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

I speak often on China IP before all sorts of groups and companies and after I give my spiel on the topic, I always (if at all possible) open the floor up for questions. Both live and via webinar, the one question I am nearly always asked is some variant of when I think China will “start improving its protection of IP.”

My answer is usually something like the following:

First off, China is already improving on its IP protection and it has been doing so for at least the last decade, slowly but surely. China’s trademark protection is already pretty good and its protection of copyrights and patents has consistently improved. But what do you mean by IP protection? Do you mean government enforcement against counterfeiters? Do you mean the laws as written that allow a private party to sue for infringement? Because China’s IP laws as written have been pretty good for quite some time? When I say China’s IP enforcement has been consistently improving, I am usually referring to the whole package in terms of what a foreign company can do against a Chinese company that has been violating the foreign company’s IP rights.

What I said long ago is that when China’s powerful companies start caring about their IP rights will be when China as a whole will really accelerate in its caring about IP rights. And here’s the thing. There are plenty of powerful companies in China that now do care about IP rights and that number just keeps rising and for that reason alone I expect IP protections to improve substantially in China over the next 2-5 years.

Your thoughts?

China employment lawyers
China employee probation. Again.

If you want to set up a probationary period for your new China employee hires, it is important you get it right. If you do not understand how probation works both in China and where you will be doing your hiring, you are probably better off not even bothering.

Note that employers are not allowed to set a probation period for the following three types of employment arrangements:

  1. Employment of a part-time employee,
  2. Employment with a term of fewer than three months,
  3. Employment whose term is based solely on the employee completing a certain task.

There is a fourth prohibition/restriction: you may use only one probation period for the same employee. As straightforward as this may sound, this rule has caused much confusion to foreign employers (and many Chinese employers as well). For instance, one question that we often get asked is this: whether an employee who has left the company and returns after ten years, can be re-hired as a probationary employee? The answer to this is not quite clear, even in the same locale. A strict interpretation of the law dictates a “no” answer, as the parties are the same, and the law “clearly” states: one employee, one probation period. But many employers have argued that a lot can change in ten years (especially in high tech) and we should be able to test the employee out and not have to rely on what we knew about the employee a decade ago. As logical and reasonable as this may sound, most courts have not sided with employers on this issue.

In one fairly recent case in Zhongshan city, Guangdong Province, an employee worked for an employer from 1998 through early 2015 and then got re-hired for the same role by the same employer near the end of 2015 under a three-year employment contract with a 6-month probation period. The employee was then terminated during the 6-month probation period and he sued, alleging unlawful termination. After multiple proceedings and on appeal, the Zhongshan Intermediate People’s Court essentially ruled that the employer violated the Labor Contract Law for using another probation period for the same employee and awarded the employee damages for the employer’s illegal use of the probation period.

But what if an employee returns to the same employer, but at a different position? Even though the parties are not “strangers” to each other the employer would have little to no knowledge about how the employee is likely to perform in his or her new position. The Zhongshan case above does not answer this question, but it seems an increasing number of judges and China employment lawyers are of the view that an “exception” should exist for an employee rehired for a substantially different position.

Note though that in virtually all employment cases where an employee has sued over a second probation period, the employee signed an otherwise enforceable written employment contract agreeing to the second probation period. So if you will be doing your hiring in a place where the courts strictly interpret the one employee, one probation period law, it doesn’t matter what the employee agreed to, because a violation of the PRC Labor Contract Law violates the law and warrants an employer penalty.

As is true of just about everything related to China employment law, the best way for you to proceed is with caution. When working with our clients, we always check the written law AND confirm our interpretation of that law with the relevant employment authorities before proceeding and you should do the same. Have your employment contract checked before putting it in front of any of your employees for signing. And again, if you do not understand the ins and outs of probation in China, you will probably be better off just skipping it entirely.

What about using a probation period for an existing “employee” who has been working for you in some capacity before your WFOE was formed (see Doing Business in China with Deportation or Worse Hanging Over Your Head). In those situations, our advice is usually to just skip the probation period because you already know that the employee is working out, otherwise you would not be looking to bring him or her into your new WFOE’s fold.

