend well beyond trademarking. But if you are a small company that sells your product in forty countries, it may very well be impossible for you to register your trademark in all forty countries. Smaller companies do need to determine which countries really matter to their business and focus on those.

Reason three also has its problems with respect to China. Even if you do not care about other people using "your brand" without your permission, if you do care about someone else registering "your brand" and then preventing you from using it, you had better register it first. Remember, China is a first to register (not a first to use) country. What this means is that if someone has trademarked what you consider to be "your brand," that someone now owns the right to "your brand" and they can stop you from using it at all in China, including on goods for export.

Reason four makes sense. If you do not have a trademark to protect, you really do not have one to register either.

Reason five also makes sense, so long as you are not worried about someone else registering the trademark before you do so.

A couple additional instances where it does not make sense to register a trademark in China:

If you manufacture a product in China, but do not put your name on it until it has arrived back in the United States and you only sell your product in the United States, you do not need to worry about registering a trademark in China. If you are not using a trademark in China, you cannot be using someone else's trademark. For example, my firm is working on establishing a software R&D facility for a client right now and that client has no need for any trademarks because no product is going to be developed there, just code.

If your trademark will not be accepted for registration. We had a client whose product was named after a city in China. China's trademark office does not generally allow for registration of a geographic location as a trademark and so our client was faced with the decision of not having a trademark or having to change its "name." It chose no trademark.

The two bad reasons I most often hear for not registering a trademark in China (usually heard AFTER a problem has arisen) are that "we were not selling any product in China" or that we have a "famous" name and so we thought we did not have to file.

The fact that you are manufacturing your product in China just for export does not in any way minimize the need for you to protect your trademark. Once someone has "your" trademark in China, they have the power to stop your goods at the border and prevent them from leaving China.

Hardly any foreign company is so famous in China so as not to need to register its trademark there. And if you are so famous, does it still not make sense to spend the minimal amount necessary to register your trademark, as opposed to spending the huge amount necessary to defend the "famousness" of your trademark in litigation later on?

Stan ends his post with this sage advice for lawyers who help their China clients with these issues:

I would certainly advise China practitioners that, when in doubt, file the damn trademark — the cost/benefit analysis is a no brainer. However, if you can devote even a couple of minutes of time to thinking this through, you may find that the albeit small cost of registration may be needless spending. And if you can advise a client how to save some money, even if it’s only a few hundred dollars, they’re going to love you and give you more work in the future (i.e. if you are really trying to gouge your client for the cost of a trademark, not only are you being unethical, you are also extremely short-sighted when it comes to client management).

For more on China trademarks, check out "China Trademark Law: Simple And Effective."

Update: A client today asked me about using the Madrid System for their China trademark filings. My response was that in our experience, using the Madrid System usually ends up being just as expensive as filing in individual countries but in many countries, including China, is not as effective. Even though China is a member of the Madrid Protocol, China filed trademarks seem to get more respect than those filed under the Madrid System.

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A few weeks ago, I did a post emphasizing the need to follow China's laws so as to avoid jail time. My point (taken straight from Aimee Barnes) was that what actions that may be overlooked in your home country of Australia or the United States or some other Western country very well may be deemed to be criminal in China.

I just read a Sydney Morning Herald article on how an Australian mother of four spent two nights in a Thai jail and is facing a potential five years in prison for allegedly having taken a bar mat. I am not saying this same thing could happen in China, but then again, I am also not saying it could not. This article on the mom in Thailand ought to convince you that what happens in the West is not necessarily what will happen in Thailand or in China. Or as Apple would say, Think Different.

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I have a young relative who has for quite some time been "a challenge" for his parents. For years, whenever we would get together, we would all start out, charitably enough, by spending around thirty seconds talking about how "he's getting better." For the next ten to fifteen minutes we would then enumerate all the things he had done that made us all feel good he was not our child.

China's intellectual property protection tends to get the same treatment. There seems to be near universal agreement that things are getting better in China, and yet the focus is always on how bad things are. The International Trademark Association (INTA) is putting on its 131st annual meeting in Seattle this week and since I am nearly fully booked for breakfast, lunch, and dinner with someone attending, I figure I am going to be getting asked a lot about China's progress on IP.

My answer will be as follows:

Trademark. Much, much better than widely believed. Much (though certainly not all) of what you hear a about foreign companies having trademark enforcement problems in Chinese courts is due either to their own mistakes in not registering their trademark or in not vigorously enforcing them. Proof of the value of China's trademarks is that the Sanlu name just sold for more than a million dollars.

Copyrights. Yes, it's bad out there. But it is getting better. So much so, that now, nearly without exception, we are telling our software clients that they should register their copyrights in China. Proof is that the Wall Street Journal's China Blog just did a post entitled,
"Global Software Piracy Gets Worse, But China Improves." The gist of the story is that in 2004, 90% of the software in China was pirated but that declined to "only " 80% in 2008.

Patents. Patents are doing about like copyrights. Things are pretty bad, but things are getting better.....

What are you seeing?

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You got to know when to hold em, know when to fold em, Know when to walk away and know when to run. You never count your money when youre sittin at the table. There'll be time enough for countin when the dealins done. -- Kenny Rogers, The Gambler

A couple weeks ago, a long time client of mine called me with a concern. This is a tech products company that has been doing business globally since forever and with China for at least five years. It is a small, but very successful company and my dealings are typically with the company owner, which was true this time. Its product sells for around $100,000 each.

I am going to have to be pretty vague here, but I can lay out the essentials. My client had been working with a Chinese company (let's call this China Company A) to which it had been selling its product for years. This Chinese company had told my client that a very large and clearly state owned company (China Company B) was interested in using China Company A to secure my client's product, with China Company A assisting in installation and ongoing service. Needless to say, my client was very interested. A few weeks later China Company A tells my client the deal is "done" with China Company B, but that as soon as my client receives the first payment from the deal, it will need to send 10% of that payment (and the same percentage from any subsequent payment) to China Company A to pay to a person who is with China Company B. China Company A explains that it was able to get this sweetheart deal by agreeing to make this payment.

My client calls me.

He tells me that even with paying out the 10% "commission," this would still be a good deal for him. But it is far from a make or break deal for the company and the company will be just fine without it. He tells me this deal (then adds, "make that no deal") is not worth going to jail over. I tell him that I am not expert in the Foreign Corrupt Practices Act (FCPA), but this deal has all the indicia of coming within that Act and he should NOT go forward with it unless it changes substantially.

We then decide he will go back to China Company A and make very clear, in writing, that the US company will not pay anyone at China Company B anything, either directly or indirectly and that China Company A is also forbidden from paying anyone at China Company B anything either. China Company B a commission. My client will tell China Company A that if the deal cannot go forward without paying this person at Company B, it will not go forward at all. We also decide that If China Company A comes back to my client and says the deal is still a go, we will bring in an FCPA expert to figure out whether my client should go forward with the deal under this scenario and, if so, what steps it should take to avoid setting itself up for FCPA problems.

Within a few days, China Company B comes back and tells my client the deal is off. My client thanks me for my counsel and I apologize for his deal having been ruined. He tells me he is fine with it and that it was apparently never a real deal in the first place. Smart client.

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In her post, Hot Water in China? Don’t Get Burned: Part I, Aimee Barnes highlights how important it is for foreigners to follow the law in China. All of the laws. All of the time. No matter how much you may disagree with them, no matter how silly you may find them, and no matter how different they may be from those to which you are accustomed. Most importantly, you must strive to follow the law no matter how much you may see those around you disobeying them, particularly if those you see are not foreigners.

Ms. Barnes puts forth the following list of what to avoid if you "want to steer clear of a legal snafu and avoid hanging out with the Public Security Bureau or other inmates at a local jail" ....even if they’re not a big deal in your own country":

1. Driving without a Chinese drivers license
2. Leaving “home” without your residency permit and passport
3. Living or cohabitating illegally
4. Letting your visa expire, visa overstay
5. Participating in “under the table” deals in any way, shape or form
6. Carrying or doing drugs, even if it’s just a plant that you picked off the side of the road
7. Attempting to bring back large quantities of counterfeit goods to your home country
8. Mouthing off or being generally uncooperative with a Public Security Bureau officer
9. Taking pictures of military exercises, crime scenes or police activities
10. Bribing a police officer or official to “let you off the hook”
11. Use of GPS devices
12. Real-time blogging of protests or other police activities
13. Openly criticizing China’s government, politics and/or leadership
14. Conducting or operating a business without ALL of the necessary permits
15. Working “under the table”

Trust me, I have dealt with or heard of criminal law type problems arising from most of the above. In fact, I was in the midst of writing a "just say no" post on kickbacks when I came across Aimee's post. Last week, a client and I very quickly decided that it would not be worth it for him or his company to pay a 10% kickback to someone at the state owned entity that was about to sign a five year contract with my client. It did not take much analysis on our part for us to determine that the potential Foreign Corrupt Practices Act (FCPA) repercussions from this deal dwarfed whatever money his company might make. We decided he had no choice but to go back to his contact and make crystal clear (in writing) that the only way to go forward with this deal would be on such and such terms.

I would add the following to Aimee's list:

16. Importing something into China that is not supposed to be imported into China. This includes things for your business that might be perfectly legal elsewhere or even perfectly legal to use within China;
17. Doing business with a country with which you are not supposed to be doing business;
18. Selling something in China that foreigners are not supposed to be selling in China;
19. Conducting a business in China that foreigners are not supposed to be conducting in China;
19. Illegally raising funds in China;
20. Engaging in financial fraud in China. China's definition of this can be fairly broad;
21. Engaging in environmental crimes

Now I know that many of the above twenty-one items are oftentimes handled with a slap on the wrist (sometimes even less than that) or deportation, but the problem is that the authorities do have tremendous discretion to turn what we might think of as a civil matter into a criminal one.

My advice (once again) is as follows (yes, I know this is really basic, but please bear with me).

1. Know the law and follow it, not what someone tells you they heard someone else get away with. There are murderers who never get caught, but that does not make it legal nor does it mean you will get away with it. Want to know the law? The best way is to read the webpage of your embassy or consulate or chamber of commerce and to talk to people at your embassy or consulate. Or hire a lawyer who deals in this arena every day.

2. Keep a copy of your visa and your passport with you at all times. Make sure everything is current.

3. Be civil. Be respectful. Keep your cool. Tell the truth. If you get caught in a lie you are done. Done. Do not make jokes and especially do not make jokes about China. Do not act arrogantly. Act respectfully (I am intentionally being repetitive). Make the job of the authorities easier, not more difficult. Just remember, the people in front of you are just doing their jobs and no matter what you do, your actions that day will not advance democracy or human rights or any other ideal one iota further in China.

4. If nothing seems to be working, ask if you can call your embassy, your consulate, your lawyer, your Chinese joint venture partner, or anyone else you think might be able to help you. Immigration/law enforcement people in every country of which I am aware have amazing flexibility. They are human beings. Give them a reason to cut you a break. This does NOT mean paying a bribe, which has the very real potential of getting you in worse trouble than being deported.

5. If you think you might have China visa or other legal issues down the road, deal with them now. Start your application, find the right lawyer, talk to your embassy or consulate. Whatever. Just do not wait.

If you ever get caught or ever get accused of committing a crime in China, my advice is to not make light of it in any way. This means you do not complain about the law, this means you do not talk about how what you did is legal somewhere else and this means you seek to hire a top-flight Chinese criminal lawyer as quickly as possible. There are definitely such lawyers, but our experience is that they virtually never speak English. This means that if you are not completely fluent in Chinese, you also need to retain someone who truly is bilingual.

What would you add to the list?

For more on the criminal side of living and doing business in China, check out the following:

-- "Amazing Lawyers and The Criminal Side of China Business"
-- "Criminal Law and Business in China -- A Strong Caution"
-- "Foreign Partners In China Crime Do The Time"
-- "Bad China Products. Hey It's A Criminal Thing"
--"Bad China Products. Hey, It's A Criminal Thing, Part II"

One Adam 12 .....

UPDATE: Off The Record Blog did a follow-up post on Aimee's post, entitled, "When in Rome … follow the law, damn it!" This post makes a very good additional point. If what you are thinking about doing is illegal in your own country, it almost certainly is also illegal in China too, but the penalty for an infraction is likely to be much stiffer:

When you enter China, as with any other country, your visa has an invisible caveat emptor attached to it. You really do need to be aware of local laws and customs and abide by them; even if the locals do not appear to do so themselves.

One rule of thumb I have always followed is that if it is illegal in my own country, even as just a minor infraction there, it is probably illegal in a country like China. Here, however, particularly if you are a foreigner, the punishment is most likely going to be much more severe. For example, while your country’s own police might turn a blind eye to drunk and disorderly behaviour or let the offender off with a small fine, Chinese police are more likely to see you as a foreign trouble maker they can do very well without. Visitors to Beijing should not be surprised to find themselves in a prison cell for several days followed by a quick deportation after a heavy night investigating the Sanlitun bar scene.

Very true.

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One of the great things a about being a lawyer is that we hear all kinds of things from our clients and potential clients. And then when we start hearing those same things on the blogs, we know something is up. I am hearing a lot of things about the difficulty of getting anything but a three month visa.

I actually got a call from a potential (very broadly defined) client the other day wanting our help in getting him a one year visa. He "owns" a business in China and it is "absolutely critical to the point of it being do or die" that he be in China at the end of May. He had applied for a business visa (an F Visa) and been turned down cold and essentially told not to bother coming back until 2010 to try again. We talked a bit about what he was doing in China and it turned out he had set up an internet business with a Chinese "partner" where, on the books, his Chinese partner owns the business entirely, but this American has an oral agreement with the "100% trusted"Chinese partner that the business is really owned 50-50.

I hate these sorts of arrangements for thousands of reasons, and the inability of the foreigner (in this case the American) to have easy and relatively secure access to a Chinese visa only ranks about 60th on the list (way behind losing the business entirely). Anyway, this guy seemed really panicked and I got the strong sense it was finally starting to dawn on him how easy it would be for his "100% trusted" Chinese partner to simply cut him out, especially now that he would almost certainly end up letting the business down by failing to come to China for this "super important" May event. I ended up telling him that it would not make sense for him to hire an American law firm to help sway the China visa office and that he should probably just retain one of those Chinese "fixer-type" firms that charge a lot and half the time seem to pull off miracles and the other half of the time seem to just run off with your money without doing anything. He asked me for the name of a good one and I begged off.

I also suggested he think about turning his stealth business into a legitimate WFOE or joint venture, such that he could qualify for a Z visa (an employee visa). He did not seem terribly interested, but said he would get back to me on that. There is no way this "solution" could be done soon enough to get him a China visa by late May.

This was actually the second call like this in the last two weeks and when I couple this with the rumors of visa tightening I have been hearing from clients and lawyers in China, I knew something was up. The always excellent Shanghai Scrap just did an aptly titled post, "Visa Madness All Over Again,"explaining the situation and why there is a situation.

Seems Shanghai Scrap (Adam Minter) had just learned that a high-powered Beijing industry conference he was going to attend in May had been canceled because so many foreigners would be unable to secure visas for coming:

Moments ago, I received a phone call from the organizers of a major industry conference and exhibition scheduled for Beijing in late May. For the sake of the people involved, I’m not going to name the conference or the industry, except to note that it is a very, very big industry employing many, many Chinese people in factories receiving a whole lot of Chinese economic stimulus funds. As for the conference: it’s being sponsored by a major Chinese trade group, several major Chinese state-owned enterprises, a notable division of Xinhua, several major foreign trade publications, and one foreign newswire. The people who own and operate companies in this industry (or, heck, analyze them) are not, generally, rabble-rousers. Indeed, they tend to be very conservative, verging on boring, with a strong preference for what some people like to call “stability.”

The explanation from the conference representative was that "because of the 60th anniversary of the Communist Party the visa policy changes. So we will postpone until November. Perhaps you can attend then?”

Minter notes that it is actually the 60th anniversary of the founding of the People's Republic of China (PRC) and then rightly compares the existing visa situation to that of the Olympics:

Even short memories will recall the Olympics-related visa restrictions from last year (see here, and countless other places). Then, the authorities were concerned with disrupting anyone who might care to disrupt a high profile international event. They may very well have succeeded; I don’t know. But what I do know - and so does everyone in Beijing who hoped to make a buck off Olympic tourism - is that they also succeeded in dissuading tourists from visiting China. Fine and good. Now, the 60th anniversary of the PRC is not the Olympics - that is, it’s not an international event - but one can argue that, in light of the global financial crisis, China needs international visitors now more than ever. After all: Hotel vacancies are on the rise; FDI is down; exports are down. At the same time, the US, China’s most important trading partner, is finally showing a willingness to approach China pragmatically, instead of ideologically. I don’t claim to understand a tightening of visas under these circumstances, but I can’t imagine that it helps it economically, or diplomatically, over the next several months.

Shanghaiist also has a post on the tightening visa situation,entitled, "F Visas will be scarce during upcoming anniversary." Shanghaiist links its readers over to "amazing visa procurers Meshing Consultancy Service, which on its site has the following to say about tightening visa requirements:

From 15th Apr 2009, Oct 2009 is our China 60 Years Liberation ceremony(very huge ceremony). The visa policy start to become tight again from now. According to that, right now, we can get 6 month F visa with maxmium 2 entries(you can leave and come back 2 times during the 6 month), multi-entries or 1 year F visa is not available, and the 6 month visa will only valid till the end of Sept.

Bottom Line. There are three very important things that should be taken away from all this. One, if you need certainty in terms of being able to get into China, you cannot rely on either an F visa (business) or an L visa (tourist) for that. Two, if you need certainty in terms of being able to get into China, the solution is usually to legitimately set up your own company so you can get a Z visa (employee). Three, and probably most important, is that the Chinese government will nearly always place politics and stability over economics.

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I should have waited a couple of days.

The day before yesterday, I did a post on foreign employees getting sued in China by their ex-employees, entitled, "Wanna Get Sued In China? Your Ex-Employees Can Help." Today, Corporate Counsel Magazine came out with a related article, in which I am quoted. The article is entitled, "Companies Considering Layoffs in China Must Coordinate With Government." It is written by Anthony Lin, an attorney and Chief Asia Correspondent at Incisive Media. The article does a great job describing the topsy-turvy labor situation in China these days.

The article starts out by setting the stage regarding the Chinese government's somewhat contradictory messages:

Beijing is doing what it can to stanch the loss of jobs by downplaying some aspects of the new labor law and emphasizing others. Even before the economic downturn hit, companies complained that they would have to get rid of employees because the statute's social welfare provisions were a burden. Now that the government seems eager to preserve jobs at all costs, businesses are being excused from complying with some of these requirements.

On the other hand, a provision in the new law that covers layoffs has been strengthened. While the provision says that companies must notify local governments about large-scale job cuts, some officials now claim the right to approve layoffs, too. Many foreign companies operating in China don't have to worry about this because they outsource their work to local suppliers (whose compliance with the law varies widely). But some multinationals with direct employees in China have conducted substantial layoffs, apparently with behind-the-scenes counsel from government officials. According to Asia-based employment lawyers, these companies were advised to have their employees sign termination agreements that circumvent the labor law almost completely.

It then nicely summarizes China's "new" labor contract law:

The new law contains several social welfare provisions, including requirements that employers make larger contributions to pension and insurance funds. More controversially, it requires employment contracts for a much greater proportion of workers. These contracts must spell out exact job descriptions and pay, including overtime. Workers with over ten years' experience are also entitled to employment agreements of no fixed term. In the event of legal termination, contract employees are entitled to one month's severance for each year of employment, up to 12 months.

It then details the issues foreign companies are presently facing in China with respect to their workers. Do they follow the law to the letter or do they go along with the winks and nods they are getting from (mostly local) government officials who seem to be stressing job preservation above strict adherence to the law?

I chime in on this debate:

"This idea that nothing else matters except jobs is definitely out there," says Daniel Harris, a partner at Harris & Moure in Seattle who also authors the China Law Blog.

Other government officials are more subtle about dismissing the labor law's requirements. Harris says that one of his clients, a food processing company operating in Shandong, discussed the statute with a local bureaucrat. According to Harris, "The official basically told [my client] not to worry about it." Harris advised his client to ignore the official, which the company did.

The head of Baker & McKenzie's (check out this link!) China employment practice concurred with my advise:

Andreas Lauffs, the head of the China employment practice at Baker & McKenzie, agrees that foreign companies shouldn't take advantage of reprieves even if they're offered. "Multinationals always need to follow the law," says Lauffs.

The article then notes what is probably the chief difference between US and China labor laws: employment in China is NOT at will, as it is in the U.S. For more on this difference between US and China labor laws, check out "China's Labor Laws: The Cultural Disconnect Goes Both Ways."

The article then does a nice job of getting down to the brass tacks and explaining what is generally going on in China right now regarding foreign company layoffs and what foreign companies need to do if they want to layoff employees and yet stay in good graces with the government. The conclusion is the same as that which I put forth in my premature post the other day. If you are going to layoff workers in China, you should negotiate their severances and you should make sure each and every laid off worker signs a contract (in Chinese, obviously) setting forth the terms of their termination and blocking them from pursuing litigation against you.

The first step for multinationals that want to shrink their Chinese workforce is to consult with the local office of the Ministry of Human Resources and Social Security. [Susan] Munro[an attorney at O'Melveny & Myers] says ministry officials have been suggesting alternatives like wage cuts or reduced hours. They've also pushed for the delay of layoffs, hoping that companies' fortunes will shift. "They know that a lot can change in two months," Munro says.

Companies that really need to cut workers can generally do so, but the key is to get employees to agree to their own dismissal. "The only way out is individual mutual termination agreements," says Lauffs. In these pacts, employees consent to being laid off in exchange for their contractual severance compensation and a small amount of extra money, perhaps a few weeks' pay. Getting employees to agree to such deals avoids triggering the layoff provision of the labor law, says Lauffs, even if the number of employees eased out is far more than 20.

It then notes how employees are favored in disputes with their ex-employees (with whom it does not have a termination agreement). Our experience says that if a Chinese ex-employee ends up pursuing legal (or governmental) remedies against its American employer, the American employer is going to lose virtually every time. Arguments like the following have virtually no chance of prevailing:

1. This person was an independent contractor, not an employee.
2. This person was a terrible employee.
3. This person and my company had an agreement that the position would be for only two months.
4. We specifically told this person never to work overtime.
5. This person's high salary was based on our agreement that he/she would not get paid for overtime.
6. This person's high salary was based on our agreement that we would not make pension payments.

My sense (and it is just a sense because we have not heard about or been involved in enough cases to be able to base anything on empirical data) is that because the US employer will lose just about every time, the best strategy is nearly always to negotiate an agreement with your soon to be ex-employees if at all possible. The fact that this article seems to conclude that this is what the large multinationals have been doing lends further credence to this.

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China Daily (h/t to my friend Brian over at China Challenges) just came out with an article headlined, "Cases soar as workers seek redress."

The article gives facts behind what many of us already knew: "the number of labor disputes heard by courts has skyrocketed this year." I knew it because my firm's handling of such matters has probably just about doubled in just the last three months. According to the numbers, employee cases have increased by 59 percent over last year. The article rightly ascribes this increase to three things: 1) the economic downturn; 2) "Ever since the implementation of the Labor Contract Law in January 2008, workers have become more aware of their rights and the legal avenues available to safeguard them:" and 3) A reduction of costs for such suits to at most 10 yuan.

We are finding that most of these cases arise from one (or more of the following):

-- Firing of an employee for a reason not explicitly mentioned in the employer manual or not having an employer manual at all.
-- Firing of an employee who was not paid overtime.
-- Firing an employee who did not have a written contract.
-- Discontinuing a relationship with someone whom the "employer" never considered to be an employee.
-- Firing an employee for whom the employer did not make required social insurance or pension payments.

The article makes clear the government's position on all this:

We encourage enterprises to assume more social responsibility, and try not to lay off workers or reduce salaries. On the other hand, we suggest workers show more understanding toward enterprises in financial difficulties.

Still, courts will punish such violations as arbitrary retrenchment, and guide employees and enterprises in resolving disputes through shorter working hours, training shifts, temporary vacations or salary negotiation.

As bad as all this sounds, my firm's experience with these cases has, almost without exception, revealed the following:

1. Those foreign companies being sued or threatened with legal action did indeed fail to abide by China's labor laws. This is a good thing because it implicitly means that those companies that follow the laws are far less likely to get sued.

2. Even when the foreign company was clearly in the wrong, it has been relatively easy and inexpensive to settle these lawsuits quickly. Our experience says that the employees are very quick to trade some money now for not having to go through the uncertainty of collecting more money at some indeterminate future date.

The obvious take homes from all this are that it does pay to comply with China's labor laws (including those regarding overtime and payment of pensions) and that if you are sued, it pays to act quickly to try to settle. Settling quickly not only usually makes sense for the instant case, we are also finding that it makes sense to stay in reasonably good graces with the powers that be.

Back in November, 2007, in our post, "China's New Labor Law -- It's A Huge Deal. Huge I Tell You," we pretty much predicted all this. In one comment, I talked about how the new law is not dependent on the government:"It requires lawyer enforcement and there are plenty of hungry lawyers in China who will sue early and sue often on this. I can assure you of that." I predict these cases will continue to increase over the next year or two, but declining after that as the economy improves and as companies finally get wise to the fact that these laws are being taken very seriously and will not be revoked.

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The Wall Street Journal Law Blog did a post the other day touting Chinese drywall as the next big mass tort action in the United States. The post is entitled, "Does the New Product-Liability Boom Lie . . . Inside the Walls?" and to the extent it hints at a "yes" answer, it is likely going to be dead wrong. It is going to be wrong because it ignores one critical point. The US plaintiffs are not likely going to be able to collect anything from the Chinese defendants by suing in them in the United States and collecting from the German defendants is likely to prove difficult as well.

WARNING: I am going to have to get rather technical in this post as there is really no other way to handle a subject as legalistic as enforcing a judgment overseas.

Near as I can tell, the US drywall plaintiffs are mostly suing the Chinese manufacturers of the drywall and the name most often mentioned for that Knauf Plasterboard Tianjin Company. Additionally, the plaintiffs are also naming Knauf, a German company that appears to be the base for the Knauf empire worldwide.

I have written many times on how US judgments are of virtually no value in China. Put simply, Chinese courts simply do not recognize them for anything. They cannot be converted to a Chinese judgment and they are not even evidence of anything. For example, see "Enforcing Foreign Judgments in China -- Let's Sue Twice" and "Taking Judgments To China (And Korea), Let's Not Sue Twice." Nothing has changed and I cannot see how a US judgment against a Chinese drywall manufacturer will have any value, unless the Chinese drywall manufacturer has assets in the United States or in some third country that will enforce the US judgment.

It all reminds me of the melamine in pet food cases. I actually called one of the plaintiff's lawyers who was suing a Chinese pet food company and asked him how he planned to collect on any eventual judgment. His response: "to be honest, I haven't thought of that yet. I figured I would get the judgment first and then deal with it."

Even if the plaintiffs succeed in finding Knauf Germany liable, they will still face some of the same issues in terms of taking the US judgment over to Germany to get it enforced. My law partner, Nadja Vietz, who is a licensed German (and Spanish) attorney, wrote a cover story on this just last month for the Washington Bar News. Her article is entitled "Will Your U.S. Judgment Be Enforced Abroad?" and it focuses on how to get US judgments enforced in Europe.

Nadja starts the article describing an all too typical scenario:

My law firm is frequently contacted by U.S. lawyers with judgments they are seeking to enforce overseas. The lawyer is seeking our assistance to enforce its U.S. court judgment against a foreign company that did business with the lawyer's U.S.-based client. The procedural history is nearly always the same. The litigator served the defendant and, several months and many dollars later, he or she now has a U.S. judgment. When the foreign company refuses to pay even pennies on the dollar on the judgment, the litigator realizes the judgment will need to be taken overseas for enforcement. Only then (and usually not until we relay this information) does the litigator realize very few countries will enforce U.S. judgments. To have a chance at collection, the case often must be tried anew, only this time in a far less sympathetic forum.

Nadja then offers some suggestions on how to avoid these problems through better contract drafting, "emphasizing European and, particularly, German legislation." The problem with the drywall cases, however, is that there almost certainly is no contract between the homeowners and the German or Chinese drywall companies and the contracts between the US contractors and the drywall companies were probably not written with these sorts of cases in mind.

Nadja explains how foreign courts do not even like US judgments:

The United States is not a party to any bilateral treaties or multilateral international conventions governing reciprocal recognition and enforcement of foreign judgments. The reasons for the absence of such agreements seem to be that foreign countries perceive U.S. courts (particularly U.S. juries) as granting excessive awards (particularly in tort cases and particularly with respect to punitive damage awards) and as too often asserting extraterritorial jurisdiction and disregarding international law. Absent a treaty, the question of whether the courts of a foreign country will enforce a U.S. judgment is governed by the local rules of the foreign country and by international comity.

Most countries do not enforce US judgments and they particularly do not like tort judgments, as they view US tort damage awards (which would most likely be the sort of award the plaintiffs in the drywall case will receive) as excessive:

Generally, U.S. judgments cannot be enforced in a foreign country without first being recognized by a court in that foreign country. The recognition and enforcement of U.S. judgments depend not only on the domestic law of the foreign country, but also on the principles of comity, reciprocity, and res judicata. Foreign courts generally do not recognize U.S. money judgments unless: (1) the U.S. court had jurisdiction; (2) the defendant was properly served; (3) the proceedings were not vitiated by fraud; and (4) the judgment is not contrary to the public policy of the foreign country. Most European countries have similar code provisions, setting forth something along the lines of these four rules, but enforceability of U.S. judgments still varies widely from country to country, even within Europe. Some countries tend to enforce U.S. judgments, and some countries virtually never do. It can generally be said that non-default judgments not involving tort claims or punitive damages are more likely to be enforced.

Nadja then sets out the three most common reasons for European courts refusing to enforce a US judgment: "when the U.S. court lacked jurisdiction, when the defendant was not properly served, or when there are public-policy concerns."

U.S. Court Jurisdiction European courts will not recognize U.S. judgments if the U.S. court lacked jurisdiction. Special attention needs to be paid to the fact that for purposes of recognizing foreign judgments, jurisdiction must be determined by the law of the European country, not by U.S. law. For instance, under the so-called "mirror-image principle," German law projects its own jurisdictional rules on the foreign court, which is then treated as having international jurisdiction if a German court would have had jurisdiction had the situation been reversed.

It can hardly be said to be clear that a German court would assert judgment over a US company that owned a Chinese company that sent drywall into Germany and so it is also quite possible a German court would deny enforcement of any US judgment against the German defendant in the US drywall cases.

Surprisingly, US plaintiffs oftentimes fail to properly serve foreign defendants as well. They frequently just assume that personal service of the company at the company's main office will be sufficient, even though this usually is not the case. I will not go into the various service mistakes my firm has seen in those cases where we have been retained by other law firms to try to enforce a US judgment overseas, but I estimate that service has been done improperly in about half those cases.

The German courts will also likely at least hesitate to enforce a drywall judgment on public policy grounds as well. Nadja sets out what is meant by "public policy" when it comes to European courts enforcing US judgments:

Public Policy.European countries will not recognize foreign judgments where doing so cannot be reconciled with their own laws. Enforceability will be denied if major principles, such as the violation of fundamental rights or fundamental principles of local civil procedure or the like, were disregarded by the foreign court that granted the judgment.

Since punitive and treble damage awards are generally regarded as excessive and contrary to the public policy of most European countries, these almost always should be removed from the U.S. judgment before taking it to Europe for recognition and enforcement. Our experience is that the U.S. federal courts are quite willing to give a new judgment with these damages removed, so as to make their judgment more likely to be enforced overseas.

My concern in the drywall cases is that the US law legerdemain that will likely need to be employed to find the German company liable for what the Chinese company apparently did will be the exact kind of thing that a German court will find violative of Germany's public policy.

Maybe I should call this lawyer and ask him to show me the money...........

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Last year, I wrote an article for the Complete Lawyer, entitled, "Working with Korean and Chinese Lawyers." I was originally asked to write on working with Asian lawyers, in general, but convinced the magazine to allow me to focus on just China and Korea. I asked for this limitation because I did not believe myself experienced enough in working with lawyers from other Asian countries to write about working with them and, more importantly, because I did not see enough similarities to talk of Asia as a whole.

I was reminded of that article today after receiving a complimentary email from a Chinese lawyer studying law here in the United States.

An article like this has to generalize a bit and there are certainly exceptions to everything I say, but having worked with dozens of law firms in Korea and China, I have noticed the following four problems in dealing with lawyers from those two countries, respectively:

KOREA

1. Non-responsiveness is the norm. American lawyers generally see their role as helping clients achieve their goals and keeping their clients informed. Korean lawyers operate far more independently. They consider themselves the legal experts and can get offended when questioned. According to their perspective, a client should trust them, not ask questions, and not expect updates.

This obviously does not work well for American clients. Two excellent Korean law firms have admitted to me they “always get fired” when they work directly with American companies or with American lawyers inexperienced with Korea. If a Korean lawyer has a hearing scheduled in a case, I email him the day before to urge him to provide me with a full report by the next day, at the latest. I usually send another email reminder after the hearing concludes and if I do not have a timely report, I call.

2. Your matter is not important. Most Korean lawyers have plenty of work and any one matter from an overseas client is not likely to be of paramount importance to them. This may mean your Korean lawyer will not fight hard on a particular motion where the chances of winning are low; he or she would rather stay in the good graces of a judge or fellow lawyer than challenge the status quo. I try to get around this by hiring “outsider” lawyers if my case is going to be particularly difficult or contentious, or by attending the hearing if it is particularly important. I also always make clear, upfront, that a good result for this client will lead to more work from my firm's other clients.

3. The Korean lawyer’s role is different. Korean lawyers tend to view themselves as “above it all.” I learned this when, trying to settle a case, we offered $900,000 and the Korean company on the other side offered to pay us $700,000. I asked the Korean lawyer to go back at $850,000 and I could feel his reluctance. I say “feel” because while he was telling me he would go back at $850,000, he was also asking me questions to let me know he did not think he should go back at $850,000. Weeks then passed with no updates and vague responses to my emails. Then, out of the blue, a US-educated paralegal from the firm called me to say the $850,000 offer had never been passed on because the Korean lawyer considered it beneath him to negotiate “as though at a flea market.” I do not know if that paralegal was put up to the call by the attorney or if he called me on his own, but I have since learned to control negotiations myself. It is not just in negotiations that the Korean lawyer sees himself as above the fray. If you do not put pressure on your Korean lawyer, you can pretty much assume that numerous time extensions will delay your case for years.

4. Confidentiality? What’s that? Korean lawyers simply do not respect the attorney-client privilege the same as American lawyers do. I try to handle confidentiality problems by using the same few lawyers in Korea for all of my firm’s clients. Because I provide so much work to these attorneys, I have a personal relationship with them, which makes it less likely that they will hurt me by hurting my client. It also decreases the incentive for the Korean lawyer to hurt my client because doing so will cut off the regular stream of work my firm provides.

CHINA

There are many lawyers in China scrambling for work, but most of them have neither the experience nor the language skills to handle international clients. The problem is that most either do not know this or will not admit it. The four most common problems I see in retaining Chinese lawyers are:

1. Chinese law firms often aren’t “firms” as we understand the term. There are very few really good Chinese international law firms in China and many of them are not really firms at all; they are a collection of solo practitioners. Many American companies think they are using the best lawyer in a firm for a particular matter when in fact that lawyer has the case not because of his skill set but because he or she is the one who brought the case in.

2. Chinese lawyers are rarely power brokers. The importance of connections isn’t as strong as it once was, though it is still a factor in certain industries and certain parts of the country. Chinese lawyers are usually not well connected (even if they are reluctant to admit it) so hiring a lawyer as a power play is rarely recommended. China’s good lawyers are very smart and very well educated, but if they were truly well connected, they would most likely have a top position in the government or with a big company, and they would never have attended law school in the first place.

3. The Chinese lawyer’s role is different. Chinese lawyers far too often see their role as doing what the client tells them to do, rather than telling the client what should be done. If a client calls me and says she wants to do A, my knee-jerk response is to ask why. The typical Chinese lawyer’s response is to say yes.

4. Chinese lawyers do things the Chinese way. Chinese companies can get away with all sorts of things in China that American-owned companies cannot. Chinese lawyers tend not to account for this. Chinese lawyers also almost never know the various US law strictures under which American companies must operate. The Foreign Corrupt Practices Act is a classic example. There are also many things American companies can do legally in China that would be a public relations disaster back home. This is particularly true regarding labor relations and environmental stewardship.

As always, I would love to hear what you think. I particularly welcome comments from those who have worked with (or for) Korean or Chinese lawyers and from Korean and Chinese lawyers. Have at it people.....

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Last week, I attended co-blogger Steve Dickinson's lecture on China labor law. Steve's lecture was part of a truly superb Doing Business in China seminar put on by Global Nav. The thrust of Steve's speech was that labor laws in China have changed, they are being enforced against foreigners, and they are very different from U.S. labor laws. In a nutshell, the biggest differences are that written contracts with all employees are required in China and firing an employee generally must be for cause. Neither of these are true in the United States.

Judging from the audience questions (and this was an extremely sophisticated audience), many were surprised by this and many had trouble understanding the full import.

A few days later, Steve and I were talking about this with the Chinese lawyers we work with in Qingdao. In explaining to them some of the cases we have handled for American clients who got themselves into trouble by improperly laying off Chinese employees, it soon became apparent to Steve and me that the Chinese lawyers were not grasping why these American companies were making these mistakes. They would ask questions like, "how could these American companies really believe they could lay off 100 people without first securing their approval and that of the government as well?" When Steve and I told them about US labor laws, the Chinese lawyers found them so bizarre, they actually laughed.

We told them of how there is a saying in the US that one can fire an employee for good reason, bad reason, or no reason at all, just so long as the reason for firing is not one prohibited by law (such as racial or gender discrimination). We talked about how one might fire an employee for wearing a green shirt. We told them of how most employees in the United States do not work under written contracts and how companies generally prefer not to use them. It took us at least a half an hour for us to give a basic explanation of employer-employee relations in the US and even then, it was pretty clear that these exceedingly bright lawyers were still nonplussed.

It was a good exercise for Steve and me and only reinforced why it is that Americans (the labor laws in Europe are not so wildly different in China) in China so often act on Chinese employment law matters based on completely false assumptions as to how things are really done there.

For more on China's Labor Contract Law, check out the following:

1. A podcast with Steve over at the China Business Network.
2. "China's New Labor Law As Plague On All Employers' Houses."
3. "China's New Labor Law And Why Vietnam Is No Big Thing."
4. "The Impact Of China's Labor Contract Law."

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China Daily did an article the other day on how China's courts are now going to post its unpaid judgments online. It is entitled, "Court launches website showing who hasn't paid." A bit of background is in order.

China's court system (and I am talking about commercial disputes ONLY) is not as bad as is so widely believed in the West. Foreign companies can sue and win against Chinese companies and they can and do. All the time. But winning a lawsuit and getting paid on a lawsuit are two very different things, both in China and everywhere else in the world.

Many years ago, my firm brought a cross-border lawsuit against a foreign company on behalf of about 35 mostly foreign companies. The clients would often ask me if I thought we were going to win the lawsuit and my response to that was always, "yes, we are almost certainly going to win. Defendant took money that should have gone to you without your approval or authorization. This is about as blatant a breach of contract as one will ever find. But that is not really the right question here. We are almost certainly going to win, but the real question is whether our winning in court will lead to everyone getting paid. In other words, does defendant have the mult-millions necessary to pay everyone and will the court in X country really enforce the judgment. The problem with that is that we will not know the answer to that until months after we win." We eventually settled that case, compromising the various claims based in large measure on the uncertainty of collection.

China is notorious for being a country in which it is very difficult to collect on a judgment. Had someone asked me what percentage of Chinese court judgments actually get paid, I would have guessed around 50%. Turns out more like 75% of judgments get paid, at least according to the China Daily article.

Now, in an effort to improve that figure, China's courts are going to put online the names of all judgment creditors who have not paid the judgments issued against them. This is big. Really big.

Here's what China Daily has to say about the need for this online dunning and the results it is likely to achieve:

The public can log on to http://zhixing.court.gov.cn/search/ and search individuals and groups to see if they have any pending obligations from civil court rulings nationwide, Jiang told a press conference yesterday.

Prior to the online service, members of the public who wanted to search civil cases had to submit paper-based enquiries to local courts.

"An online platform is the most direct and effective method for the public to learn the results of court rulings nationwide," Ren Jin, a law professor with National School of Administration, told China Daily.

An individual will face moral and mental pressure and even lose employment and economic opportunities for poor credibility if he or she fails to carry out a court ruling, Ren said.

As the global financial crisis expands, it becomes more important to establish a system of credibility to prevent and resolve social and economic crises of all kinds, Ren said.

The online platform will help lower risks of market management and solve problems from the start, Ren added.

The failure of the courts to enforce verdicts on civil cases has been a significant challenge for the country's judicial system, with many litigants possessing limited awareness of legal proceedings and refusing to fulfill their legal obligations, Jiang said.

"The fundamental reasons lie in the lack of a deterrence," Jiang said.

"Those refusing to comply with court rulings should face heavier costs in their morality, creditability and property than the costs of an enforcement."

The website is a prelude to a systematic improvement of the enforcement of court rulings nationwide.

Interestingly, within hours of my having read this article, I found myself in a discussion with Sam Goodman on the importance of "face" in China business. Sam is a long-time China-based entrepreneur who will soon be out with a book on doing business in China. And I am betting it will be a really good one.

Sam is of the view that face is critical for China business. I generally agree with him, but with many caveats. First off, I do not like the word face. I do not like that word because I am not sure I understand what it means and I do not think most Westerners understand it either. It is just too loaded with exotic connotations. I prefer using everyday words like "respect" or "reputation." Sam and I agreed on how Americans doing business in China so often get frustrated by a Chinese company's unwillingness to admit it made a mistake. I told Sam that I thought the unwillingness to admit a mistake has to be put on a spectrum in that some Chinese will admit their mistakes and some Americans do not.

I talked about how I once worked with a law firm associate (not from the United States or Asia) who would always fight me when I would criticize his work. Most associates simply agree with whatever a partner says, but this one (this was not at my present firm) would dispute my assertions. The more he would dispute my assertions, the more I would talk about how horrible his mistakes were. It was not unusual for me to conclude our discussions with a throwaway line along the lines of "I just am really worried we are going to lose the client over this." Our discussions were not productive. I eventually complained to my psychologist wife about this associate and her response was to ask whether this associate was incorporating my suggested changes and improving in his work. I told her that he was. She then asked me why it was so important to me that this associate essentially break down and admit to his wrongdoing and I told her I did not know. She told me to focus on the change going forward, not the past. I started doing so with this associate and our relationship greatly improved (no surprise!) and his work continued to improve. I had learned to "let it go" and it worked. Had this been from China (or many other places in Asia), many might say that I had let him "save face." I would say I had simply improved my management skills.

Now back to the collection of judgments in China. When I told Sam about this new online plan, we both immediately vehemently agreed that we thought it would be hugely effective. Sam talked again about the importance of face. I argued that this online posting of judgment creditors would work not so much because of face, but because one's reputation is so important in China because for so many who do business it is all they have. I said the reason for this was not so much something inherent in Chinese culture as it was an outgrowth of an undeveloped legal system. I talked about how this same sort of thing would work well in Russia. In both China and Russia, companies place huge importance on the reputation of the companies with which they conduct business because they know the court system is not a great remedy should something go wrong. Getting one's name posted online as a someone who does not pay one's bills is just plain bad for business.

No matter what you call it, there is now increased justification for pursuing litigation against Chinese companies that owe you money.

What do you think?

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China Hearsay has a great post on private equity and investment bankers in China. The post is entitled, "Great Recession Watch — Living With Mendacity in China." Why am I certain it is a great post? Because I wrote that same post, with that exact same conversation, IN MY HEAD, many times. I am, however, certain Stan Abrams did not pry this post from my head because I am far too low-brow to be quoting from Tennesse Williams; I would have quoted from Bob Dylan's song, "Sweetheart Like You."

Essentially, Stan's post talks about investment bankers/venture capitalists coming to him to "do deals" in China without having any clue whether the substance or the structure of the deals of which they are talking are even legally possible in China: Oftentimes, they came to him after having spent huge amounts of time and money on "the deal" already:

Over the past few years, as China became a red-hot market, everyone wanted to get in on the game. Throw some money together and get some folks to buy Chinese companies. Sounds like a good idea. But some of those people working for these funds (PE in particular) had little industry-specific experience and no idea about some of the legal hurdles involved. I don’t blame them for the latter, but it did piss me off to no end when they belittled the contribution of lawyers and only got us involved after they pissed away hundreds of thousands of dollars evaluating projects that were structurally impossible to begin with.

Seriously, it is a must read post.

For more on the need to examine the legalities of your potential China business early in the process, check out "Want To Succeed In China Business? Make Sure Your Business Is Legal."

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Four in the mornin and they haul rubin in, Take him to the hospital and they bring him upstairs. The wounded man looks up through his one dyin eye Says, whad you bring him in here for? he aint the guy!

Not entirely sure why, but just about every week for the last month, I have been getting calls or emails from tiny tech companies telling me they have heard I'm "the guy" for these sorts of difficult technology joint ventures. I have gotten so many of these that I now know pretty much exactly what is going to follow next and here it is:

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

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

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

What do you think of that argument?

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

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

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

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

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

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One of the many things I love about being a lawyer is learning about various industries. What so happens to lawyers is that we get one client in an industry, and then, through word of mouth, we end up getting a whole slew of others in the same industry. That has happened to us in spades with clinical testing, a global industry booming in China. I woke up this morning to an email between my firm's lead China lawyer, Steve Dickinson, and a potential client needing help in establishing its clinical testing business in China.

The email does a great job laying out the basics of what clinical testing companies must do to establish themselves legally in China and to protect themselves legally from employee and IP issues. But nearly everything in this email applies with equal force to nearly all businesses, particularly service businesses, seeking to get off on the proper legal foot in China. This email sets out the essential big three for doing just about any business right in China: 1) Proper entity registration: 2) Proper HR/employee protections; and 3) Intellectual property protection.

Here is the email, with a few changes to protect the recipient's identity:

As you know, the medical testing field has great promise in China. However, working with Chinese hospitals is extremely difficult. Frankly, India and Russia are even worse in this regard, so working in China makes a lot of sense.

Based on our discussion, this is what you will need to start up in China:

1. Form a WFOE. The key is to pick the city. If you go with a second tier city, the cost will definitely be less than in a Shanghai or Beijing. You can always add branches if you set up offices in other cities later.

2. Employment agreements. The new labor contract law requires you deal with employment very carefully. For a company like yours, you will need the following:

a. Basic employment agreement.

b. Company rules and regulations.

c. IP/Trade Secrecy agreement.

d. Non-Compete agreement with key personnel (optional).