 

China manufacturing contracts
Use your China manufacturing contract to get out

When foreign buyers purchase products from Chinese factories the big issue is usually who owns the design of the product. This issue is often discussed in a theoretical way, based on intellectual property law principles, without getting to the real point. You are having a product made at Chinese Factory A. You decide the price Factory A is charging you for the product has become too high. The fundamental issue is this: can you take that exact product and have it made at factory B?

Say you are using the following procedure. You find a product made and designed by a Chinese factory. Normally, you will not purchase off-the-shelf products in their “as-is” condition. Normally you will customize the product by maybe changing its colors, and/or its surface design and/or small surface features such the number of buttons.

In this situation, the Chinese factory will take the position its own the design and you have no rights to the underlying design. In general terms, the Chinese factory will say:

a. Chinese Factory owns the underlying design and can sell that product anywhere in the world.

b. Chinese Factory agrees to “customize” its product for you by making surface changes such as color, logo, surface design features. Chinese Factory agrees not to manufacture and sell a product using those same features for sale anywhere in the world.

Given this basic position, what happens if you want to go to a different manufacturer for the same product? There are several alternative responses:

i. The normal response is that the Chinese Factory says you can go ahead and customize the product made by a different factory, but you CANNOT have that factory manufacture your product based on our underlying product design.

ii. In the alternative, some factories will say that you can go to a different factory, but you must pay us a royalty.

iii. In the alternative, some factories will agree to give you a license to go to another factory solely to manufacture the product but not to make any adaptation or other “new work” relying on the underlying design.

Where does your Chinese program fit into this system? Most buyers settle on alternative b. This is a type of stand-off. The Chinese factory cannot sell “your” customized product anywhere in the world, but you are stuck with the Chinese factory. If you want to go to a different factory, you have to start over from scratch or pay what is usually a very high royalty. This can be a disaster if there is no readily available alternative source for your product.

Another issue that arises from this situation is the question of exclusivity. If you have worked hard to create a market for a specific product in a certain territory, you will not want virtually the same product to be sold in that territory in direct competition with your product. It is common to provide that your factory is not permitted to sell the customized product to any other buyer. On the other hand, the factory is free to work with a different buyer who customizes the product in a different way. It is that alternative customized product that will then appear as a competitor in your territory.

Obtaining the agreement of your Chinese factory not to sell your customized product to anyone else is relatively easy because no one else really wants that product. It is much more difficult to get your Chinese factory to agree not to sell an alternative product to another foreign buyer. If you are looking for that kind of protection, you must be clear about the rules and you must expect the Chinese factory will only agree to those rules if it receives a substantial benefit for doing so. That benefit is normally your agreement to a specific volume of product purchase for each year of exclusivity. Big companies often get this sort of deal; SMEs, far less often.

China IP protectionOf course they do, but not always and not for every company doing business in China or with China.

Let me explain.

I just read an article on Engadget, entitled EU withheld a study that shows piracy doesn’t hurt sales, and subtitled, “The $430,000 study’s conclusions perhaps didn’t fit what it wanted to hear.” To grossly summarize, the study indicated that of books, movies, music and games, only blockbuster movies were negatively impacted by piracy. The study indicated that game sales may actually be aided by piracy.

I have from time to time been known to question the dollar losses often attributed to counterfeiting as well. The most commonly cited number is that United States companies lose $600 billion a year to counterfeiting. But the problem with this number is that it is based at least in part on an analysis that says every counterfeit purchased gives rise to a dollar lose equivalent to the real item that was counterfeited. This is usually true (especially when the buyer does not realize it is buying a counterfeit), but is this really true when someone buys a fake Rolex watch for $55 or a fake Gucci purse for $15? I don’t think so.

But let me be crystal clear here. I am not in any way condoning piracy or counterfeiting as both of those things are not only economically damaging, they can reduce innovation and be downright dangerous. Do you want fake brakes in your car? How does counterfeit medicine sound to you? No, all I am saying is that the extent and the damages caused by these things — as a whole — is sometimes over-dramatized. And that, as I will explain below, can have real-world business consequences.

Piracy and counterfeiting and the lack of strong IP protection in China are huge issues. They are a huge issue for some companies, a big issue for some companies, an issue for some companies, and really not much of an issue at all for other companies. Nonetheless, for most (not all) companies they are not a valid reason for ignoring China entirely.