For employers with a U.S. background, there is always a certain amount of shock at the detail and complexity of these agreements. HR is currently the number one issue for foreign investors in China. Starting with the contracts the right way is a key to future success.

3. Basic agreements for trials.

a. Agreement with hospital.

c. Three way agreement.

If possible, it would be good for you to make these agreements "modular" so you can reuse the agreements with new hospitals.

For more on the business of clinical testing in China, check out our previous posts on the subject:
-- China Medical Testing Gone Bad
-- Novartis Into China -- Where Have You Been?
-- China's Service Sector Will Reign, Part IX -- World's Best For Clinical Trials
-- China Medical Testing Redux: P. Diddy Checks Back In Come One Come All: China As BioMedical Nirvana

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Just about whenever I read about some company leaving China in the middle of the night, I think about the Baltimore Colts and this line from "Beware: Do Not Read This Poem":

statistic: the US bureau of missing persons re-
ports that in 1968 over 100,000 people
disappeared leaving no solid clues
nor trace only
a space in the lives of their friends

Then I wonder if the company that has left China without leaving much of a trace realizes that it and most of its people just made it difficult/impossible to ever return to China.

There is a right way and a wrong way to shut down your China business and guest writer, Robert Zierman, will explain the difference. Robert recently started working with my law firm after many years spent as an in-house counsel in China and running his own China related businesses.

Here goes:

On November 19, China's Commerce, Foreign Affairs, Public Security and Justice, issued Working Guidelines on Cross-border Pursuit of Liability and Initiation of Legal Action by Relevant Interested Parties in Connection with Abnormal Withdrawal from China of Foreign Investors. The mere fact that these four ministries got together on this at the inception of massive factory shutdowns in China is a good indication of how important these guidelines are meant to be.

The aim of the guidelines is to prevent foreign-invested enterprises (FIEs), or more realistically the owners and managers that run them, from shutting down their China operations without “undertak[ing] proper closure procedures” relating to “creditors, employees, and other affected parties.”

China's Company Law states that foreign individual or corporate shareholders can, under certain circumstances, be held civilly liable for the obligations of their China company. In legal speak, this means that creditors may pierce the corporate veil to get at those who own and/or run the foreign company doing business in China.

Though leaving in the middle of the night has some obvious short term advantages, the reality is that the smarter long term decision will likely be to follow China's company dissolution rules. There are a couple reasons for this. First, China claims it will pursue you for liability back in your home country. And though I have my doubts about their actual resolve and ability to do this, it certainly is not a good thing to be facing a law suit where you live. Second, if you ever want to go back to China for any reason, leaving a whole slew of creditors hanging high and dry is not the way to get that coveted China visa. We have heard through reliable sources that those who "abandon" China will/have become persona non grata and will never be allowed back. Are you really reading to foreclose the opportunity of ever doing business in or with China again?

Not that proper dissolution is cheap or easy, as it typically involves the following:

-- informing all creditors of the closing
-- resolving all pending transactions
-- settling all outstanding taxes.
-- liquidating company property
-- officially de-registering the company with the government

If company assets are insufficient to pay the company's outstanding debt, it should file for bankruptcy.

We are actually working on a matter right now for a good-sized US company that was in China until a few years ago and then left without following all of the proper procedures. The company has retained us to get back into China and we are having to go back and do the various things it should have done upon its initial exit. Because this company was actually current on its taxes and debts when it left China, it will be allowed to return. However, it is having to work with (and pay) former employees to get everything done and this is making things much tougher and more expensive than it would have been had all matters been properly handled when the company originally left China.

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We are programmed to receive. You can checkout any time you like, But you can never leave!

China Economics Blog used the term, Hotel California effect (borrowing from a scholarly article), to describe the problems foreigners so often have in getting their money out of China. I love that term (both because it so well describes things and because it combines law and music) and I have since used that term many times with clients who insist something in China "must be legal" because so and so did it or because the local government is encouraging them to do it. If my using lyrical symbolism fails, I flat out tell them that, "of course, China will take your money, but the problem will be when you try to take it out." I then tell them of the person who came to us after having sold his condo that he had purchased illegally and having been told by all of the banks that he would not be able to deposit his cash proceeds.

I have a speech I give to American lawyers that focuses on the mistakes they tend to make in advising their clients regarding China. One of the foremost is the failure to account for business expenditures in such a way so that they can qualify as expenditures that apply towards the minimum required capital for forming a wholly foreign owned entity (WFOE).

I recently received two very similar emails from companies that had failed to abide by China's laws on this. Both were very angry at the Chinese government. I had the not so fun job of telling them the Chinese government was merely following the law; it was their China "consultant" who had failed to comply.

Here is an amalgamation of my email correspondence with these two companies, with my having changed things to disguise all identities.

First email from American company:

We are an American company that has gone through hell this year trying to set up a ________ business in Sichuan Province. The Chinese lawyer who did this for us is not even returning our calls. We registered as a WOFE with 4.0 million RMB (about $500,000) in start up capital. The money has finally arrived in China and is about to be converted from US dollars to RMB. Needless to say we have spent at awful lot on remodeling and set up including 2.0 million RMB for five years rent up front. The Bank of China has now informed us that they cannot reimburse us any of that because that would mean sending the money back out to a foreigner’s account and that the money is meant to be kept in China. We have tried to explain that the 2.0 million has been spent and went to a local who is renting to us and all we are seeking is to be reimbursed from our own business for the money we put up front. That bank is acting as though it is in charge of our account, not us.

How would you proceed in this situation?

Here was my response:

Based on the facts you have provided, it appears the bank is merely following very clear Chinese law. We have never been in this situation because we have our clients sign what we call a contingent lease (these are very common in China and generally accepted by landlords) whereby the money gets paid only AFTER the WOFE is formed. I have heard of what you describe happening a few other times and I use it in a lecture I give called The Eight Things Every Lawyer Must Know About China.

The way I see it, you have the following choices:

1. Pay a lawyer to see if there is anything you can do here. If there is, it will have been money well spent.
2. Chalk it up to experience.
3. Get a good lawyer in China so this sort of thing does not keep happening because I can assure you that if you do not, it will.

The good news though is that you have not really lost any money, you have just lost access to it for a while. But, my big fear here is that you have done it so wrong that you will never be able to take your money out. We had someone who purchased a Shanghai condo illegally and when he sold it for cash, no bank would even take his money. He ended up stuffing ~$450,000 into the mattress at his condo and using it for daily expenditures. But you might consider just letting it go and then just using this money to build up your business. But again, I would be worried about putting more money into the business until you make sure you can get it out at some later date.

I am sorry you are in this predicament. Whomever helped you set up your WFOE certainly did you no service here as they completely ignored a fundamental rule regarding funding. Maybe you should contact them and push them to help you get out of this mess they have put you in.

For how to form a WFOE in China, check out "Chinese Company Formation -- Forming a Wholly Foreign Owned Entity (WFOE) in China" and "Chinese Company Formation, Part II -- WFOE Minimum Capital Requirements."

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David Barboza of the New York Times is out with an excellent article that nicely sums up why China rejected Coca Cola's bid to purchase Huiyuan. The article is entitled China Blocks Coke Bid for Juice Maker, and it does a great job summarizing the rejection because it quotes China Law Blog's own Steve Dickinson and because it reaffirms what we have been saying all along.

Barboza rightly notes that "very few foreign companies have taken full control of a major Chinese company....[but] "many legal analysts said they had expected the deal to be approved because China itself is moving aggressively this year to acquire foreign assets during the global economic downturn." It then quotes Steve:

Steve Dickinson, a China-based lawyer at Harris & Moure, said China usually restricts foreign takeovers because of a longstanding belief that state assets should not be controlled by foreign entities.

“China’s very open to green field investments, allowing foreign companies to start up businesses,” Mr. Dickinson said. “But China strongly discourages outright purchases of existing Chinese companies to enter the China market.”

This is exactly what we have been saying all along. In one of our posts from more than a year ago, entitled, "Meet China's New M&A Policies. Same As The Old Policies," we set out what we saw as the basic rules for China government approval of a foreign led M&A deal:

China's basic policies for M&A is as follows:

Foreigners are permitted to purchase small Chinese companies that the central government is not interested in managing.

Foreigners are permitted to purchase large, state-owned enterprises that suffer from financial difficulty, provided the foreign investor agrees to restructure the purchased company.

Foreigners are permitted to purchase non-majority interests in strong, successful Chinese companies, but only if there is some added benefit, such as transfer of technology, advanced management or access to foreign markets.

Foreigners are not permitted to purchase a majority interest in a large and financially successful Chinese company. Even smaller companies are off the table if they are financially sound and work in a core technology field or have created a strong or historically important brand.

China is "remarkably receptive to direct foreign investment that creates new business activity in China," but opposed to purchases of successful existing businesses and assets. "Such purchases are strongly disfavored, since they are seen as providing no net benefit to China:"

Under this policy regime, venture capital and troubled company buy-out businesses have plenty of room to operate. Strategic alliances in core industries also work well. On the other hand, traditional private equity that focuses on the outright purchase of strong and successful companies simply does not work under this system. Central government regulators will consistently step in and exercise their veto powers to prevent the foreign acquisition of a majority interest in any existing, strong Chinese company. This is not likely to change anytime soon.

For more on what goes into China's M&A policy for foreign investment, you should also check out "China M&A: Can You Hear Me Now?" "China's Anti-Monopoly Law. People, We've Got The Rules."

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My firm just seized a large sum of money from an Asian company that has owed our client a large sum of money for some time. I cannot describe this case here because it is still ongoing, but it makes for a great example of a little known way to grab money from Chinese companies.

Here is a hypothetical scenario, that is not at all uncommon for companies doing business in China:

1. US company buys product from China supplier.
2. US company sends $1 million to China supplier for order of widgets.
3. Widgets either never come or what does come is clearly not what was ordered.
4. Chinese company refuses to give any refund.

What to do?

Sue the Chinese company in the United States and secure a US judgment? Unless the Chinese company has assets in the United States or in a foreign country that recognizes US judgments, this probably will not make sense. This is because China does not enforce US judgments. For more on this, check out "Will Your US Judgment Be Enforced Abroad? Not China, But Maybe."

Sue the Chinese company in China? Maybe. There are definitely difficulties with this. First off, about 85% of the supply contracts I see between Western and Chinese companies are written in such a way as to be pretty much unenforceable in China, under most circumstances. Second, collecting on a judgment can be very difficult in China.

So what to do? The best solution might be to seize US dollar funds heading to the Chinese company. Let me explain. The Chinese company with which you did business may very well conduct business with companies in Germany, South Korea, Japan, Honk Kong, France, Singapore, or wherever. These companies probably pay the Chinese company in dollars for the widgets they buy from the Chinese company. Let's take the example of a German company. The German company buys product from the Chinese company and pays the Chinese company in dollars. This means that the German company will instruct its German bank to wire dollars to the Chinese company. These dollars will at some point have to go through a US correspondent bank. And when they do, you have the potential to seize them.

New York State Courts will, under certain circumstances, issue orders requiring the various US correspondent banks to "freeze" the dollar funds heading to the Chinese company so as to secure your debt. These orders remain in effect pretty much indefinitely, but service on the banks must be made every 24 hours, so the trick is to secure your orders before the money hits the United States. Oftentimes, one must constantly serve such orders before actually succeeding in freezing actual funds. Freezing these funds is not cheap and it is not easy, but it can be extremely effective in intercepting money heading to a Chinese company that formerly thought of itself as pretty much exempt from ever having to pay.

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I did a post the other day entitled, "China Business. We Never Said It Would Be Easy" In that post, I talked about how the global (and China's) economic downturn is accelerating legal problems for foreign businesses.

Someone named Tim left the following comment, to which this post is addressed:

I think there is a disconnect between your assertions of Beijing interests in not turning back the clock and what is happening on the ground in terms of FDI. At the local levels, we are beginning to see a reverse on policies regarding quantity vs. quality that was introduced in late 2007/early 2008. Mid-Summer ’08 it was almost impossible to setup an export-oriented trading company within a 2nd/3rd tier development zones in the Yangzi River Delta Region, now many of these areas are beginning to introduce incentives to draw in new investment: including 2/3 tax holidays, subsidized rents, etc.

We are also beginning to see these incentives being offered in districts within Shanghai regardless of whether or not the entity has qualified for incentives underneath encouraged statuses.

Further, WSJ, just reported that Beijing is easing the registration process by allowing investments under US$100 million to seek approval from local commerce bureaus. It is not clear from the article if they mean local AIC’s; however, this could effectively take state-level interests out of the approval process and a reversion of the trend.

I would suggest, however, that in the long run you will be right as many of these local-level changes will fall on the wayside, but at least right now it looks like pre-’08 investment climate.

I agree with Tim 100%. There is a dichotomy between what happens in terms of getting into China and what happens once you are there. There is also a dichotomy between getting into China legally and operating legally, and making legal mistakes. Let me explain.

A couple months ago, I wrote a post, entitled, "China Joint Ventures And The Hotel California Effect." In that post, I talked about how joint venture business was (and still is) going crazy at my firm. We have seen a massive uptick in BOTH forming China joint ventures and in helping Western companies extricate themselves from their existing China joint ventures. In that post, I explained the situation as follows:

By way of explanation, here are the key lines from the Eagles' song, Hotel California:

We are programmed to receive. You can checkout any time you like, But you can never leave!

China Economics Blog used the term, Hotel California effect (borrowing from a scholarly article), to describe the problems foreigners so often have in getting their money out of China. I love that term (both because it so well describes things and because it combines law and music) and I have since used that term many times with clients who insist something in China "must be legal" because so and so did it or because the local government is encouraging them to do it. If my using lyrical symbolism fails, I flat out tell them that, "of course, China will take your money, but the problem will be when you try to take it out." I then tell them of the person who came to us after having sold his condo that he had purchased illegally and having been told by all of the banks that he would not be able to deposit his cash proceeds.

Today's post focuses on joint ventures and why, somewhat paradoxically, my firm's business both in forming joint ventures and in trying to get companies out of joint ventures has grown exponentially in the last 3-4 months. It is meant to serve as a warning to those planning to "joint venture" in China, thinking it is automatically an easier, cheaper, faster way to get into China.

* * * *

The down economy has had the interesting effect of accelerating the formation of joint ventures by companies that likely would have gone it alone when funding was easier and also accelerating the breakup of joint ventures due to disputes that were overlooked when plenty of money was coming in. Four to five years ago, many companies would contact my firm with very ill-formed ideas of how to go into China. These companies were seeking to go into China not so much with well formulated plans for success, but because they were worried that if they did not go in, they would be missing the boat. To a lesser extent, those days have returned as foreign companies feel they "must" go into China because its economy, though weakened, is a last bastion for growth. Believing they lack the funds to go it alone, many mouth the joint venture mantra.

The problem with joint ventures is that their formation is virtually never easy, because the key to a good joint venture is to raise and resolve as many potential problems as possible, before entering into the joint venture agreement. It is virtually always more expensive to form a joint venture than to form a wholly foreign owned entity (WFOE). This is not a reason not to do a joint venture, but it is a reason not to think of them as easy, quick or cheap. The problem with easy, fast and cheap joint ventures comes down the road, when the problems arise.

That down the road time is now for many joint ventures. The end of the boom times means that what could once be passed over or ignored is now important. Foreign businesses that entered joint ventures 4-5 years ago are now trying to get out of them with some semblance of assets, while their Chinese partners insist that they instead put more funds into the venture.

The problem we are seeing is that so many of these hastily formed joint ventures were set up in such a way that the Western company pretty much has two choices: walk away and turn everything over to the Chinese partner or continue in the money draining venture.

The same is true of China overall. It has always been relatively easy to get your money into China or to start a business in China illegally; the difficulty then comes down the road when you cannot get your money or assets out, or when you get deported, or when you are hit with a massive tax penalty, or when someone uses your intellectual property and you have no recourse.

Now though, what is happening, and what I think Tim is highlighting is that there is much more of a welcoming attitude by the various Chinese governmental agencies towards foreign business. We too are seeing that. Foreign businesses that a year ago would probably have been required to put up $500,000 in minimum capital, are now being hit with a $300,000 assessment. Businesses that formerly might have taken months for approval are getting approved in weeks. Businesses that might have been told to clean up their act environmentally are now being allowed in without comment. Tiny foreign businesses that might have been treated with disdain a year ago, or at best indifference, are now being welcomed and sometimes even subsidized. Yes indeedee folks, step right up, China is most definitely open for foreign business again, just like 2007.

But, and this requires emphasis, this welcoming is not reflected in a change of laws so much as it is reflected in an overall change of attitude by the various bureaucracies towards law abiding foreign companies. We have seen no evidence that once in the country, there will be any increased tolerance towards foreign companies violating Chinese laws. On the contrary, over the last few years, we have seen a straight line towards increasing intolerance of foreign companies that violate China's laws.

Bottom Line: It is easier to get your (legal) business into China than it has been for years, but, once in, you absolutely should abide by the law.

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Tough times make for tough business and China is certainly no exception. For foreign companies doing business in or with China, We are already seeing increasing problems and/or the likelihood of increasing problems in the following four areas:

1. Intellectual Property. Local software company (not one with which you are likely to be familiar). Tells me it wants to sue its employees in China over IP violations. The conversation went sort of like this:

Me: What are the IP violations?

Him: They stole all of our software.

Me: What do you mean they stole all of your software?

Him: We hired them to develop specialized __________industry software for us to market in China and they have taken all of the work for themselves.

Me: Explain to me how this happened.

Him: [After going off on a wild tangent for about five minutes] We started the company in China about two years ago. I hired Mr. Wang [name is made up] to head up our operations there and he eventually brought on about 20 more people for us. I knew him from my days with _________ and thought I could trust him..... We spent two years on this and more than a quarter of a million dollars and the product is now finally ready and they've just taken the whole thing for themselves. You HAVE to stop it.

Me: Okay. Do you have written contracts with these employees that include non-competes, trade secret protections, or non-disclosures?

Him: No. We don't have written contracts with them.

Me: Hmmm. That could be a problem. Why don't you have written contracts with them.

Him: Because we wanted to keep this really under the radar.

Me: What do you mean really under the radar?

Him: Mr. Wang told me that if we didn't keep everything under the radar that our software IP would get stolen.

Me: Mr. Wang told you this?

Him: Yes. And I trusted him.

Me: Because you knew him from your days at __________.

Him: Yes.

Me: Okay, so no written employee contracts.

Him: Right.

Me: Did you pay employer taxes.

Him: No.

Me: Ummmm.

Him: We weren't exactly their employers.

Me: What do you mean?

Him: Mr. Wang was our only employee.

Me: How would you pay Mr. Wang?

Him: We would send him $10,000 a month and he would use that for everything he needed, including to pay the other employees.

Me: Who is the we that sent the money?

Him: Our company.

Me: Your US company?

Him: Yes.

Me: Do you have a Chinese company?

Him: No?

Me: Do you realize that virtually everything you have described to me was illegal in China?

Him: I do now.

Me: I don't see how you can sue here. Essentially, we would be asking a Chinese court to rule in favor of an American company that, for all intents and purposes, was never in China. Our claim would be that the people who stole your IP were your employees, even though there is no evidence they were your employees and if we argue that they were your employees, we will be admitting you violated nearly every labor law on the books. I take it you never registered any of your IP in China?

Him: No, should I?

Me: It might have helped.....

Him: Can you help me.

Me: I don't want to tell you I cannot help you without first doing all sorts of research to confirm it, but off the top of my head, I just can't see your having a decent case in China and you certainly don't have one here either, unless these China people start trying to bring your software into the US.

Him: So you don't see any way at all to help me?

Me: Not off the top of my head I don't.

Him: It just strikes me as ridiculous that I could have paid these people for so long and China won't protect me at all.

Me: Yeah, I think they just feel that if someone does everything illegally they cannot use the Chinese system for protection.

Him: But it was one of their own people who tricked me.

Me: Yeah, but I think the government would probably say that you should not have relied on him and that you should have been there legally, should have been paying your taxes and should have registered your IP. It's possible you hold the copyright in China anyway and we would be happy to research this for you.

Him: I'll get back to you on that.

He never did. This is just a really interesting example, but we are definitely seeing more instances of employees (real employees, oftentimes those whose salaries have been cut) seeking to use their employers IP. If you want to protect your IP in China, do things legally. At minimum, register your business, use written contracts (in Chinese) with your employees that include trade secret protections, and register your IP.

When times are good, there is a much greater belief that loyalty will lead to long term reward. When times are bad, there is a much greater tendency for people to try to grab onto any potential short term rewards. For more on protecting your China IP, check out this article on China trademarks.

2. Disappearing Chinese companies. We got one this week and they are definitely becoming more common. Here is how they work. Chinese company on the verge of shutting down takes an order from Western company anyway. Chinese company then ships out the dredges of its product before shutting down for good. We have been called by American companies that essentially received dirty rags instead of shirts, that received bricks instead of fish (this actually was during the Asian crisis), and that had received what looked like sugar instead of candy. In all of these cases, the Chinese company had taken the money and had simply shut down, "leaving no solid clues nor trace, only a space...."

Does Chinese law allow for piercing the corporate veil to go after owners for fraud in these circumstances? Yes, the law allows it, but the Chinese lawyers with whom I have discussed this issue tell me most Chinese judges are neither terribly familiar with this concept nor terribly enamored with it. I am not saying that no such case should be pursued, but I am saying that one must think long and hard about whether pursuing such a case makes economic sense.

Now more than ever, you must make sure you know as much as possible about those with whom you have business dealings. You also should strive not to pay the entire cost in advance of the products you are buying. A year ago, most Chinese manufacturers were requiring full payment in advance. That has changed and many of our the contracts my firm is writing with Chinese manufacturers are now calling for anywhere from 0 to 50% payment upfront.

3. Joint Ventures Gone Bad. We are working on a number of failing joint ventures right now whose general scenario is that the joint venture has basically ceased providing financial reports and ceased remitting any profits back to the Western joint venture participant. Maybe these joint ventures are no longer even profitable, but our clients are entitled to determine this and if the joint venture should be shut down, our clients are also entitled to a share of the joint venture company's existing assets. For how to prevent/mitigate such problems, check out this article on China joint ventures.

4. Labor Laws Violations. I just received an email from co-blogger Steve Dickinson regarding China's labor laws and the belief among many foreign businesspeople that those laws are being relaxed to prop up the economy. Here's Steve's email:

I just sent you a copy of an article on the labor contract law. This is an important issue. I have been seeing statements on blogs and in the press that foreign companies no longer have to worry about Chinese labor law because the falling economy has led the Chinese government to basically abandon the law. This is untrue and it is a dangerous belief. What the government has been doing is working with large employers in negotiating mass layoffs and wage reductions. However, this process is part of the labor contract law, not a rejection of it. Moreover, all the other provisions of Chinese labor law, such as minimum wage, working hours and safety are being even more strongly enforced now than ever, particularly against foreign companies.

I am in the process of reading the numerous policy documents coming out the the current National People's Congress. One thing that is being constantly stressed at the NPC is that China has no intention of responding to the world economic situation by turning back from the last 5 years of reform. Its intention is the opposite. China's leaders see the non-Chinese economies as even more unreliable and risky and they are pushing even harder to make China self reliant and thoroughly modern. They do not intend to allow the financial crisis to push back the recent trends of Chinese development. Two of those trends are to shift away from export led growth and to shift away from reliance on foreign direct investment. For exports, they want to move from being a foreign outsourcing center to a country that exports products of its own design. For FDI, they want to shift from quantity of FDI to quality of FDI. Many foreign observers thought (and still think) that China would turn away from these goals in the face of the financial crisis. Exactly the opposite is happening. China is reconfirming these goals in its search for economic stability.

When the Chinese government puts out a notice in English that it is going to strictly enforce a particular law, the only wise thing to do is to believe it.

What are you seeing out there?

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This past weekend, to great fanfare, the Standing Committee of the National People's Congress ratified a new Food Safety Law for China. It likely will have little real world impact.

China Law Blog's own Steve Dickinson wrote a Wall Street Journal article on this, entitled, "Food Fumble: China can't regulate away its safety problems." According to Steve, the problem is not in the laws, so now laws are likely to have little to no impact:

All this activity looks good on paper, but it probably won't work. Even if one accepts that China's problem is a lack of centralized food regulation, there are few signs that any of these steps would address that shortcoming in practice. The law's text provides absolutely no details about how it will be implemented. The law includes no standards, no timeline, no budget, no procedure for obtaining the input of regulated parties and no clear way to resolve disputes. In China today, laws adopted on controversial topics are often vague and leave all the details to later regulation. Often such regulations never appear, rendering the law essentially meaningless. The standards and procedures portion of the Food Safety Law will likely meet the same fate.

The existing problems with food safety in China do not stem from lack of regulation; they stem from lack of enforcement:

But the bigger problem with the new law is that a lack of regulation per se is not Beijing's problem. Generally comprehensive regulations are already on the books. But as with most countries, China simply does not have the funding or expertise to hire enough qualified inspectors and regulators. China has more than 200 million farmers and more than 500,000 food production companies. The food production system is too vast to allow for meaningful inspection at all stages of the food production process.

Steve (and I too) see a better solution in allowing private parties to sue offending food companies for damages:

One of the most important reforms would be to allow the effective operation of the existing system of private civil litigation and bankruptcy that would allow injured parties to take action independent of the government. It is only when the citizen can use the court system to obtain damages that the food-safety system will ever affect the behavior food producers. As further support, the producer must know that the producer will be forced into bankruptcy if the frequency or extent of litigation is too great.

The Sanlu case has shown all too clearly that the threat of private sanction doesn't work in today's China. Courts have refused to accept lawsuits parents have attempted to file. In general, the tort law system is undeveloped and regulators strongly discourage its use in safety- and health-related matters. The bankruptcy system is even less developed, providing no real threat to any company owner under the current system. Bankruptcies that occur are orchestrated by the government to avoid private access to offending company assets. The bankruptcy of Sanlu is an example of this process. Bankruptcy as protection for independent creditors and outside of government control is still virtually unknown in China. Without these effective private sanctions, the standards imposed by the new food-safety law are unlikely to have any real effect.

Much of the problem stems from low, government set food prices, which make it difficult for producers to distinguish themselves on quality:

Experience has shown that some will violate the law if they believe this will give them some financial benefit. This is why even the death penalty has not been a sufficient deterrent.

Since these problems are getting worse in China during the current economic situation, no new set of even more detailed rules is likely to have any impact. The only true solution to this element of the food-safety problem is a broader reform of China's agricultural sector geared toward strengthening property rights and allowing the market to set food prices. Such a broader reform would start by giving producers greater incentives to care about quality, as well as allowing those who can build reputations for safety and quality to earn sufficient returns to pay for higher-quality production.

What do you think?

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When I was learning the law, I was trained to hate insurance. One of my law professors, whom I greatly respected, would say that insurance law is to law as military music is to music. Those who went straight from my law school to insurance companies were invariably in the bottom quartile in class rank. I saw their job as claiming someone's wrecked Honda Accord was worth $6,200, not $7,000.

I eventually came to realize that insurance has a legitimate place in the practice of law. When clients come to my firm with a risk of being sued, or after having been sued, or even on issues requiring they sue, insurance nearly always pops into my head. My firm has been having to deal with insurance issues more and more as the bad economy sends us more defective international product and international fraud cases. We usually call in outside lawyer help to assist us on the insurance side of these issues.

Insurance has always been a fairly big issue in the OEM contracts we write with China manufacturers. Our Western clients often tell us they want a provision in their contracts with their Chinese manufacturers that makes clear the Chinese manufacturer must secure X dollars in insurance protecting our clients from any harm the Chinese manufactured product might cause. On top of this, our clients want that insurance to name them as a third party beneficiary. Our response is that we are happy to put such a provision in the contract, but that it is dangerous to rely on it. Insurance in China is still a nascent industry and many (most?) Chinese manufacturers have little to none. Having seen instances where Chinese companies agreed to purchase insurance but never did and even instances where Chinese companies sent back fake certificates of insurance, we explain the high cost and great difficulty of ensuring the Chinese manufacturer has secured the insurance it contractually promised to secure. We strongly suggest how it might be easier/cheaper/way safer for our clients to secure their own insurance, rather than rely on their Chinese counterpart. Virtually without exception, they agree.

I thought of China insurance today when I read yet another post at Absurdity, Allegory and China (AAC) on the Chinese drywall that is stinking up homes in the United States. AAC has been covering the drywall situation since its inception and it has done a whole host of excellent posts on it.

From day one, I always saw this whole "Chinese" drywall thing as essentially a domestic issue and so I have not written on it much, nor really immersed myself in its minutiae. The story goes essentially like this. US companies buy drywall from China. Chinese drywall emits odors into US homes. The way I saw it, this would lead to US homeowners suing the US companies that bought/imported/marketed/made/sold/mentioned/looked at the drywall. I figured some of these homeowners would also sue the Chinese companies here in the US, not realizing that US judgments against Chinese companies are, at least in China, not worth the paper on which they are printed. I also figured some of the US companies would go back to their Chinese suppliers seeking refunds and more for the allegedly defective drywall, but figured they would end up getting little to nothing, whether they sued in China or not.

It never occurred to me that the Chinese manufacturers might have insurance to cover all this. If I had thought about it, I am sure I would have thought, "no way."

Well it turns out I will probably end up being right about all of the above (gosh.... I just love writing long posts with this conclusion), but it also turns out that some of my assumptions were wrong.

I assumed the Chinese drywall manufacturers were domestic Chinese companies. Wrong. According to AAC, it turns out at least one of them, Knauf Plasterboard Tianjin Company, LTD, is "part of" (I am guessing it is a Wholly Foreign Owned Entity owned by) Knauf, "a German multinational supplier of building materials with a worldwide presence in 58 countries." Despite this connection to a German MNC, Knauf Plasterboard Tianjin is reported not to have insurance that would cover this. That is contrary to what I would have expected and contrary to what AAC would have expected as well:

No insurance? Right. And I’m posting this blog entry from Mars where I’m sitting with Manny Ramirez passing one back and forth, wondering where we’re gonna find some water and a better contract than the LA Dodgers waved in his face.

The takeaways from all of this are the following:

1. Insurance does matter.
2. Insurance you have gotten yourself, through people you know, is usually a much safer bet than relying on your Chinese counterpart.
3. If something goes wrong with your Chinese made product, the odds of your being able to secure reimbursement or damages from China are not good.
4. Even foreign companies doing business in China may have less insurance than one would tend to believe.
5. Manny Ramirez will be 37 next season and likely has only one or two really good years left.

UPDATE: I could not have scripted this better. China's leading online travel agency, Ctrip.com, just apologized for having (inadvertently?) issued fake insurance policies. Go here for more on this.

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Got an email the other day from Andrew P. Fennell, of Savills Property Services (Shenzhen) Limited, in which Andrew posed the following to me:

I wanted to follow-up with a quick question and ask for your opinion on the operation of foreign law fims in China. If you've done a blog post on this before I became a reader, I apologize for the redundancy. However, if you haven't, this might be an interesting topic.

I've noticed that the presence of foreign law firms is growing rapidly in the Chinese market. However, it seems that the scope of services --and expertise-- that foreign firms can offer here must be quite limited as compared to their local counterparts. What kind of services can they hope to offer, now and in the future? Do you think the China based offices of these firms are currently profitable? Or are they losing money with the hopes that over the years, they will have established the necessary expertise and local network to turn these operations into profitable ventures?

Any thoughts on this matter would certainly be enlightening for those of us witnessing this phenomenon in action.

I LOVE this question because it is really a whole slew of great questions, all of which I frequently discuss with clients, potential clients, and other lawyers, but few of which I have ever addressed here. Until now.

Let me break it down.

-- "I've noticed that the presence of foreign law firms is growing rapidly in the Chinese market." Yes, Andrew the presence of foreign law firms is growing rapidly in China, but I think much of this is a function of the time it takes to open an office in China, not some sudden onrush of firms seeking to go there. Yes, every time a new office opens, the law firm's managing partner talks of how central Asia is to the firm's practice and the importance of thinking long term. I do not buy it. Big law firms laying off hundreds of employees are not thinking long term. What is really going on is that it takes a large cash outlay, hundreds of hours of time, and years of waiting and schmoozing to get a law office open in China. After having incurred/undertaken all this and finally succeeded, virtually no firm would then back down.

-- "It seems that the scope of services --and expertise-- that foreign firms can offer here must be quite limited as compared to their local counterparts. What kind of services can they hope to offer, now and in the future?" It depends on how you define "limited." Foreign lawyers in China cannot go to court and cannot physically register trademarks, copyrights or patents." They also are not supposed to give China legal advice without the assistance of Chinese attorneys. This leaves whole swaths of legal work that can be performed and it is mostly the sort of work foreign law firms wish to perform. For example, the typical foreign mega firms with offices in China might focus their practices on providing legal assistance in the following areas:

* International business tax
* Chinese company public offerings (IPOs) in New York, Hong Kong, and London
* Big case dispute resolution
* Complex financing of infrastructure projects
* International Trade and other Regulatory Matters
* International mergers and acquisitions (M & A)
* Private equity/venture capital (vc)

These all tend to be big money practice areas, requiring huge firms with massive worldwide depth. To a large extent, these mega firms face very little competition from Chinese law firms, at least so far. Competition from Chinese law firms will no doubt increase as time goes on, but (barring major political change) I am confident most of the mega firms in China now will still be there ten and twenty years from now.

Chinese lawyers who go to work for foreign law firms cannot retain their license to practice law in China. Despite this, the mega-firms manage to draw top Chinese lawyer talent.

Many of the mid-sized foreign firms in China are seeking to do these same sort of things. But, to a certain extent, I am convinced many of them went to China hoping to capture some growth there and, more importantly, in an effort to prevent their domestic clients from going to other firms. The fear is that once a client goes to another firm, even in China, it may not come back as often for domestic matters.

My firm (dubbed a "micro international law firm" by Above the Law or, by Law & Politics as, "an international law boutique." Wow, I just learned we have the top three spots on Google for that term.) has, I think, carved out its own, very necessary niche. Our work mostly consists of acting as "China counsel" for our small and medium sized business clients. Our practice consists mostly of the following:

1. Helping Western companies figure out the proper entity for their China entrance and then helping them get legal as a Wholly Foreign Owned Entity (WFOE), Joint Venture (JV), or Representative Office.

2. Helping Western companies sort through their China intellectual property issues.

3. Drafting China contracts for our clients. These mostly consist of Licensing Agreements, OEM Contracts, Non-Disclosure Agreements (NDAs), Management Services Agreements, Intercompany Agreements, and Employee Manuals and Employment Contracts. With the exception of Intercompany Agreements, these are nearly always done in both Chinese (as the official version) and English (for the benefit of the client).

4. Helping Western clients purchase Chinese real estate, retail, and industrial assets.

5. Providing day to day business law advice.

6. Handling CEITAC arbitrations and overseeing China litigation matters, including white collar criminal actions.

Unlike the mega firms which have local Chinese lawyers on staff (all of whom are no longer licensed), we work with Chinese lawyers in cities such as Beijing, Shanghai, Shenzhen, Harbin, Chongqing, Chengdu, Xiamen, Qingdao, Dalian, Tianjin, and Yantai.

My firm is able to offer Western clients doing business in China the following:

1. We are bound by US lawyer ethical rules.
2. We know what it means for Western businesses to be bound by Western ethical practices and laws.
3. We understand Western business culture. In particular, we know what Western clients want and expect from their law firms.
4. English is our first language, but we also have two lawyers and a paralegal who are completely fluent in Chinese.
5. Our China lawyers all went to US law schools, which law schools are widely considered the best in the world at training people to "think like a lawyer."
6. By working directly with local Chinese lawyers (many of whom do not speak English well or sometimes at all), we are able to keep costs down.

I am absolutely convinced that these things will mean our China business will continue growing.

-- "Do you think the China based offices of these firms are currently profitable? Or are they losing money with the hopes that over the years, they will have established the necessary expertise and local network to turn these operations into profitable ventures?" I think the top mega firms are making huge sums of money in China and building their practices for the future. I suspect many (certainly not all) of the mid-sized firms are losing money in China and will never be profitable there. These firms are chasing Chinese clients for overseas legal work because they do not have sufficient in-country legal work to keep their attorneys busy. To get these Chinese clients, they greatly reduce their rates, wrongly figuring they will be able to raise them later. I have heard of one firm that allegedly took on an anti-dumping case for a Chinese client for a $100,000 flat fee and it ended up burning more than $1,000,000 in attorney time.

I would love to hear from you all on the topic of foreign law firms in China.

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Just got back from Chicago/Evanston, where I was on a panel at Northwestern's University's Kellogg School of Management's Greater China Business Conference. The Conference was excellent and I am sure I will be referring to it again over the next few days. At one point during my panel, an audience member asked how foreign companies in China can stay on top of China's ever-changing business laws. My response was essentially, "any way they can."

My firm has handled far too many matters involving foreign businesses that have gone way too far in their China businesses without making sufficient efforts to learn of laws that will apply to them. One company boasted to us of the $250,000 marketing study it had done proving the viability of their business, only to have us tell them their business was completely prohibited to foreigners. Another company with a factory already built and ready to go came to us after having been told they needed all sorts of government approvals before they could throw the switch.

Michael Barbalas of the American Chamber of Commerce of China (AmCham) spoke at the Conference on opportunities for foreign business in China and set out what it takes for businesses to succeed. When asked what he saw as the chief cause of foreign businesses failing in China Michael answered, "lack of planning....lack of preparation." Certainly failing to plan for or research the legality of your own business comes within Michael's answer.

Before incurring time and money determining the best way to enter China, you should first determine whether you can enter China legally at all.

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Regular readers know that CLB generally does not like to write much about upcoming laws. There are three reasons for this. One, there are plenty of existing laws about which to write and those, for obvious reasons, tend to be more central. Two, upcoming China laws often never come. Three, it is difficult to write about a law without having seen it in action first.

On top of that, I generally avoid writing about patent laws because I am not a patent lawyer.

But I am going to violate all of the above by pointing out an excellent Wall Street Journal opinion piece, entitled, "Patent Reform With Chinese Characteristics: Beijing's amended intellectual property law holds dangers." The piece is written by Ronald A. Cass, dean emeritus of Boston University School of Law, president of Cass & Associates, and former vice-chairman of the U.S. International Trade Commission. The reason I so much like this article is because it so clearly explains much of the current patent situation in China and the likely implications of the Third Amendment to China's patent law, which was approved in late December and is scheduled to go into effect in October.

If you are interested in learning more about China's IP policies, this article is a must read.

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By Dan Harris and Steve Dickinson

There's an expression out there about tides exposing things but I know if I try to use it I will muck it up, so I'm going to quote from that which I know: Bob Dylan:

Johnny's in the basement
Mixing up the medicine
I'm on the pavement
Thinking about the government
The man in the trench coat
Badge out, laid off
Says he's got a bad cough
Wants to get it paid off
Look out kid
It's somethin' you did
God knows when
But you're doin' it again
You better duck down the alley way
Lookin' for a new friend
The man in the coon-skin cap
In the big pen
Wants eleven dollar bills
You only got ten.

Maggie comes fleet foot
Face full of black soot
Talkin' that the heat put
Plants in the bed but
The phone's tapped anyway
Maggie says that many say
They must bust in early May
Orders from the D. A.
Look out kid
Don't matter what you did
Walk on your tip toes
Don't try "No Doz"
Better stay away from those
That carry around a fire hose
Keep a clean nose
Watch the plain clothes
You don't need a weather man
To know which way the wind blows.

Now I apologize for going a bit overboard with Dylan here (is it even possible to go overboard with Dylan), but I have to believe this song, Subterranean Homesick Blues, explains China's current legal situation with more panache than I could ever muster on my own.

So what is it saying? To sum up, you had better know which way the wind is blowing and it is harder than ever to tell because the directions just keep on shifting.

The economy is trending down and paying bribes is illegal. You knew that already. What you probably do not know is that downward trending economies (queue the tide quote here) always seem to expose things that upward trending economies do such a good job of hiding. Madoff type ponzi schemes are a great example in the private sector. Corruption is a great example in the public sector. When things are going down, people get unhappy and start ratting out their co-workers. When things are going down, people lose their jobs or get demoted and secret files then tend to get exposed. When the economy is going up, nobody much begrudges the guys skimming off the top and nobody has much time to focus on that anyway. When things are going down.....

meet me in the Trap it's goin down meet me in the mall it's goin down meet me in the club it's goin down anywhere you meet me guaranteed to go down

And things appear to be going down for a Mr Garth Peterson, Morgan Stanley's former head of China Real Estate. I do not know what led to exposure in Mr. Peterson's case, but I do know that we should be expecting a lot more of these sorts of things to come out in the next 6-12 months.

FT.com just did a story on Mr. Peterson, entitled, "Morgan Stanley acts over possible China corruption." China's leading business magazine, Caijing, has done a number of stories on this as well and those are, according to co-blogger, Steve Dickinson (who has been reading them in Chinese) painting him as having come from Singapore with little more than an ability to speak both mandarin and shanghainese and an ability to secure access. What is clear is that he secured a number of huge Shanghai real esate projects for Morgan Stanley and that, as usual, everything was fine while the party was rolling along. Now that things are cooling off, the fingers start to point and the heads start to roll:

The former China head of Morgan Stanley Real Estate is under investigation for possible violations of the foreign corrupt practices act, a US law that prohibits corporate bribery.

In a filing to the Securities and Exchange Commission, the investment bank said it had discovered actions initiated by an unnamed China-based employee that "appear to have violated" the act.

Three people familiar with the matter said the employee referred to in the filing was Garth Peterson, Morgan Stanley's top property deal-maker in China until he was fired around Christmas.

The bank said it had "terminated the employee" involved and reported the activity to the authorities.

Morgan Stanley has been particularly active in the murky and corrupt Chinese property market.
"Morgan Stanley was one of the first movers into the Chinese real estate market," said Sam Crispin, managing director of Crispins Property Investment Management.
"They have raised a lot of money and have done some great projects."

The article describes China's real estate sector as "rife with bribery and corruption. Consulting firms promise access to senior government officials and preferential treatment in bids for land and projects in exchange for large "consulting fees:"

"Unfortunately this kind of thing happens a lot in China but it is unusual for an international company like Morgan Stanley to let itself get directly involved," said one large real estate investor in China who asked not to be named.
Morgan Stanley has put Sonny Kalsi, its global head of real estate investing, on administrative leave effective immediately.
US companies and their agents are prohibited from paying bribes to win business abroad.
Mr Peterson was based in Shanghai during the rise and fall of Chen Liangyu, the city's former mayor who was arrested in 2006 for corruption that was partly related to property deals.

One of our constant themes on this blog has been that the risk of doing things by the side door/back door in China is just too high. It may work for a while, but eventually you get caught. As a foreigner, when you get caught there is no network of protection to ease the burden. Even within the Chinese context, the guys that get caught can get into big trouble: life in prison, death penalty. The unfortunate truth is that if you don't play the corruption game, many markets are foreclosed. That's just the way it goes. It is better to stay out than take an unacceptable risk.

Does anyone disagree with that?

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By Steve Dickinson

As we previously reported, the WTO decision in the copyright claim brought by the U.S. against China was recently released. As expected, the U.S. claims victory since it prevailed on two of three claims. However, careful review shows the U.S. lost. As usual, however, the WTO case was a part of a larger strategy, so the question of who won or lost is probably not relevant.

The U.S. WTO case had one serious issue: the argument that Chinese criminal sanctions are not severe enough to deter piracy. The other two issues were trivial and technical. The U.S. lost on the serious issue and won on the trivial issues. This means the U.S. lost the case. So we should just say that: the U.S. lost.

However, it was a foregone conclusion the U.S. would lose on the criminal sanctions issue. No WTO panel is going to tell a country how to organize its criminal system. The U.S. knew this from the start. So why did the U.S. bring the action at all since it knew it would lose? China has made enormous progress on IP protection since its accession to the WTO. China's reward: the U.S. brings an action with the WTO. On the surface, this was an entirely stupid thing to do. However, the U.S. does not bring these actions out of stupidity. Therefore, the useful question should be why did the U.S. bring this claim? What was the strategy?

I think there are two elements to the strategy. First, at the simplest level, the U.S. did this to appease U.S. media companies who want to see some action on the issue of market access (not piracy). This would explain why the case was so weak: it was not taken seriously by the people who brought it. Second, the whole process is part of a larger effort by U.S. media companies to "pry open" the Chinese market. The real problem in China for U.S. media companies is that the market is relatively closed. The U.S. approach to market opening is to batter down the door rather than negotiate. The U.S. approach to China on this matter has been consistent with its normal approach.

In my view, this attempt to open the market for media products will fail. The Chinese government does not see media and ideas and the rest as a "market". They see it differently. They see it as an impediment to government control. Accordingly, they have no intention of ever opening this "market". Consistent with this basic viewpoint, China makes no attempt to seriously protect its own media. Chinese film, TV, books, magazines, music, visual arts and the rest are routinely pirated and the associated businesses and artists are left undeveloped and in poverty. That is changing in small increments, but not in any serious way. Chinese film directors and actors, for example, have grown rich, but only from their earnings on foreign releases. They still complain that they make no money in China, primarily due to piracy. With that as a base, how can China protect foreigners? It simply cannot happen. If foreigners are protected, then China has to protect its own citizens first. In this area, a two tier system simply cannot work. So the whole discussion is pointless.

The fact that this is not a pure intellectual property issue can be seen by the alternative fate of patents, trademarks and trade secrets. Of course, piracy in these areas is rampant in China. However, both administrative and court based protections are also very effective in China. As I often say, the courts are good at these cases because they have so much practice. Protection of IP in this area is successful because the Chinese government views it as entirely a commercial matter. The attitude is not the same for media, with predictable results.

One area where there is real tension is copyright protection of software. Even where software is purely commercial (i.e. outside of the video game world), its protection falls entirely within the realm of copyright. It is in this area where the Chinese refusal to protect copyright is actually commercially quite damaging. China is responding not by increasing enforcement of copyright, but rather by attempting to create a special regime just for software protection. This regime will benefit both domestic and foreign software developers, so it does not fall into the trap of creating one system for domestic companies and another regime for foreign companies. Moreover, it appears that this sui generis approach to software protection may be successful.

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By: Steve Dickinson

The China Economic Review recently published this column by CLB's own Steve Dickinson, entitled, "Foreign Managers Are Not Above the Law." [subscription presently required] It bears mentioning that Steve wrote this article in China (where he lives and works) before the news of the Peanut Corporation of America's salmonella outbreak in the US.

Here's Steve's column:

The San Lu tainted milk scandal reached a typically Chinese conclusion on December 31, 2008. On that day, San Lu group chairperson Tian Wenhua and three other top group executives pleaded guilty to the crime of production and sale of substandard product. Since at least six deaths occurred, the defendants face a maximum penalty of life imprisonment or death.