Really, only a small percentage of companies need to worry much about IP theft in China. It exists, of course, but how much impact does it really have on your business? With very few exceptions, my firm’s China clients have either not been hit with piracy/counterfeiting or are too focused on making money from their own products to worry about it much. It is not nearly as much of an impediment to profits as believed.

Too often companies are so afraid of being copied that they fail to do things they should be doing. I can tell you that far more of my law firm clients have expressed the wish that they had gone into China to manufacture or sell their products sooner than have suffered negative IP consequences from having done so.

And on the flip side, every few months a company will come to one of our China lawyers overly concerned with their China IP protections after having read our blog. Oftentimes, they will believe they are too late and other times they will give us a long list of the IP protections they are convinced they need, usually including one or more of the following:

  1. NNN Agreement
  2. Product Development Agreement
  3. Contract Manufacturing Agreement
  4. Trademark Registration
  5. Trademark Registration with China Customs
  6. Design Patent Registration
  7. Copyright Registration
  8. And much more

And maybe 10 percent of the time they are coming to us with an astronomical quote from some other law firm for all of the above contracts and IP registrations. But here’s the kicker. Well under 1 percent of the time does a company need all of the above, and even less than that does it need all of the above immediately. Most of the time, in fact, the typical company doing a typical China deal or transaction usually needs less than half of these. And guess what? Probably 25 percent of the time none of the above makes sense for the company either because none of these things will be effective or because the company is too early (or worse, too late) or because the company would simply be better off spending its money elsewhere, at least in the short term.

So the point of this winding post is simply this: there is no one size fits all when it comes to best practices for protecting your IP from China and you should not let scare tactics and big numbers scare you into believing otherwise. Instead, treat China and China IP protection the way you treat the rest of your business and weigh the costs and the benefits of your IP actions accordingly.

 

China sourcing agentsMany companies start outsourcing their products from China using a broker/sourcing agent. Tomes have been written about the pros and the cons of using a sourcing agent versus dealing directly with a Chinese manufacturer and I have no intention of rehashing all that here. My relatively succinct and simple and mostly unhelpful view is as follows:

About 45 percent of all sourcing agents are corrupt. About 45 percent of all sourcing agents are incompetent/worthless. About 10 percent of all sourcing agents are invaluable.

I cannot tell you how many times a client has retained one of our China lawyers to assist in making the switch from using a sourcing agent to going direct with a brand new and far cheaper factory only to have the old factory tell our client it can now reduce its prices by 30-40 percent because it will no longer need to kickback 30 to 40 percent to the sourcing agent. I also cannot tell you how many times a client or a potential client has given us some completely invalid reason as to why their sourcing agent is so clearly different from the rest. We commonly hear that such and such sourcing agent must be good and honest because it is being used by some competitor or because it has an office in the United States. If only it were that clear-cut.

One of the legal issues we often must resolve is whether our client who is using a sourcing agent would be better off contracting with that sourcing agent for the manufacturing of its product, or contracting directly with the Chinese factory, while still paying the sourcing agent for its services. One of our China lawyers recently explained to a client some of the things the client should consider in determining whether to contract with its sourcing agent or to contract directly with its Chinese manufacturer, as per the below, with any identifiers stripped off:

You raise the usual and standard issues related to this kind of contract. To start, it makes no sense to have essentially the same a contract with two parties. You must choose with whom you are going to contract. Will it be your sourcing agent or will it be the Chinese factory? You must contract with the entity that will issue the invoice for the product and in this case (unless we change things), that is your sourcing agent. But if you contract with your sourcing agent, you can and you should also have a contract with the Chinese factory that deals with issues like ownership of intellectual property, ownership and control of the materials, non-circumvention and non-compete and similar. See China NNN Agreements. However, many Chinese factories are not willing to enter into that kind of contract if they are not the direct seller of the product.

The old way was to enter a contract with the sourcing agent, loading all of the liability on it. Since Sourcing Company X is a U.S. company, operating in this way is pretty much just like making a purchase from any U.S. company that outsources its manufacturing around the world. The question is: can Sourcing Company X perform? Does it have the resources to do the work and the asset base to deal with any problems?