Resolution of the tainted milk scandal followed a fairly typical Chinese pattern:

• San Lu was forced into a government-supervised bankruptcy.
• An industry wide compensation fund was established and managed by the government.
• Individuals considered responsible were subject to criminal sanctions, pleading guilty in non-public trials featuring rehearsed written confessions.
• Civil tort lawsuits against San Lu were rejected on the ground that the public criminal and bankruptcy proceedings preempted the private litigation process.

A key feature of this process is the use of harsh criminal sanctions against company executives. In the U.S. or Europe, it is almost unheard of for a high-level executive to be criminally sanctioned for a food safety or pollution violation. The opposite is true in China. Where there is major damage affecting a large number of people, private civil action is considered inadequate. The issue is public and requires a public response. A key element of the public response is that punishment must be imposed. Financial sanctions imposed on a lifeless company are not enough: some human being must suffer.

This is an important issue for foreign investors in China. Every year, China approves 25,000 or more foreign owned businesses in China. Many of these businesses engage in manufacturing in China and an increasing number sell their products in China. It is simply a fact of life that manufacturing and sale of products can result in damages to the public and to consumers. Modern businesses attempt to reduce such damage to a minimum, but even in the best of situations, damage can occur. In the West, liability for such damage is usually resolved within a well-developed system of private tort law. Foreign managers in China normally assume the same is true in China and that they will never be held personally responsible for damages caused by the company.

The San Lu case shows this is not true. Under the Chinese system, causing damage can be a crime, and the person who is responsible for the damage can be held criminally liable. This is true even when the manager had no direct involvement in the activity that caused the damage. A manager whose duties included supervision of the specific activity can be held liable even if the manager had no actual knowledge of the criminal acts. The treatment of the San Lu defendants illustrates this principal. The defendants were the Chairman of the Board and three general managers of the group company. The crime was committed by a subsidiary company over which none of the defendants had direct management control. However, the lower level managers who actually committed the crimes were not prosecuted. Instead, the senior managers of San Lu were prosecuted and convicted. They are now facing life imprisonment or death for actions that they did direct and over which they may have had no control.

The risk of such a result is always present in China. Consider the following examples:
• A chemical manufacturing plant experiences a major breakdown due to faulty equipment and a dangerous chemical is released into a local river. It is shown that engineering staff were aware of problems with equipment and chose not to make needed repairs.
• A food manufacturer suffers a bacterial infection in its food product leading to illness or death in children who consume the product. It is shown the quality control staff were aware of high levels of contamination but chose to continue production.
• A disgruntled employee of a drug manufacturer inserts poison into an over the counter medicine, leading to death and injury to consumers. When initial reports are released concerning such deaths, direct supervisory staff deny the problem is related to the company product and more deaths occur.

These kinds of situations are distressingly common in China. Even where foreign management seeks in good faith to introduce best management practices, it is not unusual for this to have little effect on the day-to-day practices of local staff. It is also not unusual for a foreign manager to be convinced to do things according to "local standards." Such so-called “local standards” often not only are not in accord with industry best practices but they also often violate the strict provisions of Chinese law.

When foreign management learns damage has occurred, their concern is that the company will be sued and liability will be so severe the company may be seriously damaged or even forced into bankruptcy. It is rare for foreign management to consider the possibility the event will be treated as a crime and that the foreign Chairman of the Board and senior management will be subject to criminal sanctions. As the San Lu case shows, the risk of exposure to criminal sanctions is very real and must be carefully considered by management of every foreign company operating in China. The next time local staff recommends ignoring industry best practices and Chinese law concerning health and safety standards, the foreign manager should consider the issue carefully. Is the financial benefit to the company worth the potential for an involuntary stay in a Chinese prison, or worse?

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For the last few years, one of the main themes of this blog has been how China has and will continue to increase its enforcement of its commercial laws, particularly as they apply to foreigners. We have written about the increase in crackdowns on those in China without the proper visa, about closing of unregistered businesses, the need to comply with the Labor Contract Law, and a stepping up of environmental enforcement.

I'd like to take some of it back.

In the last three months or so, the law for foreigners has definitely shifted a bit in China. It has not changed on the books, but it has changed out in the field and foreigners doing business in China and those considering doing business in China need to be aware of these changes and how they might impact their business.

Without delving too deeply into legal philosophy, let me just state that there is real value in having written laws that are consistently enforced. This is true for all kinds of reasons, many of which should spring immediately to mind. For the last few years, China was marching towards a more consistent and sustained enforcement of its written laws relating, most of which are really quite sensible. The last few months have seen a change in this march.

In determining how a country or a region will enforce its laws, one first has to figure out the determinative questions. In China, the questions I always ask is what is best for the Party's maintaining its power and/or what is best for the local bureaucrat making the decision. The changes in China over the last few months are not so much due to a change in questions as in a change in answers. Over the last few years, foreigners often made the mistake of believing the Chinese government would not shut down their small business because their small business brought money to China. This was wrong because though the small business may have brought money to China, it also brought anti-foreigner sentiment, and foreigner hassles. As China's economy continued to grow, the perceived value of small foreign businesses declined and their legal treatment worsened.

Now, as China's economy is declining, the perceived value of foreign businesses has increased, but the perceived value of foreigners has actually declined. Let me explain this in simple and stark terms (which is how this sort of thing should be explained because this is how this sort of thing is usually viewed): businesses bring in jobs and money, but foreigners take jobs that would otherwise go to the Chinese. I am not saying these statements are true, but with this sort of thing, perception is what matters.

So what we have been seeing in China, in answer to the questions, is that approvals for the registration of foreign businesses seem to be getting easier, faster and cheaper. Labor law enforcement is on the decline (see some of our previous posts on this here and here), and the crackdown on unregistered businesses and visas is continuing apace (see previous posts on this here and here).

What this means for foreign businesses in or seeking to get into China is the following:

1. If you are a foreigner in China illegally, watch out. But you probably already knew that;
2. If you are a foreign business doing business in China and want to stay, you should register right away to get legal;
3. If you are a foreign business in China, now is a good time to seek to register your business, at least from a strictly bureaucratic perspective. Government concerns about minimum capital requirements and impact on the environment seem to be down as compared to the desire to bring in that which will or even may create jobs. The focus now is on job creation and if you can show that your business will create jobs, your chances of being welcomed into China have just increased;
4. If you are a foreign business doing business in China, you should still strive to follow the law to the letter. As tempting as it is to take advantage of this legal softening on, for example the labor law and environmental front, there are huge risks in doing so. Local officials in China are notorious for telling foreign businesses that X is okay and then the foreign business gets in trouble with Beijing for having done X. There is also the very real possibility that while one local official tells you X is okay, some other local official will penalize you for doing X, since X has always been prohibited by law.

It is easy being a lawyer when the laws are clearly written and always followed. In those circumstances, we just explain the law to the client and tell them what they must do to comply. When enforcement gets really spotty, however, we are also called upon to aid in the more difficult and dicey task of assessing the risks and rewards of non-compliance.

What are you all seeing out there?

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Forbes Magazine (which, BTW, does a consistently excellent job in covering China) has a new and interesting article out, entitled, "U.S. Talks Up WTO Piracy Ruling, But It's All Wind" and subtitled, "Washington claims that the trade body took its side in a suit against China, yet the decision will not halt intellectual property theft."

The article talks about how the United States government has been playing up its victory on two out of its three claims, but since it lost the one really important one, its victory claim is little more than spin control. To grossly oversimplify, the WTO ruled that China's criminal IP laws are not inconsistent with China's WTO obligations.

China Law Blog's own Steve Dickinson is extensively quoted downplaying the U.S. "victory":

The U.S. claim was trivial and hyper technical. They won on the hyper technical issue. The only serious issue was the criminal sanctions issue, and they lost on that one. So what this means is exactly nothing," said Steve Dickinson, a Qingdao, China-based lawyer and partner at Harris & Moure.

Moreover, piracy involving China's own copyrighted films, music and other works is just as rampant as that for foreign-licensed goods. "If China cannot solve the problem for their own domestic industries, how can they solve it for the foreigners?" Dickinson asked. Indeed, Chinese copyright owners are as unhappy as American ones: the Music Copyright Society of China and domestic record companies last year sued popular Web portal Baidu for offering unlicensed music content.

This goes back to something we have been saying on this blog since its inception: China is getting tougher on IP violations and it will continue to do so in tandem with the growth in the IP requirements of its own companies. IP in China is going to be much more closely tied to its own self interest, as opposed to the dictates of outsiders. Chinese companies are increasing their demands for IP protection within China and as that continues, we can expect to see IP protections in China continue to improve. But very, very slowly.

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The other day I did a post on the United States Trade Representative Office's (USTR) release of its report on China's compliance with World Trade Organization (WTO) rules. The report is a daunting 115 pages and at the time we wrote about it, in our post entitled, "USTR Releases Its Report On China's WTO Compliance. Will Someone Please Read The Damn Thing?" we had not read it, nor could we find anyone online who had.

I am happy to report that Experience Not Logic has read it and commented on it and so if you are interested in learning the gist of if without having to read it yourself, I urge you to read, its post, entitled, USTR on China's WTO Compliance: Damn Thing in a Nutshell. For those wanting to read the report in its entirety, it can be found [in pdf] by clicking here.

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China Journal has an excellent interview with Alexandra A. Wrage, president of Trace International, a nonprofit group that works with corporations to reduce bribery as they do business abroad. The post is entitled, "Bribes and Transparency on Chinese Holidays: A Primer," and it sets out the basics of the US Foreign Corrupt Practices Act (FCPA), and some of the most important things to do and to avoid to remain in compliance with it.

I highly recommend it for Americans who does business overseas.

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By way of explanation, here are the key lines from the Eagles' song, Hotel California:

We are programmed to receive. You can checkout any time you like, But you can never leave!

China Economics Blog used the term, Hotel California effect (borrowing from a scholarly article) to describe the problems foreigners so often have in getting their money out of China. I love that term (both because it so well describes things and because it combines law and music) and I have since used that term many times with clients who insist something in China "must be legal" because so and so did it or because the local government is encouraging them to do it. If my using lyrical symbolism fails, I flat out tell them that, "of course, China will take your money, but the problem will be when you try to take it out." I then tell them of the person who came to us after having sold his condo that he had purchased illegally and having been told by all of the banks that he would not be able to deposit his cash proceeds.

Today's post focuses on joint ventures and why, somewhat paradoxically, my firm's business both in forming joint ventures and in trying to get companies out of joint ventures has grown exponentially in the last 3-4 months. It is meant to serve as a warning to those planning to "joint venture" in China, thinking it is automatically an easier, cheaper, faster way to get into China.

We have written frequently on how to structure joint ventures so as to minimize the likelihood of harm for the foreign joint venture partner, most recently in the post, entitled, "Chinese Joint Ventures -- The Information The Chinese Government Does Not Want You To Know." We draft these agreements both to prevent problems and to ease the exit should something go wrong.

The down economy has had the interesting affect of accelerating the formation of joint ventures by companies that likely would have gone it alone when funding was easier and also accelerating the breakup of joint ventures due to disputes that were overlooked when plenty of money was coming in. Four to five years ago, many companies would contact my firm with very ill-formed ideas of how to go into China. These companies were seeking to go into China not so much with well formulated plans for success, but because they were worried that if they did not go in, they would be missing the boat. To a lesser extent, those days have returned as foreign companies feel they "must" go into China because its economy, though weakened, is a last bastion for growth. Believing they lack the funds to go it alone, many mouth the joint venture mantra.

The problem with joint ventures is that their formation is virtually never easy, because the key to a good joint venture is to raise and resolve as many potential problems as possible, before entering into the joint venture agreement. It is virtually always more expensive to form a joint venture than to form a wholly foreign owned entity (WFOE). This is not a reason not to do a joint venture, but it is a reason not to think of them as easy, quick or cheap. The problem with easy, fast and cheap joint ventures comes down the road, when the problems arise.

That down the road time is now for many joint ventures. The end of the boom times means that what could once be passed over or ignored is now important. Foreign businesses that entered joint ventures 4-5 years ago are now trying to get out of them with some semblance of assets, while their Chinese partners insist that they instead put more funds into the venture.

The problem we are seeing is that so many of these hastily formed joint ventures were set up in such a way that the Western company pretty much has two choices: walk away and turn everything over to the Chinese partner or continue in the money draining venture.

Joint ventures. Do them right or you may never leave....

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Professor Clarke at the Chinese Law Prof Blog did a post linking over to the United States Trade Representative Office's just released report to Congress on China's compliance (and non-compliance) with its WTO obligations. It consists of 115 pages and Professor Clarke states that he has no comments because he has not read it yet. I have not read it yet either and so I would love to hear from anyone who has (or does). The full report can be found [in pdf] by clicking here.

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In early December, 2008, in "China's New Labor Contract Law. Harmonized Out Of Existence?"we wrote about hearing from clients how local officials were giving them broad hints that they would not be too tough on enforcing China's new Labor Contract Law, so long as those companies maintained their employment numbers. We covered this issue again, in "China's Labor Laws. Worry Me Or Worry Me Not," a few weeks ago, after more clients reported the same thing to us.

For those seeking additional confirmation that China is going to be loosening up on its enforcement of its labor laws, the Wall Street Journal just did a story, entitled, "Factory Closures Strain China's Labor Law."

Again, though, our position is that foreign companies will almost certainly be required to continue to abide by at least some portions of the new labor law and that it is not a good business practice to violate the labor laws even if promised immunity by local officials. In particular, we believe it remains critical for foreign businesses in China to have a written employee manual (in Chinese) and to have written contracts (again, in Chinese) with all employees.

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Not sure how I missed this until now, but Experience Not Logic did an excellent series of posts on taking depositions in China, here, here, here, and here.

The first post sets out the issue:

Here's the scenario: you're a litigator preparing a case in the United States. You have reached the onerous task of discovery. A key witness is located in the PRC. You, or your adversary, need to take the Chinese witness's deposition. The witness is unable to come to the U.S., and their deposition must be taken in China. How do you go about taking this deposition, or preventing the other party from taking the deposition?

Though deposing a Chinese witness in China for a US court case is possible, the post goes on to say that only one such deposition has actually occurred in the last 25 years:

Only one limited deposition of a Chinese citizen in China has been allowed in 25+ years of China signing agreements allowing depositions to be taken. There is a very good reason for this. Depositions require the swearing of an oath. China has very strict laws regarding the administering and swearing of oaths. China likely regards the administering of oaths by foreign attorneys and consular officials as a "violation of China's judicial sovereignty." When foreign attorneys or consular officials administer an unauthorized oath in China, the penalties include arrest, detention, expulsion, or deportation of all participants in the oath. Even conducting a deposition in a hotel room with an oath by private persons could result in criminal penalties under Chinese law.

If you are involved in litigation and wish to take a deposition of a Chinese citizen, and you would mind having to sit in a Chinese prison, then you should probably seek permission from the Chinese authorities. If you are on the other side, and want to block the deposition of a Chinese citizen from being taken then you should raise an objection to the deposition as illegal under Chinese law, in a timely manner.

My firm has been involved in a number of cases where it has made sense to depose Chinese witnesses in China and in none of them did it ever occur. Instead, the following happened:

1. In one case, the opposing party wanted to depose five witnesses in Hong Kong. I moved to require opposing party to at least try to secure Chinese government approval for these depositions to go forward in China. I pointed out that my firm had a lawyer in China who could handle the depositions there and that flying him to Hong Kong would greatly increase cost. The court denied our motion and the depositions went forward in Hong Kong.

2. In one case, I was representing the defendant and two China witnesses were absolutely critical to plaintiff's case. The case ended up settling before trial for nuisance value when it became clear plaintiff''s two witnesses would never leave China to be deposed or to testify at trail.

3. In one case, we brought a key witness to the United States for deposition.

One possible option would be to convince a Chinese witness to be deposed within a US embassy or consulate. My firm has taken depositions overseas in US embassies, consulates, and on US military bases, but never in China. The problem with China is that the cost/risk of seeking to depose someone in China (even at a consulate or embassy) is so high that it is usually just easier to fly the witness to some other country for the deposition.

I would love to hear what others have done to depose Chinese witnesses for foreign court cases.

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Blogger Ryan McLaughlin (and my firm's webmaster) recently posted on media coverage of the death of his beloved Golden Retriever, believed to have been caused by a package of Optima dog food. The post is entitled, "US-made Optima dog food in China may have killed my dog," and in it, Ryan discusses how the US-based Mars company makes Optima dog food, but it does not ship it or sell it in China. Mars does sell Optima to Taiwan, however, and it is not clear if the Optima dog food Ryan purchased in Suzhou, China, came from real Optima dog food sent to Taiwan (which may have been compromised by poor storage or age) or was counterfeit. Ryan wrote again here about the media coverage his dog's death has been receiving.

So here's the question. Might it make sense to bring a claim against a US product manufacturer in a US court based on its failure to monitor its brand worldwide? Can one argue that Mars was negligent in not doing more to prevent its product from being sold in China or in preventing counterfeits from being sold? Has there ever been such a case? Please understand that that I have absolutely NO evidence one way or the other regarding Mars' actions involving Optima, I am merely using it as an example.

What do you think?

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Twice last week I got calls from companies wanting to get legal in China. URGENTLY. One company is in Shandong province, the other is in Shanghai. Both have been operating illegally in China for years. I asked both "why now?" and they both gave essentially the same response:

I want to register my business in China so I can work in China legally. I'm hearing that the government has begun and will be stepping up its efforts to root out foreigners here illegally.

With both, we then discussed how a crackdown on foreigners in China will play well politically as a counterweight to its tightening job market. Chinese citizens are not going to take kindly to its government allowing illegal foreigners to "take jobs" from the locals.

The People's Daily wrote on this the other day, in an article entitled, "Illegal workers identified," in what I see as the government's opening salvo/warning on the issue of foreigners working illegally in China. (h/t China Economic Review Editor's Journal) The article talks about a recent crackdown on foreigners in Shanghai involving 377 foreigners "found to be working here last year without the necessary documentation."

The People's Daily article highlights the classic way in which foreigners manage to get into China to work illegally: entering on a tourist visa.

If you are working in China you need a work visa. If you are working for a Chinese company or a properly registered foreign company, you need to make sure you and your employer go through the proper steps to secure approval for you to work in China as an employee. If you are working for a foreign company in China that is not properly registered to do business in China, you have two choices for getting legal. You either register the business and secure approval for you to work in China as an employee or you leave the country.

Or, maybe you think tightening China employment will not impact you, in which case, I would love to hear why you think that is the case.

What are you seeing/hearing out there?

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Absurdity, Allegory and China is doing an excellent job in covering the recent problems with Chinese drywall that have cropped up in Florida. AAC has done a series of posts on this issue, the most recent one, entitled, "Just Follow the Links," which, as its name implies, links over to the previous ones.

As I am always saying, lawyers make for excellent canaries in terms of what is happening and what is going to happen. This is because we oftentimes hear of things from our clients before they become public, through either litigation or an announced deal. My law firm has been hearing much more about and/or getting much more work in four areas relating to China. Only one relates to the drywall problem, but all four directly relate to the downturn in the economy.

Here goes.

First, we are hearing of even more incidences (yes that is possible) of China quality control problems. Chinese companies that are strapped for cash are the most likely to skimp on quality and with more Chinese companies strapped for cash....well you do the math. In "How To Protect Your Company From Bad China Product," we wrote on how foreign companies can reduce the likelihood of receiving bad product from their Chinese manufacturers. Our advice from that post still holds, but the need for foreign companies to follow it has increased.

Second, we are getting an increasing amount of work from foreign companies who want to exit from their Chinese joint ventures. The reason this is happening now is that when times were good, the foreign participants in joint ventures have a tendency to "let things slide." Now, with profits tanking, they are feeling they cannot just sit back and wait.

Third, and paradoxically enough, we are doing a greatly increased business in forming joint ventures in China. We are getting clients who are saying that up to a few months ago, they were planning on going into China on their own, via a Wholly Foreign Owned Entity (WFOE), but now they want to go the joint venture route to "spread the risk."

Fourth, we are getting a ton of work from companies owed money from other companies that are either unable to pay their bills or just choosing not to pay the companies that are calling us. I estimate our breach of international contracts business has doubled in the last six months. As Jeremy Gordon over at China Business Services, puts it, "this is a risky time for payment."

Are you seeing these same legal/business trends? How are they impacting your business?

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The following is an outline of a talk co-blogger Steve Dickinson gave yesterday at The China Economic Review" forum on "Foreign Direct Investment in China: Optimizing FDI strategy in the current economic climate."

UPDATE AND FORECAST OF REGULATORY FRAMEWORK FOR FDI IN CHINA

I. Major features of the current FDI system in China as of January 1, 2009.

The PRC FDI system dramatically changed during the period of 2006 to 2008. The main features of that change are:

A. Tax neutral FDI policy.

In 2008, China reversed its prior tax policy concerning FDI. Under the old policy, foreign investors were taxed at a lower rate than domestic investors. Investors in specific regions such as Pudong were provided with various tax exemptions. All this was eliminated in the new income tax code, which mandates a neutral FDI investment framework: no incentives based on nationality or region. Incentives are instead provided for specific encouraged business activities. A limited exception to this policy is provided that allows for tax benefits for investment in the central and western regions.

B. FDI through M&A strongly discouraged.

C. Direct foreign investment in real estate prohibited, with remaining foreign investment in real estate strongly discouraged.

D. FDI policy changed from export led growth to quality investment supporting domestic led growth. This shift was a result of the general economic policy adopted by the 11th Five Year Plan and set out in detail in the 11th Five Year Plan on the Utilization of Foreign investment. This plan is a combination of prohibitions and incentives.

1. Prohibitions, as stated in the 11th FDI Five Year Plan:

• No projects that rely on cheap Chinese raw materials or energy
• No projects that waste energy or raw materials, are excessively polluting or that rely on outdated technology, as listed in the 2005 Catalog of Industrial Restructuring
• No projects that are oriented solely towards export
• No projects that center on low technology, low investment, low value added and high employment: toys, apparel, furniture, house wares, shoes, etc.
• No projects in luxury real estate, with general investment in real estate also significantly restricted
• No support for such projects in the form of VAT or other tax benefits

2. Incentives, as provided in the 2007 Catalog of Foreign Investment and the 2008 Catalog of Foreign Investment in the Central and Western Regions

• List of encouraged industries listed in the Catalog is greatly expanded
• Foreign investment is encouraged in business areas emphasized by the 11th Five Year Plan. These areas include: energy and resource saving (“circular economy”), environmental protection, transportation infrastructure development, hi-tech manufacturing, logistics, business outsourcing, improvements in agricultural technology. The revised tax code allows tax incentives to encourage such investment.
• Regional investment is encouraged in the central and western regions. The encouraged investment category for such regions is expanded in the revised 2008 Central/Western Catalog. Regional tax breaks are still permitted for this region, as an exception for the general prohibition on regional tax incentives.

II. The new investment policy in 2009: Facing the global economic downturn.

A. Quality Investment or Export Led Growth?

The question for 2009 is whether China will continue to pursue the quality FDI approach, or whether China will return to the export led growth model. The key factors are:

• FDI in China saw a large downturn in 2008: As of November, approved projects were down by over 25%. An even greater decline is expected in 2009.

• The macroeconomic factors that supported the “quality over growth” program were: unsustainable high growth in GDP, general price inflation, hot money inflows, consistent growth in exports, consistent growth in FDI. All of this has reversed. Wen Jiabao, in a recent article, stresses that growth is of paramount importance. Recent action on the part of the government in support of traditional export manufacturers included reinstatement of VAT rebates, access to lending, and other revisions to tax policy. China appears committed to reliance on the export led growth model, at the expense of other competing exporters.

B. What should we then expect in Chinese FDI policy for 2009:

The current response from the PRC regulators suggests that there will be a qualified return to the export led growth model. This means the following:

• Support for low tech, high employment manufacturing will return.
• Support for pure export manufacturing will return. The resulting high trade deficit is no longer a political concern.
• However, projects listed as prohibited in domestic Industrial Restructuring Catalog will continue to be restricted or prohibited. There will be no return to approval of high pollution, high waste, high-energy usage projects merely to obtain investment.
• Projects that use excessive amounts of energy will be highly restricted. Energy is still in short supply in China, even in the face of economic slowdown.
• However, projects that take advantage of low raw material costs will no longer be discouraged.
• No major changes in the income tax code will occur. The level playing field in tax policy will be maintained.
• The current ineffectiveness of tax policy for encouragement of investment will continue. Tax incentives to encourage FDI in the central and western regions will continue to be ineffective.
• However, the VAT tax system will undergo major changes that will benefit FDI focused on export and low-tech manufacturing. There will be a revival of VAT rebates in support of export-oriented manufacturing, which will benefit FDI focused on low-tech manufacturing. There will also be a general restructuring of VAT, which will benefit FDI based manufacturing in China.
• The incentive systems based on the catalogs for foreign Investment will remain relatively unchanged. However, the actual encouragement for investment arising from such categorization will continue to be relatively weak.
• No major change will take place in the general policy discouraging M&A investment.
• The policy on FDI in real estate remains unclear. It seems likely that the restrictions on FDI in this area will be loosened. However, there is no indication at this time of any move in this direction.

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Foreign companies contemplating doing business in China are getting more sophisticated about the need to register their trademarks in China. I think. I say this because the number of companies contacting my firm who think the have a trademark in China simply by virtue of the fact that they may have one in Puducah has drastically declined. So if our post, entitled, "China Trademarks -- Do You Feel Lucky? Do You?" was China trademarking 101, this post, on what to trademark, should be China trademarking 102.

IP Dragon blog did a post, entitled, Trademarks in China: Nomen Est Omen that nicely sets out the basic alternatives companies face in deciding what to trademark in China, using Shell Oil Company as the example:

If Shell wants to sell their products in China they can do three things:

-- Register only your non-Chinese name, this is unwise, because it invites Chinese counterfeiters to jump into the vacuum;

-- Register also a translation of the meaning of the mark into Chinese, a so called conceptual translation. Shell, the oil giang, choose to translate the meaning of the external skeleton of a mollusc: 壳 shell you pronounce ke2 in Mandarin and hok3 in Cantonese, 牌 brand you pronounce pai2 in Mandarin and paai4 in Cantonese;

-- Another option is to register a transliterated or phonetic translated mark. This can be a great route, if you choose characters that correspond to the characteristics of the brand. Coca-cola transliterated its brand into ke kou ke le, but then you have to find Chinese characters that fit to your brand: if you do not pay attention you can find Chinese characters that are pronounced in Mandarin as "ke kou ke le", but which mean: "female horse fastened with wax". However, the Coca-Cola company paid attention and came with the splendid result: 可 ke3 (approve) 口 kou3 (mouth) together means tasty, 可 ke3 (approve) 乐 le4 (joy) or in the words of Marc Garnaut "permitting the mouth to rejoice".

After you choose between these options or a combination thereof, you have to decide whether you want to register traditional Chinese characters (used in Hong Kong, Macau and Taiwan) or simplified Chinese characters (used in People's Republic of China and Singapore).

There are really four primary considerations that go into deciding what to trademark. First, there are the legal issues, which should be handled by a lawyer. What is/are the best categories in which to file and what exactly should be filed? Second, there are the marketing issues, which should be handled by the marketing team of the company seeking the trademark. Thirdly, there are the Chinese linguistic and cultural issues that should be handled by someone both fluent in Mandarin (or maybe even Cantonese or whatever other language is being considered) and knowledgeable about Chinese marketing and culture. Lastly, there is the question of money as every additional filing costs.

In situations where our clients are making product in China for export only and their product has the trademark on it only in English, securing just an English language trademark is usually enough. In situations where a company intends to manufacture its product in China and eventually sell in China eventually, the company must weigh the costs and benefits of securing a Mandarin (or other language) trademark now, or just wait. In situations where the company knows it will be selling its product in China right away, it needs to analyze the options set forth by IP Dragon above. I would say that in almost all instances where our client's trademark has actual meaning (such as the word "Shell") they have chosen to trademark both the English and the Mandarin of the word. Rarely do our clients seek a China trademark in a language other than either English or Mandarin. Only around 25% of the time do our clients seek to secure the trademark for a transliterated or phonetic version of their English language trademark. Most of the time, they choose to wait and see how their product does in China and then, if it proves successful, they usually come back and register more on it.

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About a month ago, we did a post entitled, "China's New Labor Contract Law. Harmonized Out Of Existence?" In that post, we (I say we here because some of what I was reporting was coming to me from co-blogger Steve Dickinson who is based in China) talked about how local and provincial authorities were giving out broad hints that they were not going to be all that keen about strictly enforcing China's labor laws other than those related to preventing layoffs:

We have talked so much about the labor law because it applies to every business in China with an employee. Complying with the law is relatively easy and the penalties for failing to comply can be so harsh.

But last week, a long-time client of ours with a factory in Shandong Province (just outside Qingdao) told me of how a Chinese government employee had essentially told him not to worry so much about China's labor contract law. The gist of the government employee's statements to our client was that so long as this company did not lay off any of its approximately 250 Chinese employees, the government would look the other way regarding other labor law violations. My client and I agreed that it needed to remain in strict compliance with the labor laws because it had nothing in writing from this official, because this official does not control everything in the province or the country relating to labor laws, because violations of the labor laws can lead not only to problems with the government, but to employee lawsuits.

I have since talked with a couple other of our Shandong Province clients and they report no such conversations, but they do say they have "heard" that China's labor laws surrounding everything but layoffs are being loosened

In a recent Danwei post, entitled "Trade unions and social unrest in 2009," (h/t to China Challenges), Peter Ford of the Christian Science Monitor (one of the best reporters in China) talked about hearing similar things:

I have heard, though not been able to confirm, that provincial governments have been quietly telling employers for several months that if they do not abide by the provisions of the Labor Contract Law they need not worry, and this seems perfectly plausible.

A lot of employers have been complaining for a year or so that the labor law, along with the rising value of the RMB until last July, was a major factor in making them uncompetitive.

That may be true of the low margin, low quality producers, and while the government clearly did not mind driving them out of business last year (so as to move China’s economy up the value chain) such firms do at least offer jobs while they are still in business, and jobs are going to be in short supply this year.

Actually, since I did the December post on this, I have heard the same thing from a couple more clients, one from Dalian and one from Tianjin. So what is a foreign company doing business in China to do in light of this? Should it all of a sudden start violating China's labor laws in the hope of sliding by?

Our advice is to continue following the laws to the letter and we base this largely on two things. One, just because one government official says one particular government entity is going to be lax on enforcing the labor laws does not mean much. This one government official may believe in lax enforcement, but that does not mean all of his cohorts do. Also, it does not mean Beijing does either. Two, one of the biggest risks of not following China's labor contract law is a private lawsuit by a disgruntled present or former employee. A local government may be able to bring about a decline in private lawsuits and more favorable rulings from the administrative bodies or courts that rule on such lawsuits, but I do not believe such lawsuits will be extinguished completely and I also think foreign companies will continue to fare rather poorly in such lawsuits. Down economy or not, a Chinese worker suing a foreign company will always go in with an advantage.

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Recieved an email from Toronto-based international lawyer, Paul Jones, on China's just amended patent laws. I liked it so much, I secured Paul's permission to run it here:

"Last week in Beijing there was the last meeting of the Standing Committee of the National People’s Congress for 2008. On Saturday it was announced that they had found that the revisions and consultations (they received some 500 responses) had gone so well that that the amendments had been voted on and adopted. The Amendments will come into effect October 1, 2009.

The Amendments and the Amended Law (in Chinese) are here. [We will be watching for a good English language translation and will post it when and if we find it]

The amendments introduce a number of changes such as an absolute novelty requirement, make it easier for judges to increase the penalties for patent infringement, require disclosure of sources for genetic resources, and require inventions made in China to be first applied for in China unless a license is granted for a foreign filing.

Interestingly and although “junk patents” were a major target of the drafters of the amendments, it was decided not to insert a concept of patent abuse. It was felt that this concept should be dealt with under the provisions of the Anti-Monopoly Law. In other words there is to be no separate doctrine of patent abuse as there is in the U.S.

Secondly some are now suggesting that it is time to codify all the IP laws, as came into effect in Russia on January 1, 2008. Apparently however there are other priorities at this time such as the proposed new Tort Liability Law."

While on the subject of IP protection in China, it also bears mentioning that a Chinese court just handed down stiff prison sentences to a large and previously very successful software counterfeiting group. All of this reinforces what we have always been saying on this blog, which is that IP protection in China is and will continue to improve, but slowly, very slowly.

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Went to a party last night where a large group of us discussed the following scams:

1. Bernie Madoff.
2. Mark Dreier. I brought this one up and I have to give Dreir credit for managing to pull off a 300 million dollar scam, yet gain very little recognition for it because Madoff so quickly threw him off the front pages.
3. Lou Pearlman. I brought this one up also because the article on it in Vanity Fair does such a great job explaining it.
4. All of us lawyers then told about the scam cases on which we had worked or are working.

We then all concluded that blind greed had been a large factor in all of them. Obviously nothing revolutionary in that.

Stan Abrams over at China Hearsay (which is a blog you HAVE to put on your reader) did a post, entitled "In Defense of Due Diligence," tying Madoff in to China and pointing out how due diligence would probably have prevented the whole affair:

So what’s the point? There are a lot of crooks out there, and some of them are even pillars of the community. Why, oh why, would anyone ever do a deal without checking out the other party? Why do anything based on trust? I know the usual excuses, I’ve heard them for the past 10 years with respect to Sino-foreign deals:

1. Due diligence costs are too high.
2. We don’t have enough time to conduct proper due diligence.
3. People I trust vouch for this company.
4. The CEO is a close friend of . . .
5. The company has ties to the Ministry of . . .

You get the idea. None of this is new, and most people have read countless articles over the years on this topic. I am wondering whether the recent goings-on will make some people stop and think before doing something stupid. Perhaps, but I also know that the list of five excuses is compelling, even to the most professional deal-maker out there.

By the way, I shouldn’t keep this post limited to due diligence. All of this goes for other kinds of investigations and audits of licensees, distributors, suppliers, etc. Multinationals that don’t do their homework are asking for trouble, and with all the examples out there of bad practices, there really is no excuse anymore — if something goes wrong, you will be punished.

Stan is, of course, dead-on. I will add one more excuse to the list, one which I have heard twice in the last few months as an explanation for having already lost pot-loads of money: "We had never had any problems before."

For countless reasons, international deals are ripe for scams and I have worked on a ton of them. Virtually without exception, there were weird things that should have tipped people off as to what was going on, but these things were always ignored. Examples:

1. Why would there be an Atlantic Bank in Australia when it is not on the Atlantic?
2. Why would a company allegedly based in the Marshall Islands have misspelled the country's name as "Marshal Island" on its letterhead?
3. Why would an allegedly prominent London lawyer share office space with a Blimpies?
4. Why would an alleged US Federal Court case pull huge swaths of language straight out of Paul McCartney's divorce case. It took me a 1 minute internet search to discover this?
5. Why would a US lawyer call himself a barrister when the US does not have barristers?
6. Why would a large Moscow based company send all of its faxes from a mid-level hotel in Busan, Korea? Big surprise, it was not the Moscow company after all.

Be careful out there and have a MERRY CHRISTMAS.

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One of the things I love about being an international lawyer is using outside events to interpret the law. Now I know this is going to anger a lot of people, but non-lawyers generally do a terrible job interpreting the law. This is true worldwide. Examples of this abound:

Non-lawyers tend to look for "the law" that applies to their situation. Once they have found that law, they think they are done. What they so often fail to do is put the law into context. Many years ago, we had a fairly client [I am going to get intentionally vague here] who was doing a big project in a foreign country. The client had read that companies in this country for less than six months did not need to pay a particular tax and they did not pay this particular tax. They had failed to read that this law (and a whole slew of other laws) did not apply to companies employing more than 50 people and this failure ended up costing them hundreds of thousands of dollars in penalties and attorneys' fees.

Non-lawyers often fail to realize there can be many different laws applicable to the same factual situation. The easiest example is that there can be national laws, provincial laws, and even city laws (this is particularly true with respect to China's employment laws) and merely following one set of laws can leave you very much exposed.

Non-lawyers tend to believe all laws mean what they say, even though this is oftentimes not true. Laws sometimes neither mean what they say nor are they always enforced. Sometimes there are laws that say one thing, but some other law or case or bureaucrat says another, and that other essentially becomes the law.

Lack of enforcement can be a huge issue in China. There are all sorts of laws in China that are on the books, yet only sometimes enforced, only enforced in some provinces and cities, or only enforced against some companies. As I have often written, a Chinese company getting away with not following a law should mean very little for a foreign company.

I am certainly not saying anything new here and everything above is known by most lawyers and has been said on this blog many times before. But I am writing about it now because I am getting the strong sense that there has recently been yet another tightening up of enforcement in China against foreigners and I attribute it directly to the economic downturn. China, like so many other countries experiencing an economic downturn, is fighting even harder for its own people at the expense of outsiders. If the Chinese themselves are going to have trouble making money, the Chinese authorities are going to need to step it making sure foreign companies are not taking away economic opportunities from its own citizens. We can argue all we like about whether this is good economics, but I do not think it can be disputed that it is good politics.

This all came into stark relief for me in the last few months when something happened twice that has never happened even once before. Two companies called us about "cleaning up" their legal acts in China. These two companies were doing well in China, off the grid, and they retained us to get on the grid. By on the grid, I mean, registered as foreign companies with written contracts with their employees, and an employee manual. Both of these companies were located in tier two cities and both had been doing business in those cities for a couple of years. They retained my firm, paid the retainer, and we started doing the work. But, in both cases, well before we had even gathered up all necessary information, these two companies had been shut down and told not to even bother.

Over the last few years, we have registered countless companies in China that had been operating quite openly without registration for years. We registered one company that purchased more than $300 million in Chinese goods a year and employed more than 3000 people. We registered another company that had been operating for more than 15 years. But only after the economic crisis has begun have we ever been in the process of bringing a company within the law only to have that company thrown out. I cannot say more at this point because these two companies are both looking into their various options, but I can say that from our perspective, it seems China is going after foreign companies as fervently as I have ever seen and I have no doubt economics is the reason.

For more on this stepped up enforcement against foreign companies, check out the following:

-- "China Deters Foreigners From Selling Bank Stakes," at China Bystander.

-- "The New Chinese Economy & You," at ChinaSolved. This post starts out with the following:

The Chinese economy is already starting to look a little more protectionist and inward-looking. If you need proof, take a look at Sunday’s FT article that quotes a directive from China’s Civil Aviation Administration,

‘It also exhorted domestic airlines to unite and develop together “to form a ‘fist’ in the face of international competition” while avoiding competition with each other domestically.’

It concludes by very wisely warning of what it calls "legal gray areas":

Legal gray areas – Are you in a legal business, or a ‘not illegal business’? ‘Not illegal businesses’ are great for bull markets when they help facilitate the flow of funds sloshing around. Unfortunately, they quickly turn into ‘not approved businesses’ when things get leaner. Think hard about your basic business model and make sure it’s bureaucratically bulletproof. In China, bureaucrats are the shock troops of a trade war. They live for this moment.

Will Chinese bureaucrats really be the "shock troops of a trade war" or are we just being alarmist?

UPDATE: The Off the Record Blog has a great post, entitled, "Could Coke lose its China fizz over student allegations?" on very recent (and very heavy) China buzz relating to allegations (and that is all they are at this point) of Coca Cola's having violated China's Labor Laws. Is this a sign of what I am talking about above, or just an isolated incident?

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The United States has hit China with a WTO case, contending China has been subsidizing its exporters, particularly its largest and best known companies. The US government is alleging that China's central government, provinces and cities have all been paying subsidizing many Chinese companies that export.

As my kids would say, well duh!.

Since this has been going on since forever and since everyone knows it, the real question is why has the US brought this lawsuit now? I do not know. In fact, if anything, the timing seems very strange. First off, it would have been good politics to have brought it before the recent elections, but that was not done. Second, if the US wins and China has to stop subsidizing its exporters (or push those subsidies a bit further underground), this will mean higher prices for buyers in the US and elsewhere. Of course, these higher prices will also been US companies will be better able to compete with Chinese companies on the world market and that, no doubt is why this case has been brought.

Click here for the Office of the United States Trade Representatives "Fact Sheet" on this lawsuit [h/t to Laurel Delany of The Global Small Business Blog, who alerted me by email to this filing]

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Phone calls from potential clients always start out fun and this economic downturn has brought in a whole slew of new clients and potential clients needing legal help in dealing with the economic downturn.

This post is on three potential clients whose situations were so bad that I had to suggest they not hire us at all. None of them liked what I had to tell them, but two of them actually hired us anyway. One to try to deal with the matter on which they initially called, one to deal with another matter and to prevent a recurrence of the situation that precipitated the call.

All three calls started out pretty much the same with the nearly obligatory, "I got your name from so and so. He tells me you are the perfect person to solve my problem." I then respond by extolling the virtues and smarts of "so and so" and then modestly agree that I am pretty experienced with these sorts of matters. All three phone calls quickly declined from there.

The decline began when the companies started telling me the facts. Two of the companies had purchased product from their long time Chinese suppliers and had received -- for the first time -- totally substandard product. They both felt this Chinese company had shortchanged them this time around because it was becoming economically desperate. Neither company had a written contract with their Chinese supplier; they had both used purchase orders. They both wanted my firm to sue on a contingency fee basis and I immediately refused. We do not consider such cases unless there is a contract clearly setting forth the product specifications and the defect in the product stems from failing to meet a clearly enumerated contractual specification. "You are welcome to pay us by the hour," I said, "but instead of spending money on that, I suggest you retain us to write your future contracts in Chinese. That would be money well spent." Neither initially took too kindly to my suggestion; one responded in such a way as to give rise to the title of this post.

The third incident was with a company that had supplied materials to a number of vessels. This company had failed to confirm that the vessels to which it was supplying the product was actually owed by the company buying the product and we discovered it was not. Very roughly, this meant we could not arrest the vessels and the only way our client could recover on its debt would be to sue the purchasing party directly in an Asian country not exactly known for its rule of law.

I told the client it needed to change its procedures before supplying ships in the future. I was going to tell it to always require the vessel owner to also sign on to its contract and to require the purchaser to provide a certificate of vessel ownership so there would be no doubt the vessel owner is putting its own ship at risk. However, before I could say this, the person at the company with whom I was dealing, somewhat angrily told me he knew exactly what he was doing and he had never had this problem before. He made quite clear that he did not think he needed any legal advice regarding his future business. In other words, I was to work magic on his problem now and not worry about him making the exact same mistake again.

In all of three of the above cases, these companies had apparently been engaging in risky behavior for many years, without having suffered any real consequences. It seems the old stockbrokers adage that "genius is a rising market" also holds true for China business.

We lawyers are trained to think about and prepare for the worst case scenario. The economic downturn is causing worst case scenarios to happen constantly and those scenarios are exposing those who apparently believed such scenarios could never occur. In other words, we lawyers are being proven to have been right all along. I told you so.

Would love to hear from readers who are paying the price for having failed to properly document their China deals and from those readers who are faring relatively well for having done so. If there are any of you out there who are benefiting from not having documented your deal or paying the price of having good documentation, I would love to hear from you too.

PS I have been doing my utmost not to flack too much for "best blog" votes, but I certainly would appreciate your clicking here and voting China Law Blog.

UPDATE: To clarify, having a contract does not guarantee one will not have problems. Nor does it guarantee that it will make sense to sue if something goes wrong. Nor even does it guarantee one will prevail if one sues. But, in our experience, having a contract greatly increases the likelihood the Chinese company will choose to mess with someone other than you, greatly increases the likelihood that it will make sense to sue, and, most importantly, greatly increases the likelihood that you will prevail if you do sue. It is the likelihood of losing at trial that causes companies to want to settle and Chinese companies are little different on this score than companies elsewhere around the world.

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In its post, "Why I Should Stop Reading IP Case Summaries in the News," China Hearsay does a great job attacking a Xinhua news story on what appears to have been a legal victory by Apple Computer in a trademark lawsuit. China Hearsay is justifiably ticked off about the misstatements in and extreme vagueness (can something be extremely vague?) of the article and in attacking the article, actually (inadvertently) does a really good job setting out a couple of key China trademark law basics.

First, one does not just "register a trademark" in China. One must register one's trademark in a particular category or categories. This matters. Western companies frequently complain of someone having infringed on "their trademark" in China, when in fact there has been no infringement because the Western company actually never registered a trademark in the particular category in which the allegedly infringing product belongs. Second, unlike patents, China trademarks do not necessarily expire; one can easily renew them every ten years simply by paying a fee.

Where China Hearsay gets it wrong is to allow himself to get worked into such a lather by the media getting China law wrong. I am just so past that.

A couple of years ago reading two articles in the Western media of how Chinese companies had "stolen" the trademarks of two American companies. The facts in the articles did not ring true so I called up the two companies and asked them if they had registered their trademarks in China. Neither of them had. Turns out they were both advancing the morale boosting, but legally worthless argument that US trademarks should extend around the world.

I laughed.

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As regular CLB readers know, we have been flacking China's new labor contract law since even before its inception at the beginning of this year. Without a doubt, it has been one of our two or three most popular topics. To wit:

--"China's Proposed Labor Law:Going After Capitalists Like China, 1967"
-- "China's Proposed Labor Law Causing Sucking Sounds"
-- "China's New Labor Law: Enforcement Is The Key"
-- "China's Brand New Labor Law Regulations. It's All Here."
-- "China's New Labor Law -- It's A Huge Deal. Huge I Tell You."
-- "China's New Labor Law: Results Still To Be Determined"
-- "China's New Labor Law Gives SOME Employers The Jitters"
-- "China's New Labor Law As Plague On All Employers' Houses"
-- "China's New Labor Law Means Tenure For Everybody"
-- "NPR On China's New Labor Law -- Low Tech Getting 'Difficult'"
-- "China's New Labor Law: Compliance Comes Easy"
-- "China's New Labor Law. Still Coming. Still A Big Deal."
-- "China's New Labor Law And Why Vietnam Is No Big Thing"
-- "China's New Labor Law -- Just Deal With It"
-- "Putting The China Labor Law Cart Before The Horse"

Must recently, we did a piece, entitled, "The Impact Of China's Labor Contract Law," in which we discussed how the new law was influencing China's labor situation.

We have talked so much about the labor law because it applies to every business in China with an employee. Complying with the law is relatively easy and the penalties for failing to comply can be so harsh.

But last week, a long-time client of ours with a factory in Shandong Province (just outside Qingdao) told me of how a Chinese government employee had essentially told him not to worry so much about China's labor contract law. The gist of the government employee's statements to our client was that so long as this company did not lay off any of its approximately 250 Chinese employees, the government would look the other way regarding other labor law violations. My client and I agreed that it needed to remain in strict compliance with the labor laws because it had nothing in writing from this official, because this official does not control everything in the province or the country relating to labor laws, because violations of the labor laws can lead not only to problems with the government, but to employee lawsuits.