As you have figured out, there can be many problems with the “old way.” If you are purchasing from a huge company like Apple, you don’t really care about who their ultimate suppliers are because you know Apple will do the work and you know Apple will stand behind the products and has the resources to handle pretty much anything that can go wrong. For a small company like Sourcing Company X, your analysis is quite different and is more difficult.

There are two issues: First, what happens when everything goes right? If Sourcing Company X takes care of everything, then using them makes sense. Many companies fail to consider what happens when things go right. If you end up doing all the work in China, why bother with Sourcing Company X.

Second, what happens when things go wrong? As you know, things going wrong is standard operating procedure for China manufacturing. If there is a defect, can you rely on Sourcing Company X to fix things? If there is a late delivery or a short delivery, can you rely on Sourcing Company X to address this in a way that does not require your staff travel to China? Can Sourcing Company X ensure that the fabrics and other materials are properly processed and securely stored and maintained in China in a situation where you have no direct contract with the China factory? What if the China factory goes bankrupt: what happens to the materials then? Will Sourcing Company X remain liable in that situation?  Can Sourcing Company X ensure all payments will be made to the factory and to the suppliers of the factory? Can Sourcing Company X ensure that the Chinese factory and its suppliers and the suppliers to its suppliers will not steal your IP or circumvent you by going directly to your customers? If circumvention happens, will Sourcing Company X aggressively take care of the issue and does it have the financial resources to cover for liability?

On these issues, if you conclude that the answer is yes in each case, then you should contract with Sourcing Company X. The more difficult situation is if you conclude that Sourcing Company X may not be fully able to deal with these issues. In that situation, you then have to consider whether you are better off with a contract with a Chinese company that will require you to litigate in a Chinese court to deal with the issues or better off with Sourcing Company X here in the U.S. and insured here as well. See also China Contracts, But With Whom?

As you can see, the matter is complex. In my experience, I find large companies with a presence in China prefer to contract directly with the Chinese factories. And this is the modern trend. However, smaller companies that do not have the time or the people on the ground in China still often use companies like Sourcing Company X to secure their products from China. The problem with companies like Sourcing Company X is they often refuse to enter into a reasonable contract. If Sourcing Company X is willing to enter into a reasonable contract, that is one matter resolved in its favor.

 

We have to assess two issues: a) can Sourcing Company X really perform and b) if you contract with a single Chinese factory, does that really put you into a better position if something goes wrong. You will need to make this decision based on your own business judgment, since you are the one with direct contact with the players. We can help you with this by conducting due diligence/background checks on the two companies.

Please let me know if you need more information from me on this matter.

 

 

China VAT TaxesConsider the following situation. Your company is a service provider. Let’s say your business assists domestic and foreign entities register drugs with the FDA. You are contacted by a Chinese entity to do a registration. Having read China Law Blog (See Getting Money out of China: It’s Complicated), you submit a written, signed invoice to the Chinese entity and you require payment in advance. Within five days, you receive payment.

But, you are surprised to see your payment amount has been reduced by 6 percent. You complain to your Chinese client, and your Chinese client explains that the 6% was deducted as VAT tax on the payment, upon the demand of the local tax authority. You explain that all services were performed in the United States. No services were performed in China. For this reason, there is no basis for the Chinese tax authorities to impose any tax of any kind. The Chinese side explains: we agree, but if we had complained, our payment to you would have been denied and you would not have received any payment at all.

This has become a standard scenario for service providers that provide services to Chinese entities. It applies to all types of services:

  • Legal services
  • IP registration services
  • Product and advertising design services
  • Software development services
  • Environmental consulting services
  • Architectural services, both structural and landscape.

In all these areas, the Chinese foreign exchange banks will refuse to make any payment without documentation. Often the request for documentation is onerous and can cause considerable delay. Finally, when approval for payment is received, the foreign exchange bank then requires a deduction from the payment be made.

Now get this: the amount of the deduction varies from bank to bank and from region to region. We have seen deductions range from 5% to 40%. What is the reason for this wide variation? Since there is no legal basis for the deduction, its amount and its supposed basis vary. This variation means there is no way to predict in advance the amount of the deduction. Even within the same bank for the same services we have seen the amount of the deduction vary from payment to payment, depending on the attitude of the bank at the time and the identity of the bank officer and the local tax office personnel involved in the transaction. Of course, the status of the payer in the local economy is a factor. An SOE that is the sole employer in a small town is treated differently than a small privately owned business in Shanghai.