I have since talked with a couple other of our Shandong Province clients and they report no such conversations, but they do say they have "heard" that China's labor laws surrounding everything but layoffs are being loosened.

What are you hearing?

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In his post, "The Bar is Passing People By," A Modern Lei Feng sets out the following pass rates for China's bar exam:

2002 - 8%，
2003 - 11%
2004 - 11%
2005 - 14%
2006 - 15%
2007 - 22%

He goes on to posit that the percentages for this year's recently completed bar exam will be even higher and wonders whether China's rising bar pass rate will be a permanent thing. I think we will be seeing a higher pass rate in China for quite some time because, but as China becomes an increasingly more legalistic society (on the business front anyway), there will be an increasing need for lawyers.

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CLB's own Steve Dickinson has just returned from the annual China Maritime Law Conference, made up mostly of China's leading maritime lawyers. This year's conference was in Wuhan.

Steve reports as follows after the first day:

I just finished the morning session of the first day of the All China Maritime Law Conference being held in Wuhan. The theme of this year's meeting is the shipbuilding industry. The conference was organized when Chinese shipbuilding was booming and China had plans to replace Korea as the leading shipbuilder in the world. Due to the recent economic downturn, virtually every presenter revised their presentation at the last minute to discuss the effects the current situation is having and will have on the maritime industry in China.

The presenters all agreed on the following. The downturn in shipping is having a profoundly negative effect on all segments of China's maritime industry.

Shipbuilders are finding that their shipbuilding contracts are being extensively breached. Since shipbuilders in China are mostly new companies, they are heavily in debt. These breaches threaten the life of the entire shipbuilding industry in China.

Vessel owners are finding that charter parties are refusing to pay charter payments. Some charter parties are demanding revisions to charter agreements. In more extreme cases, the charter parties are simply abandoning vessels in mid-voyage. [Editor's note: charter party agreements are essentially agreements to rent out a ship]

Shippers are finding that their customers are refusing to honor long term shipping agreements and are demanding extreme reductions in shipping rates.

Ports are finding their volumes rapidly decreasing. This is an especially serious problem with smaller and newer ports. It is also a problem with ports in the middle of ambitious expansion plans.

The presenters for this morning session were primarily from Hong Kong, Singapore and England. They proposed various legal solutions for dealing with the crisis situation that has developed. The Chinese lawyers in attendance spoke in near unison on the response they are getting from their clients:

The clients first deny there is any problem.

Once the problem is too acute to deny, the clients reluctantly consult with a lawyer on what to do. When told that they will need to retain and pay for a lawyer to pursue resolution of the issue, the client refuses. The reason: "We are already losing money. Why would we pay a lawyer and even lose more money?"

What does this mean for the future? It is possible the Chinese maritime industry will wake up and start to deal with the current situation. Currently, however, the Chinese maritime industry is taking a purely passive approach to the current crisis. Since the lawyers are all new to the industry, the Chinese lawyers have little perspective on what will be the result. The industry leaders are in the same position: they have no historical perspective. If the attitude of the Chinese maritime industry does not change, it seems likely there will be a major shake out, with many companies going out of business. Only the major players who are funded by the central government are likely to survive.

The other day, I wrote the following:

We are finding that Chinese companies, for a whole host of reasons, are incredibly slow to mount full scale efforts to collect on their debts. Just this week, we were contacted by two Chinese companies seeking to collect 6 and 7 figure amounts from American companies arising from long ago non-payments. In both cases, the Chinese companies had waited so long that the US companies had already ceased operations, without ever having declared bankruptcy. Though it is sometimes possible to collect in such cases, there is a greatly increased difficulty to do so.

In response to this, someone left a comment, asking the following:

Were shipbuilders that flush for that long that they could ignore 6 and 7 figure outstanding debts owed them, and for so long?

My response to that was going to be to analogize it to the dot.com boom. During the boom, companies were moving forward so fast, seeking and getting funding, and burning through cash at such a fast pace, that nobody had any time or desire to focus on bad debt. When the dot.com boom ended, however, many companies came to us with a whole host of international bad debts for us to collect on. We had one client come to us with a very fresh debt of around $300,000 from a company in Europe. We were able to recover most of this on our client's behalf and after we did so, they came back to us with two more matters: one for about a million dollars and one for about $700,000, both of which were more than two years old and both of which were with Russian companies that turned out to no longer exist. I asked the client why they had waited so long to come to us with these and their response was that the money just never seemed to matter when they had so much of it.

Just today, my firm secured a Rule B arrest Federal arrest order to arrest a Singapore-owned vessel for failing to pay on its charter-party contract and spoke with a Chinese company seeking our help in collecting on a nearly million dollar debt on a vessel charter-party agreement. The Singapore arrest was for a British company that is paying us by the hour. The Chinese company was unwilling to hire us on either the hourly rate or the contingency fee basis we requested. It wanted us to pursue the claims for a 5% contingency fee, with my firm paying all the costs. I assured them that no firm in the United States, and certainly not one with attorneys and staff fluent in Chinese and Russian (the opposing party is Russian) would ever take on this case for anything approaching that amount.

Many years ago, another Chinese company insisted we take its case on a 5% contingency basis. That case was for around $400,000 and it too needed Chinese speaking lawyers. I knew the company that owed the money and thought the case was extremely strong, but refused to take it on anything approaching the terms sought by the Chinese company. The Chinese company rejected our terms and I asked Steve Dickinson what he thought the Chinese company would do. Steve told me he thought it would simply never collect the money. La plus ca change....

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Bear with me here non-lawyers as I promise there will be some manna for you at the end.

Just read a very good article in International Law Office by Harvey Lau of Baker & McKenzie (and no, my firm is not and has never been in merger talks with Baker & McKenzie, though we are honored by the rumors), on airplane seizures/arrests in China. The article is entitled, "Ratification of Cape Town Convention to Boost Finance" [free subscription required] and it talks about how "the National People’s Congress just ratified the Convention on International Interests in Mobile Equipment and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment, known as the Cape Town Convention, which China signed in November 2001." This convention is expected to become law in China in early 2009.

So why am I telling you all this? Again, bear with me here.

The article describes how this ratification will better protect airplane lenders and thereby reduce overall lending costs:

The ratified convention will provide owners and mortgagees of aircraft equipment with better protection for their interests in terms of perfection and priority of such interests by way of registration, which will be welcomed by existing and potential financiers, leasing companies and other participants in the Chinese aviation industry. US Eximbank had frequently indicated that it would reduce its exposure fee for airlines in China were China to ratify the convention. Given the turmoil in the financial markets, financing structures involving US Eximbank's support may be revived and might again become one of the most popular financing structures in the Chinese market.

I am going to be deliberately vague here, but around five years ago, a vessel finance company client of ours came to us regarding China asset protection issues similar to those involved in this just passed convention We conducted massive China law research and, in tandem with our client, we all eventually decided the protections just were not that to warrant our client financing vessel building in China.

And now to the point of this convention. The point is that this is just the most recent example of China's bringing its business laws more in line with the developed world and China's recognizing the benefits of enacting laws that, at first glance may appear to disfavor local Chinese companies. China's business laws are maturing, giving further lie to the idea that "there are no laws in China."

What do you think?

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CLB co-blogger Steve Dickinson wrote the following article for the China Economic Review. Steve is the monthly legal columnist for the Review, which BizCult rightly raves about today in its post, entitled, "China Economic Review: In Review." Steve's conclusion: As written, this law is no big thing:

For all the hype about recycling,the purpose of China’s Circular Economy Promotion Law (CEPL) is not to reduce waste. The primary goal of the legislation, which was approved in late August and comes into effect on January 1, is to deliver energy efficiency.

Misinterpretations in the West are understandable: Circular economy laws in developed countries tend to be concerned with recycling as a form of pollution control and waste management. But China is different. Energy conservation and recycling are viewed from the standpoint of contribution to efficiency, reduction in cost and reduced reliance on imported raw materials.

The entire circular economy initiative is based on inputs and outputs operating in a circle: Fewer energy resources are required because more of the detritus produced by energy consumption is swept up, reconditioned and reused.

Situation: Critical
Energy utilization is a very serious issue in China.

Beijing’s plan is to quadruple the size of the national economy between 2001 and 2020 while doubling energy use. The plan is based on China’s experiences in the 1980-2000 period, during which this ratio of growth to energy utilization was achieved. At the start of the current cycle, economic planners – both in and outside China – assumed that the energy utilization target would be reached with ease.

They believed that the real problem would be to keep the economy growing without overheating or falling into a recession.

In 2006, these same planners were shocked to learn that resource utilization in China had dramatically increased. For the five-year period from 2001 to 2005, economic growth was about 8% as planned, but energy utilization growth jumped 12%. Working to this ratio, if the size of the economy grows by a factor of four through the year 2020, energy usage will grow by a factor of six. For economic and physical reasons, this kind of expansion is just not possible.

If China is not able to bring energy utilization under control, its entire plan for continuous economic expansion at a rate of 8% for the foreseeable future will have to be written off. The CEPL has been adopted as a means of dealing with this problem.

Given the significance of the issue, it is surprising that the law actually offers nothing concrete in pursuit of its stated goal. It is really nothing more than a general statement of policy.

As has been learned in the environmental wars in the US, Europe and Japan, laws that require economic sacrifice now in order to achieve an energy reduction or related environmental goal in the the future only work when backed with clear standards and significant penalties. Both of these are missing from the CEPL.

What the new law does call for is for the State Environmental Protection Administration (SEPA) or some other agency to develop a national circular economy plan. The agency in question should draft formal rules and regulations for implementation of such plans, the law goes on to say.

This approach has been common in legislative drafting in China over the past several years. Controversial laws are adopted by the National People’s Congress, but rules and enforcement mechanisms are absent from the law – responsibility for them is merely passed on to the relevant government agencies.

Further delays
Where the issues are controversial, as in the case of the CEPL, there is usually a long wait before the designated agency issues any rules. And once they do this, the final rules are often no more concrete than the governing law.

The normal reason is that there is no genuine consensus within the government, and between the center and the regions on how to proceed. This is clearly the case with the CEPL. The circular economy program is not well-understood and the present economic sacrifices it would require are strongly resisted by local governments, businesses and consumers.

As a result, even though the law addresses an issue that is critical to the growth of the Chinese economy over the next 20 years, it is unlikely the CEPL will have a genuine impact.

The sadly predictable result is that China will continue to overindulge in the consumption of energy and other natural resources. Beijing faces a struggle to meet its current economic development targets -- and it appears likely to be in vain.

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China Hearsay (welcome back, Stan!) just posted on how parents of some Chinese children who "died or became ill after drinking infant milk formula contaminated with melamine say they will sue a subsidiary of a Chinese milk powder manufacturer based in the U.S. state of Maryland." The basis for suing in the United States is that "Qingdao Shengyuan Milk Co. Ltd., a dairy products manufacturer based in the eastern China city of Qingdao, had a Delaware-registered investment subsidiary with offices in Maryland, rendering it subject to U.S. law."

The story comes from Radio Free Asia, and a parent claims to have "a Maryland-based lawyer who will represent us in this collective compensation suit.” The article then talks about how the parents are "willing to pay for the legal fees and expenses" and the parents have already been requested to "send initial legal fees" and the "U.S. lawyers were hoping for a preliminary hearing in a Maryland district court soon."

China Hearsay questions how such a law suit can be brought in the US against "the U.S. subsidiary of a Chinese enterprise based on a tort that occurred in China" and calls it "kinda weak from a jurisdictional standpoint."

Without knowing all of the facts, it is always difficult to comment on any case, but since I am blogging here and not giving a legal opinion to a client, I can say that this story is behind "kinda weak." It makes no sense at all.

First off, it is quite unusual for a plaintiff's law firm that handles $100 million lawsuits (that is how this one is described) on a contingency fee basis (also so described) to require its clients to pay initial expenses. Second, I find it very strange that the US lawyers are "hoping for a preliminary hearing in a Maryland district court soon." Plaintiffs should not be wanting a preliminary hearing as that hearing is likely going to be an attempt by defendants to get the case thrown out for lack of jurisdiction. And that is the third thing. I just do not see how a US court can assert jurisdiction over a tort claim involving a Chinese defendant, a Chinese plaintiff, and a tort that happened in China. I also do not see the basis for suing the US subsidiary of a Chinese company.

Now there are two potential arguments that can be made here, neither of which am I terribly familiar. One is that the courts of China are so corrupt they are rejecting these cases, therefore, the US court needs to take this on. A few years back, I was representing a Russian company in Alaska Federal Court against a US plaintiff who seized my client's vessel when it came into Alaska. After we convinced the Court to release the vessel, the American plaintiff asked the Court to hold onto the case against my Russian client because of a purported inability to receive a fair trial in Russia. I argued that if the US were to take on every case involving claims arising in a country with a corrupt legal system, the US would end up trying all of Nigeria's tort cases. I won.

The other possible argument I see here is to make a claim under the Alien Tort Claims Act. There are maybe three people who understand that act and I know only one.

I am betting nothing much ever comes of a US lawsuit, but we will be monitoring the situation and reporting back. Any tort lawyers out there who think differently?

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This New York Times article does as good a job of any at setting out the issues China is facing in deciding whether to allow milk taint victims to pursue their claims in court. The article is, somewhat wrongly entitled, "Courts Compound Pain of China's Tainted Milk." It does a nice job dealing with the issues of whether China's courts are set up for these sorts of mass tort cases and also whether the rejection/acceptance of such lawsuits is being driven from Beijing or locally.

I would think most Western lawyers would agree China eventually needs a system that can handle class action torts (or just mass tort cases), but the much tougher question is what it should do in the meantime.

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One of the problems with being a lawyer is that we oftentimes only see or hear about things when they are a problem. This can give us a somewhat warped view on things, but so be it.

So when I say that terminating your Chinese employee will lead to problems 100% of the time, you need to take it with a grain of salt. But from my perspective, every single time a company has up and terminated a Chinese employee, it has led to big problems. Of course, those clients who up and fired a Chinese employee without a problem never needed to call us, but I am not aware of any of those.

What I am aware of is that foreign companies are terminating Chinese employees these days and it seems like these ex-employees are, nearly without exception, pursuing legal claims for these terminations, and, in many instances, retaining lawyers to assist. Based on what we are hearing out there, the chances of a foreign company doing well against a terminated Chinese employee in these cases are not good at all.

The solution here is the same solution for nearly every legal problem. A bit of preventative maintenance. If you are going to terminate an employee in China, recognize that employee has a lot of rights AND a lot of political/social/economic/sympathetic power. Do not just up and fire them and expect to walk away unscathed. Plan. Get your lawyer involved. And then negotiate a deal where you pay some money and in return you get a signed agreement, IN CHINESE, making very clear that they are satisfied with the results and are relinquishing their rights to pursue any further legal action against you. Even this may end up not being foolproof, but it is going to be the way to go almost all of the time.

The money you pay out to your employee and your lawyer to settle early will almost invariably be a lot less than you will need to pay out to your employee and your lawyer if you find yourself in a knock-down drag-out legal fight. Trust me on that.

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Now I know I am always writing on protecting trademarks in China, but that is because I have seen far too many companies make the mistake of believing they do not need to register their trademark in China either because they have registered it in the United States or because they are "just" manufacturing their product in China, not selling it there. Both beliefs are wrong and both beliefs can lead to the same result: someone in China being able to prevent you from using a name or mark you thought belonged to you.

Anyway, Laurel Delany, of the always very informative Global Small Business Blog recently did a post on global trademark protection, entitled, "Globally: Protect Yourself." The piece does a nice job emphasizing the steps companies must take to protect their trademarks overseas and it links to Ms. Delany's story in this month's Entrepreneur Magazine.

I actually have one tiny beef with the article though. It quotes US attorney Peter Sloane saying that "A pending [trademark] application in China confers no trademark rights, whereas in the U.S., it does." Mr. Sloane is absolutely right on this, but I fear this statement may lead people to infer that there is therefore no rush to apply for a trademark in China because it takes years after applying for one to get one. What should be added to Mr. Sloane's statement is that the first to apply for a trademark gets priority to the trademark.

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IP wunderkind Danny Friedmann at IP Dragon does a very nice job laying out the primary differences between Hong Kong law and Mainland China law in his post, "How do the People’s Republic of China and Hong Kong relate to each other regarding IPRs." The super-quick summary is as follows:

1. Different as night and day.
2. Registering your intellectual property (IP) in Hong Kong will not protect you in Mainland China and vice-versa.

A couple years ago I had an hour long conversation with a company regarding my firm assisting it in pursuing a trademark infringement lawsuit in China. It was not until I saw their actual trademark registrations that I discovered that when they were referring to "China," they really meant Hong Kong. This company had never registered its trademark in China and I had wasted an hour thinking it had a great case, when in fact it had no case at all. I have since learned to seek clarification as to what is meant by "China."

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Will Lewis at Experience Not Logic dissects an Economist article to come up with four methods failing businesses in China employ when faced with having to shut down their business:

1. Informal Agreements With Employees and the Government. Work out an agreement with your employees and the relevant governmental bodies to allow you to shut down.

2. Court Supervised Bankruptcy Reorganization. The laws are too vague to give confidence to lenders seeking to lend to the troubled company, so this "relief" is virtually never undertaken.

3. Walk Away. Lock the gates and leave town and hope nobody follows. Hundreds of small Korean owned companies did this in Qingdao last year.

4. Informal Governmental Recapitalization. If you are too big or important to fail, get the local government to prop you up to save jobs and the local economy.

I add my own fifth one, which is no doubt getting more difficult due to the credit crunch:

5. Get A Foreign Company To Buy You Out . Whenever a client would tell me that some local government was encouraging it to purchase or work with a local company, I would always encourage them to be wary. Many times, local governments encourage foreign companies to purchase or work with failing local companies in the hopes the foreign company's involvement will preserve local jobs.

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Not sure why the huge interest in this subject, but I have probably received more emails/comments asking if I am going to write about this than probably anything else ever. The "this" is China's expected changes to rural land laws. I was going to write about it after speaking with some of our food business clients who work with China, but I figure doing so now will stop the emails, so here goes.

Forbes Magazine did a nice piece on this, and not just because they extensively quoted CLB's own Steve Dickinson in it. The article is entitled, "China Farmers Granted More Freedom On Land Rights," and it calls the anticipated laws a "major initiative to marketize China's countryside." It describes the reforms as follows:

The reforms, approved at a Oct. 9-12 party meeting led by President Hu Jintao, still need to be greenlighted in March by the National People's Congress, China's legislative body, which has traditionally been a rubber-stamp institution. Land will remain owned by "the people," under China's constitution and effectively controlled by the state, with 30-year use rights granted to rural households.

The new policy, if implemented, would allow China's 800 million peasants to lease their land use rights to other individuals or companies, such as big farm contractors, or to exchange them.

The article goes on to say that these reforms are intended to increase agricultural production:

The agricultural sector is dominated by households operating on small parcels of land allocated by the state. The new policy likely will open the way for more U.S.-style industrial-scale farming by agricultural companies. The government wants to keep food production steady, a goal that is getting more difficult amid rapid urbanization. The country's agricultural deficit with the United States has ballooned to record levels (see "Fertile Opportunities For U.S. Agribusiness In China"), and China cannot produce close to all the food it consumes.

Philosophically and politically, this looks like a huge deal to me, but I am going to leave those areas to others. My real question is how is this going to affect foreign and Chinese food businesses. I think it will lead to bigger farms in China and increased efficiency, and with that, increased exports of food, but I am not sure. Is there a farm economist out there who can help me on this?

Steve Dickinson had this to say:

But the land system will remain only partially open, as farmers will not lose rights to land that they lease out. "Even though they use the term 'mortgage,' the terms are so restrictive that it is not a true mortgage market," said Steven Dickinson, a longtime China lawyer for Harris & Moure. "There is no mention of 'sale' in the list of transactions. A mortgage on land that cannot be sold is not a mortgage in any sense that we understand it."

He and some rural policy researchers worry that farmers may now lease their land for quick, easy cash but will have nowhere to turn if they cannot find or keep employment year-round. "The fact that people can always go back to the farm is a primary source of social stability in China at this time," Dickinson said. Allowing farmers to sell their land, he remarked, is just too risky a move for the party to take.

What do you think?

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I am frequently emailed by college students, law students and even practitioners, seeking advice on what it takes to become an international lawyer. It seems the lawyer behind the Counterfeit Chic blog (an excellent blog, BTW) gets even more of these regarding "fashion law" and she gives answers in her post, entitled, "Fashion Law."

How can I get into fashion law?"

Several times each week -- more during interview season -- a Counterfeit Chic reader asks me this question. I've heard from aspiring law students, current law students, recent graduates, law firm associates disillusioned with their current jobs, law partners interested in a new group of clients, and former lawyers who've spent quite enough time at home changing diapers, thank you very much. I've received messages from parents seeking advice for their children, colleagues seeking advice for their students, and innamorati seeking advice for the objects of their affection. Your emails have come from every continent except Antarctica -- and any day now I expect to hear from a lonely scientist with a great new anorak design and an interest in becoming a patent lawyer.

What I found so interesting about the post is how virtually all of it applies with equal force to getting into international law.

CC's tips, grossly summarized, are as follows:

-- Excel at law.
-- Think laterally.
-- Do your homework.
-- Learn the ropes.
-- Make yourself uniquely valuable.

The post is well worth a full read and not just because it manages to pull a great quote from my newest favorite TV show, Mad Men.

For more on becoming an international lawyer, check out my two previous posts on the same topic:

-- "So You Want To Be An International (China) Lawyer?"
-- "So You Want To Be An International (China) Lawyer? Part II"

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Very interesting post by David Dayton over at Silk Road International, entitled, "Recent Chinese Negotiation Tactics: Translated!" The post is on the responses (excuses?) Chinese companies give when Westerners complain to them about product quality. David handles sourcing and quality control for mostly Western companies doing business in Asia and his post focuses on dealing with these responses while still within a supplier/buyer relationship.

My job as lawyer on most quality control problems usually does not start until the relationship is pretty much over.

Over the years, I have handled countless quality dispute cases against Chinese companies and I have heard nearly all of the same exclamations David lists. I have been brought in to threaten legal action in an effort to get the money back.

We usually do this by first writing a demand letter to the Chinese company stating that we have been brought on to get our client a full refund and if we do not have that within ___ days, we will pursue litigation in _______. We always write this letter in Chinese both so the Chinese company fully understands our position and to let them know it will be no big deal for us to secure Chinese counsel to sue them in China (where these lawsuits usually need to occur) tomorrow. Our letters also usually explain the law just enough to convince the Chinese company resistance is futile.

These letters, coupled usually with weeks of negotiations, usually lead to some payment around half the time. If the letter does not work, we analyze the client's chance of prevailing were it to sue and the likely cost of suit and then recommend whether it should litigate/arbitrate or not, and where..

These Chinese companies usually claim that the quality of product they provided my client was warranted by the amount my client paid for it. According to the Chinese company, if my client had wanted better quality, it would have had to pay more for it. Unfortunately, this is often a great defense.

If you want your Chinese manufacturer to make your product made to a particular standard, you have to be unbelievably explicit about exactly how you want your product to be manufactured. For example, even if everyone in your industry uses at least 10% stainless steel for a particular product and you have told your manufacturer countless times that your product must be at least 10% stainless steel and if your manufacturer's initial sample contained 11% stainless steel, you still must make sure your written contract (preferably in Chinese) with your manufacturer explicitly states all product must have at least 10% stainless steel content. If your contract does not state that you are requiring at least 10% stainless steel content and you get product with 3% stainless steel content, I can virtually guarantee your supplier claim you paid for product with only 3% stainless steel content and there is a very good chance a Chinese court will agree.

Bottom Line: You want something from your Chinese manufacturer, you put it in your written contract. You are also usually better off with your contract being in Chinese so that if there is a dispute, your Chinese counterpart is not well positioned to claim it failed to understand and if you do need to go to court in China, you have the contract ready to go for that purpose.

Or you can listen to a whole bunch of excuses....

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My 11 year old daughter is always asking me whether I can drive any slower. I usually respond to that by proving that I can. Seems almost as though China is now doing the same thing to me in response to my constantly harping on the dangers of China joint ventures.

When I was just starting out as a lawyer, I negotiated what I thought was a great settlement for my client. The amount it would pay would be far less than we were expecting it would take to settle, and the other side would be giving us a more complete release than we were expecting. As part of this agreement though, my client, a Fortune 50 company, would have to allow the opposing party to pursue a third party in litigation, under my client's name. Legally, I thought that a very small price to pay for what I thought was a great settlement. I took this to the senior partner with whom I was working on the case, expecting nothing but kudos.

He hated the deal.

He agreed I had set things up to save our client millions of dollars, but he would not recommend it to our client and he was convinced our client would reject it. The client did reject it and the reason it gave was that it would "never" allow some other company to use [and possibly] abuse its name.

They were absolutely right and I was dead wrong.

That case came to mind recently in light of the Sanlu baby formula scandal. CLB's own Steve Dickinson was recently interviewed by the Dominion Post about the New Zealand company's (Fonterra) handling of the tainted baby formula. Steve pointed out how as a minority owner of a Chinese joint venture, Fonterra had virtually no say on anything:

Steve Dickinson, a partner at law firm Harris Moure, was surprised, however, that Fonterra learned what was going on as early as it did. Mr Dickinson, who has been based in China since the 1980s, is heavily involved in its food industry.

"If you're a 43 per cent shareholder in a joint venture in China, you don't have any power. And the fact that Fonterra even found out means that they're far more involved than a typical 43 per cent joint venture partner. It just shows you the problems of being a minority owner of a Chinese company. You're not really aware of what's going on."

Hong Kong's Media Magazine just came out with a very interesting article on Danone's China public relations problems stemming from its longstanding dispute with Wahaha. The article is entitled, "'Hegemonic' Danone loses PR battle" and subtitled, "When the People's Daily newspaper starts referring to your brand as 'hegemonic' and calls on your local joint venture partners to rise up against you, it is probably safe to say that you have a serious PR problem in China."

Media interviews David Wolf of Silicon Hutong who views joint ventures as potentially deadly for the brand and just plain bad news:

Wolf agrees that Danone sacrificed goodwill by “running to its own courts”. He also points to a deeper problem that other MNCs would do well to avoid: the temptation to sling mud in an environment where brand awareness is evolving rapidly. Wahaha founder Zong Qinghou, for example, compared Danone’s tactics to the Western powers that bullied China a century ago. “Danone was baited into a public war of words, but, in retrospect, it won nothing by doing so. It should have portrayed it as a purely legal matter, and focused on its consumers.”

* * * *

Brands experienced in foreign expansion such as Disney, Coca-Cola and McDonald’s remain well protected in China, although for some others that assertion is arguable. “Brand ownership has to be completely clear,” says Wolf. “In Danone’s case it was left up in the air. Given China’s relatively immature IP regime for protecting brands, you cannot rely on sophisticated legal agreements.”

Where, then, does the collapse leave that most storied of Chinese structures, the joint venture?

Wolf believes they are obsolete. “The strategy should be to build your company from the ground up. The other option is acquisition”. Coca-Cola, presumably, is listening closely.

I agree with David Wolf, but with a few exceptions. There are still some industries in China where foreign companies can enter only by joint venture. There are also some instances where a Chinese company can contribute so much as to warrant a joint venture, though usually in those instances, there are legal workarounds that can take advantage of what the Chinese company can offer, without need for a joint venture.

For additional reading on joint ventures in China, check out the following:

"Chinese Joint Ventures -- The Information The Chinese Government Does Not Want You To Know "

"WFOE v. JV"

"China's Joint Venture Jeopardy" (this post is on an article I wrote for the Wall Street Journal on the same subject.

"China -- Damn The Joint Venture"

"Beware The China Joint Venture"

"Beware The China Joint Venture, But Do Not Ignore It Completely"

"China SMEs: Own If You Want To Own."

UPDATE: A reader just pointed out this very interesting blog post, entitled, "Lessons for foreign investors from the Sanlu scandal," over at the Chinese Law Prof Blog, discussing what foreign participants in Chinese joint ventures can do to protect themselves.

UPDATE: Just saw that the Off The Record Blog talks about the risks of being a "passive" investor in China, in its post, "Time for new China game plan."

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This post was written by Andrew Grieve, who works with us on our Chinese employment law matters.

The implementation regulations for the new Chinese Labor Contract Law were promulgated on September 3. When the draft regulations were issued earlier this year, we discussed some of the proposed changes (here), and despite having shrunk from 45 articles to 38, the content of the regulations remain relatively intact. You can read the full text of the final version of the regulations, in Chinese, here.

The newly issued implementation regulations have four sections (compared to three in the draft version), dealing with establishing the labor contract, terminating the contract, special issues with dispatched workers, and an additional section on legal responsibility.

The biggest cuts were in the section on establishing the labor contract. A brief rundown of the contents of this first section of the final regulations follows:

-- Employees who refuse to sign a contract within the first month of employment may be terminated by the Employer without need for compensation.

-- Employees who have not yet signed a contract between the first month and first year of employment shall be paid compensation of twice their wage every month worked without a signed contract. If the employee refuses to sign a contract, the employer may terminate the employee, but must pay severance.

-- Employees employed for over a year without having signed a contract shall be compensated as above for that year, and shall be deemed to have entered into an open term contract.

-- Employees who have been moved from one company to another at the request of their employer shall have all their working time in all companies included in assessing whether they have satisfied the 10 year requirement for open ended contracts

-- If the contract term expires before the term of service agreed upon, the contract must be automatically extended to extend to the end of the term of service.

The second section deals with terminating contracts and it lays out the various conditions where this can occur. When the Labor Law came into effect at the beginning of this year, companies were concerned about having open ended contracts for employees of over 10 years and for those who had already signed 3 consecutive fixed term contracts. To some extent, the implementation regulations were designed to correct the misinterpretation that this, in effect, meant employment for life. The regulations do this by setting forth the following basis for terminating employees with open ended contracts:

(1) mutual consent between employer and employee;

(2) employee fails to satisfy the conditions for employment during the probationary period;

(3) employee materially breaches the employer's rules and regulations;

(4) employee commits a serious dereliction of duty or practices graft leading to substantial damage;

(5) employee has an employment relationship with another employer that prevents the fulfillment of responsibilities and then refuses to rectify the situation;

(6) employee deceives or coerces the employer into signing or amending the employment contract;

(7) employee is under investigation for criminal charges;

(8) employee is unable to resume employment duties after the legally stipulated period for recovery after illness stemming from a non-work related injury;

(9) employee is incompetent and remains incompetent after training or new work assignment;

(10) a major change in the circumstances relied upon at the conclusion of the contract which makes it impossible to execute, and no agreement is reachable by both parties on any amendment;

(11) employer is undergoing restructuring under the Enterprise Bankruptcy Law;

(12) employer is unable to continue normal business operations;

(13) employer changes its production, introduces new technology or changes its operating method and needs to reduce its workforce; or

(14) there is a major change in the objective economic circumstances relied on when signing the contract and that circumstance now renders performance under the contract impossible.

This list mirrors the list under the Labor Contract Law. The Labor Contract Law further divides these 14 points into those which require severance pay and those which do not. The key to being able to terminate an employee for something like incompetence is to make very clear in an Employee Manual what is required of employees, and when employees will be in breach of their responsibilities to the company.

This section also states that employees with contracts that end upon completion of a job are entitled to severance pay. This has major cost repercussions for companies that hire seasonal workers.

The third section essentially notes that dispatched employees are to be treated as regular employees regarding compensation and regarding establishing and terminating labor contracts.

The last section sets the range for fines for infractions of the Labor Contract Law. Just by way of example, incorrect staff roster information leads to a fine ranging from 2,000 to 20,000 RMB. and fins for issues relating to dispatched workers range from 1,000 to 5,000 RMB. The regulations also give the labor bureau the power to force employers to pay the compensation outlined in the Labor Contract Law and the specific amounts listed in the regulations.

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Was given this by Constance Kim, Los Angeles lawyer extraordinaire, a few months ago and then forgot all about it. Came across it today and realized how helpful it would be to our readers to put this online, so here it is. This is the most comprehensive list of international arbitration centers I have seen. Enjoy.

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Just came across this article discussing a ranking of various Asian countries' judicial system, conducted by Political and Economic Risk Consultancy (PERC) (h/t to Silk Road International Blog):

1,537 corporate executives working in Asia rated the judicial systems in the countries where they reside, using such variables as the protection of intellectual property rights (IPR) and corruption.

Transparency, enforcement of laws, freedom from political interference and the experience and educational standards of lawyers and judges were also considered.

"Year after year our perception surveys show a close correlation between how expatriates rate judicial systems and how they rate the openness of a particular economy," PERC said.

"Better judicial systems are associated with better IPR protection, lower corruption and wealthier economies."

The ratings are on a scale of zero to ten, with zero being the best:

1. Hong Kong, 1.45

2. Singapore, 1.92

3. Japan, 3.50

4. South Korea, 4.62

5. Taiwan, 4.93

6. Philippines, 6.10

7. Malaysia, 6.47,

8. India, 6.50

9. Thailand, 7.00

10. China, 7.25.

11. Vietnam, 8.10

12. Indonesia, 8.26

My firm has had some involvement with the judicial system of all of these countries, with the exception of India, and my sense is that these rankings are pretty accurate. In fact, if I were to rank the systems by tiers, I would put Hong Kong and Singapore in the first tier, Japan, South Korea, and Taiwan in the second tier, and the rest in the third tier.

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Sergio Stone, Foreign, Comparative and International Law Librarian at Stanford Law School, and Roy Sturgeon, Foreign and International Law Librarian at Touro Law Center and a contributing editor at the Law Librarian Blog, have come out with what appears to be an excellent guide to legal research on Hong Kong law. The guide is entitled, “One Country, Two Systems” of Legal Research: A Brief Guide to Finding the Law of China’s Hong Kong Special Administrative Region" and Donald Clarke over at Chinese Law Prof Blog deserves the hat tip on this one.

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This article was written by my friend, Brian Geoghegan, who describes himself as having "practiced trademark and copyright law since graduating in 1985 from the University of California at Berkeley School of Law (Boalt Hall). In 2003, he finally left behind the megafirm lifestyle and founded GeoMark, a boutique trademark and copyright law firm."

Trademarks are among the most important assets of any company. Indeed, if it weren't for trademarks, customers would be unlikely to even find a company's products. Naturally, then, most companies want to protect these essential and valuable assets to the greatest extent possible and therefore make sure that they are registered with the United States Patent & Trademark Office (the "USPTO").

But many companies stop there, thinking the job complete. It doesn’t occur to them that trademark rights are territorial and that owning a United States trademark registration creates no rights whatsoever outside the borders of the U.S. I've long since lost count of the number of companies who have suffered from this misconception. Although we now have several new tools to secure multijurisdictional protection, discussed more fully below, in large part trademark protection must still be secured jurisdiction by jurisdiction.

Often, the issue comes to light only after a problem has been encountered, such as someone selling knockoffs of the trademark owner's products in another country. If the company is fortunate, corrective action is still possible. For many, however, it may be too late and no legal remedy exists. For such a company, someone else now owns "its" trademarks in that other country (or countries) and the only option, if any, is to purchase them back from the foreign “owner”, usually at a stiff price.

Although this might sound like extortion, in most cases it is perfectly legal. Most countries, unlike the United States, grant trademark rights on a "first to file" basis, not the "first to use" basis to which we are accustomed here. The first company to file an application to register a trademark, whether or not someone else is already using it, either in the jurisdiction or elsewhere, becomes the trademark owner in that country.

For that reason, trademark registration overseas can be even more important than in the United States. First of all, without a registration in a particular jurisdiction, a U.S. trademark owner will be unable to prevent someone else from using its trademark. Moreover, to add insult to injury, if that other party has taken the step of registering the U.S. company's trademark locally, the U.S. company could even be prevented from using the trademark in that country and could be liable for infringement if it were to do so!

Given these factors, it's not surprising that a class of entrepreneurs has emerged in many countries (particularly in Latin America and Asia) who watch for successful emerging American companies and then move quickly to register their trademarks first. Later, when the American trademark owner is ready to expand into that country, it is dumbfounded to learn that someone else already owns its trademarks there. These opportunists may not even intend to actually sell product using the trademark. Rather, they are often more interested in selling the trademark back to the U.S. company, at whatever price can be extracted. The negotiated price can vary considerably but it will certainly be many (or very many) times more than it would have cost the U.S. company to register it originally.

So how does a trademark owner protect itself from these dangers? In short, by registering its marks in as many jurisdictions as possible. Unfortunately, there are roughly 200 countries in the world today, most with their own trademark registers, application procedures and, of course, costs. Until quite recently, a trademark owner wanting to fully protect its marks around the world had no choice but to file individual trademark applications in each of those jurisdictions. Needless to say, the expense of securing protection in even a fraction of those countries could quickly become formidable.

Fortunately, things are improving. While there is still no such thing as a "global trademark registration", and while virtually all countries still allow for national trademark filings, in recent years there have been two significant developments which have helped to reduce the burden on trademark owners.

The first was the introduction in 1996 of the European "Community Trade Mark" (the "CTM"), whereby a trademark owner can secure protection in all member states of the European Union by means of a single trademark application. Back then, this provided coverage in 15 countries. Today, the EU has expanded to 27 member countries and continues to grow. As one might expect, a CTM costs more than most national applications. As a general rule, the cost is approximately the same as filing national applications in three individual European countries. Accordingly, as long as one needs protection in at least three countries, then the Community Trade Mark becomes the more economical choice. But if one sells product throughout the EU, it's easily the best trademark bargain to be found.

The second development occurred in 2003 when the United States joined an international treaty called the Madrid Protocol. Under this treaty, if one owns a trademark registration in one's "home country", one can apply for an "International Registration" and designate, in a single application, as many other treaty members as one desires (each assessing its own fee, of course). Currently, 77 jurisdictions have joined the Madrid Protocol, including most of the world's major economies. Notable exceptions are Canada, Mexico, Hong Kong (still a separate jurisdiction for trademark purposes), Taiwan, India and all of South America, where protection still needs to be secured country by country.

In addition to these new vehicles, there has long been another useful international treaty called the Paris Convention to which most of the world, including the United States, belongs. Under this Convention, a trademark owner can take advantage of a six month "priority period", whereby the company can file for a new trademark in one member country and then have a six-month window in which to file for the same trademark in any other member countries and have those later applications treated as if they had been filed at the same time as the first one. Accordingly, an American company can file an application with the USPTO today for a new trademark, then wait up to six months to file elsewhere without any concern that some enterprising individual overseas might file a preemptive application for the mark. For trademark owners with cash flow issues, such as many startup companies, this can be a very valuable tool.

Finally, all three of these treaties can be used together in an appropriate situation. For example, a company may file an application in the United States for a new trademark and then, under the Paris Convention, wait close to six months before filing with the USPTO an application for an International Registration under the Madrid Protocol and, in that application, designate the European Union as one of the jurisdictions in which protection is desired.

Collectively, these treaties have brought the cost of international trademark protection down by perhaps 30-50%, depending on the particular jurisdictions of interest. However, despite these advances, protecting every trademark in every country of interest can still be beyond a company's budget. So how does one choose where to seek protection first? There are several factors a company should consider. First, where does it have the greatest foreign sales? In which countries would the emergence of knockoffs hurt the most? Where does it have manufacturing facilities (especially if the company uses outside vendors to manufacture its products)? Are there countries with notorious counterfeiting problems in the trademark owner's industry? Finally, and perhaps most importantly, in which jurisdictions would the company suffer the greatest damage if it were precluded from using its trademarks because someone else had registered them first?

Often, once these questions are answered, if the budget does not permit securing all desired protection immediately, the trademark owner will adopt a plan whereby protection is secured in stages, covering the most important markets first, then another group in six or twelve months, and so on. Although there may still be gaps in protection, at least temporarily, they will be the result of a conscious business decision, rather than a failure to identify the issue at all. Ignorance may be bliss but, at least in the trademark world, what you don't know can indeed hurt you.

For China specific trademark advice, check out "China Trademark Law: Simple And Effective."

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CLB's own Steve Dickinson was interviewed today by New Zealand newspaper, The Dominion Post, regarding Sanlu melamine tainted milk, in an article entitled, "What Fonterra Didn't Know."

Some facts first. Wikipedia tells us this about Fonterra:

Fonterra Co-operative Group Ltd (NZX: FCGHA), generally known as Fonterra, is New Zealand's largest company by turnover. A cooperative, Fonterra is owned by approximately 11,000 farmers throughout the country. It is the sixth-largest dairy company in the world, and the most influential by far when it comes to determining international dairy trade, handling over a third of all international dairy trade.

In 2005, Fonterra paid $153 million for a 43 per cent stake in the SanLu joint venture.

Now let's get to the law. What sort of control can a foreign company expect to have as a 43% stakeholder in a Chinese joint venture? Steve very bluntly tells us in the article:

Steve Dickinson, a partner at law firm Harris Moure, has been based in China since the 1980s, and is heavily involved in the food industry.

"The reality is if you're a 43 per cent shareholder in a joint venture in China you're nothing," he said. "You don't know anything, you don't have any power."

Okay, but let's say you are a minority shareholder in a Chinese joint venture entity and you learn of something along the lines of the tainted milk? Steve did some research on this issue today by, among other things, meeting with a cadre of Chinese lawyers who focus their practices on foreign investment, company law, and criminal law. Steve's conclusions from those meetings is as follows:

● Chinese law on this sort of thing is really no different than the law of most any developed country:

● If a company director learns of a problem, he or she has a duty to report it to the company board and to call a meeting if the matter is serious.

● Once the report is made, the obligation of the director ceases.

● If the board takes action contrary to the advice of the director, it is the duty of the director to follow the decision of the board.

● In particular, the director has an affirmative duty to maintain the secrecy of the information, regardless of what the director thinks about the matter personally. The duty of the director is to the company, not to the general public.

It appears Fonterra had three directors on the Sanlu JV board and those three directors pressured the JV to do something about the tainted milk and it also appears Sanlu did indeed do something: it reported the problems to the local authorities but there was no recall. It is here that things get rather fuzzy for me. The media talk about Sanlu needing to comply with governmental wishes, but I do not know why Sanlu could not have publicized the problems or even issued its own recall. Some of the articles talk about how Sanlu could not do this without compromising critical governmental relationships. Eventually, it seems the New Zealand government went to Beijing about this and Beijing acted.

We will continue trying to monitor this case and report back when we learn more.

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By: Dan Harris and Brad Luo

It has been a little over eight months since China enacted its groundbreaking new Labor Contract Law (“LCL”), which is just enough time to preliminarily assess its impact. The LCL has already greatly impacted employee treatment in China and greatly impacted how Chinese employees view their rights. It also has increased employer costs, but less than publicized. The LCL has caused some companies to go out of business and caused other companies to leave China for other countries less protective of their workers, but many of those companies were not terribly profitable in the first place.

Before enactment of the LCL, employee abuse was rampant in China and worsening. Labor disputes in China increased more than thirteen-fold between 1995 and 2006 and a large and growing number of these disputes erupted into public demonstrations. Most Chinese labor law experts viewed the existing labor laws and regulations as inadequate for solving employer-employee disputes and considered employees to lack basic legal protection. The LCL was designed to give employees greater rights and easier enforcement of those rights so as to achieve the ultimate social policy of creating and sustaining a "harmonious society":

This Law has been formulated to improve and perfect the labor contract system, to make explicit the rights and obligations of both parties of the labor contract, to protect the lawful rights and interests of laborers and to build and develop harmonious and stable labor relationships. (Emphasis added)

The LCL gives workers a private right of action to enforce their own legal rights. In other words, employees may now sue their employers directly, without the aid of the state. Chinese labor departments and agencies still may assign administrative penalties for labor law violations, but granting a cause of action to Chinese employees has greatly minimized the role of the state in the employer-employee relationship and greatly increased the power of Chinese employees to handle their employment grievances on their own.

Chinese workers are not hesitating to seek to enforce their rights in the courts and they are flooding China’s court dockets with labor cases. Since last year, labor disputes have increased in Beijing’s Chaoyang District People's Court by 106%, by 231% in Nanjing’s Qinhuai District People's Court, 126% in Shenzhen, 132% in Dongguan and 92% in Guangzhou. This increase in labor law cases proves both that Chinese workers are aware of their new rights under the LCL and that they perceive themselves as having new rights worth enforcing.

With these new employee rights comes a corresponding impact on employers. This is particularly true of foreign company employers as enforcement of China’s laws has always tended to be stricter against them, both by the government and by private action. Many labor-intensive companies that manufactured in China have shut down altogether or have moved to lower labor cost countries like Vietnam, Bangladesh, or Cambodia. Though these closures and moves seem large in terms of the number of companies closing or leaving, these numbers are deceiving. Very few of the foreign companies that have closed down or left China appear to have been based in either North America or Western Europe; most were from Hong Kong, Taiwan or South Korea. The overwhelming majority of companies that have quit China of late were in very low level manufacturing (imagine a room with 30 workers and no real machinery) and were marginal or illegal operations even before the new labor law came down. Profitable Western companies are talking about expanding outside of China (the “China Plus One Strategy”), but they generally are not leaving. The reason for this is simple: China is better equipped than countries like Vietnam, Bangladesh, or Cambodia to manufacture all but the least sophisticated products.

Though factory closings and moves outside China have been rare, the impact of the new law has been widespread. In reaction to the new labor law, French supermarket giant, Carrefour, required most of its forty thousand strong Chinese employees to resign and then sign a new two-year contract on the eve of the LCL becoming effective. Carrefour did this to try to circumvent the LCL’s provisions requiring indefinite contracts, which make employee termination difficult.

Since enactment of the LCL, foreign direct investment (FDI) into China has continued to increase; China attracted $42.78 billion in FDI from January to May 2008. A recent (post-LCL) Ernst & Young survey indicated 44% of world business leaders still consider China the best destination for FDI. Many Western companies that were already meeting or exceeding the LCL requirements are pleased with the new law because it is forcing their less employee-friendly competitors (particularly domestic Chinese companies) to spend new money to meet the new LCL standards.

On a micro level, the new law has changed the way nearly every company does business in China. Smart companies in China now use written employment contracts, in Chinese, with all of their employees and maintain a written policy manual, also in Chinese, explicitly setting forth the various bases for employee termination. The written contract is necessary to avoid potentially huge penalties and the policy manual setting forth grounds for termination helps militate against having lifetime employees.

Emboldened by the new laws, local governments and unions are also stepping up their efforts to protect worker rights. In an effort to circumvent Article 42 of the LCL, which gives existing long-time employees extraordinary rights when terminated, Huawei (China’s largest networking and telecommunications equipment company)