Our China lawyers constantly get calls seeking help from American and European service providers whose payments have been held up by China’s banks. We tell them the following: “we can help you get the money out, but it will be net of taxes and we do not know what that amount will be.” A classic good news/bad news scenario.

What though can you as the foreign service provider do to eliminate this tax deduction risk? The only solution is to put all of the payment risks onto your Chinese customer by providing in your service contract that all payments must be made net of taxes and fees. If the amount of the invoice is $60,000, the service provider must receive $60,000. All taxes and fees are paid by the Chinese customer on behalf of the foreign service provider. This approach places the risk where it belongs: on the Chinese side. The Chinese government/foreign exchange bank is imposing the fee. The Chinese payer is the only party that can object to the fee and argue it should not be imposed or should be reduced. You as a foreign entity receiving payment have no standing and no power to impact the decision of the Chinese authorities, but your Chinese customer does. Placing the risk on the Chinese payer is, therefore, the only practical way to deal with this issue.

It is essential to deal with this issue in advance in the written service contract and in the written invoice for services. If the written documents are silent, the Chinese side will fall back to the basic rule that VAT and income tax is the liability of the foreign party and make little to no effort to prevent or reduce it. Though this rule has no application to arbitrary and illegal exactions imposed by foreign governments, the foreign service provider will always lose on this kind of claim.

So this then leads to the following rules for performing services for Chinese entities:

1. Execute a written service agreement.

2. Provide a written, signed invoice for every payment.

3. Provide in the agreement and invoice that payments are net of taxes and fees.

4. Do no work until after full payment is received.

Service providers outside China normally operate with a relaxed contracting and billing system. The rules for China are very different and contrary to service provider culture. Moreover, many Chinese entities will resist following the rules. My response to all this is: So what? As my first law firm boss explained to me: there is only one thing worse than working. That is working and not getting paid. If you want to get paid by a Chinese customer, you need to follow the rules.

China employee terminationsTerminating a China-based employee without severance is generally a difficult thing to do. Even terminating a probationary employee can be tricky. See China Employee Probation: All is NOT What it Seems. Mutual terminations with settlement agreements and claim releases are usually the safest route for employers to take.

For a mutual termination to work well you should put the terms and conditions surrounding such termination to writing even if both parties (employer and employee) have reached a mutual understanding through friendly consultation. Without a written agreement, the employer is at great risk of later legal action by the employee for the exact same issues you settled verbally.

How should you as the employer proceed to effectuate a mutual termination? You initiate the process by coming up with an initial severance amount and a list of any additional matters that need to be resolved with the employee. You then approach the employee and ask him or her if she would be agreeable to a mutual termination with your proposed terms, which will include among other things, a fair amount of severance. In our experience, Chinese employees usually will agree to a mutual termination as they prefer receiving a quick payout to many months of contentious litigation. We normally suggest our clients talk to the employee themselves during the initial stages (with our employment lawyers coaching them in the background). It can often be a mistake for an employer to bring its lawyers into employee termination negotiations too early as doing so can make things more confrontational and indicate to the employee that the amounts at stake may be higher than he or she initially realized.

As you are nearing the end of your negotiations with your employee, you should inform the employee that you will be providing a written agreement that contains all agreed-upon terms for the employee to review and sign.

You will next want to provide the employee with a hard copy of the mutual termination agreement and give him or her time to review it and ask any questions. We make our employee termination agreements clear, reasonable and concise, and China employees usually sign them with little to no fuss. Make sure your agreement covers all relevant issues regarding your specific employee. Sometimes, your employee may want you to leave out certain things for various reasons or put in something that is not true. For example, your employee may want to make it ambiguous about the mutual nature of the termination. You need to say no and inform him or her that the agreement must be clear about the termination being mutual. You need to proceed with extreme care. It is not uncommon for foreign companies to call our law firm after they have been sued by an employee a month or two after believing they just settled with that very same employee.

Do not issue the mutual termination agreement to your employee before you have communicated with the employee regarding the termination and have agreed on the issues. Nor should you make the employee sign an agreement on the spot that he or she has not previously reviewed; the mutual termination agreement should not come to the employee as a total surprise.

Finally, make sure both parties fully execute the agreement and then you should be sure to fulfill your obligations under the agreement, such as wiring the employee his or her full severance payment. Retain one original copy of the fully executed agreement for your records. You must also meet all your other obligations with respect to the employee departure, such as transferring the employee’s social insurance.

Do not treat the mutual termination agreement as a “mere formality” as this document is key to your protection. It should be in Chinese as the official language (preferably with English as well for you) and you as the employer need to know exactly what it says and agree with all of its terms. It is common for Chinese employees to draft Chinese-only agreements “merely as a formality” and try to get you to sign off on that. These employee-drafted termination agreements virtually never protect the employer and they often lead result in the employee coming back to the employer for more money a few weeks later.

Don’t skip the formal mutual termination agreement just because the employee you are terminating is in a “special” status. For example, even if the employee is on probation, so long as it’s a mutual termination, you should enter into a written mutual termination agreement with that employee. Just because the probation/employment period is short does not mean you should not handle the termination properly. You should document ALL employee terminations in writing

Did you handle your employee terminations properly? Now is the time to check to make sure.

 

China Law: Don't fight the trend
China Law: Don’t fight the trend

China Bystander (a very thoughtful deep-dive type China blog that has been churning out truly excellent posts since 2007) just did a story, entitled, China Cracks Down On Cryptocurrencies. The story begins with what I see as its money quote:

The default position of Chinese authorities is that if it exists, it should be regulated. Cryptocurrencies are a prime example.

Exactly.

I was a big fan of uber-investor Martin Zweig who would often talk about how the “trend is your friend” and how “you don’t fight against the trend.” That advice applies to Chinese law and business. A CEO I know will every five years put the basics of China’s Five Year Plans on a small card, get the card laminated and then keep that card in his wallet at all times. He does this so that he can easily check all of his iany’s proposed actions against the Five-Year plan to make sure it coincides with it or at least does not contradict it. In other words, he makes sure his company acts in harmony with China’s plans, not against them. Smart. Very Smart.

Our China lawyers constantly get phone calls/emails from potential clients (it is almost always potential clients and not actual clients) convinced they have found a “workaround” for some Chinese law and they want us to confirm their workaround will work. When we immediately express our serious doubts, they express their serious doubts about hiring us. This indicates to us they do not really want an objective answer to their question regarding the viability of their workaround, they just want confirmation of it, preferably in writing and they move on.

Anyway, this sort of interaction happens quite often and the following are the most common instances:

1. Getting more than $50,000 out of China. We get at least 2-3 emails every week from someone wanting to know if we can help their Chinese counter-party get x millions of dollars out of China, usually to buy real property or to invest in an American or European business. See Getting Money out of China: It’s Complicated and while you are at it, you might as well check out parts 2, 34, 5 and  6 of that series.

About half of those emails include some “new” idea for getting the money out and about half of those involve a long explanation as to why that idea is legal under Chinese law. Our response is essentially to point out that if it were easy to get money out of China legally, people would be doing it AND their Chinese counter-party would be contacting a Chinese lawyer to do it, not having the American/European side do the contacting. About half the new ideas involved cryptocurrencies, usually Bitcoin. Our position on all of these ideas, especially the Bitcoin ones, has always been that if China is not now blocking them, it will soon and those who facilitated such transfers when the facilitating was perceived as relatively good could face serious consequences.

Starting a few months ago we started getting communications from frantic foreigners whose bitcoin accounts had been frozen in China asking our help to unfreeze them. Starting about a month ago, we started getting communications from people who were having their associates arrested for actions tied in with Bitcoin (but not for using Bitcoin directly). Things like conducting business in China without an entity and without paying taxes. More than one caller who had millions of dollars in Bitcoin frozen AND one or more associates on the ground in China would insist that they were not conducting business in China because all they were doing was sending money out of China and that is not conducting business.

What people need to realize about China law is that when it comes to something like this, China is just not a particularly big fan of these sorts of arguments. In other words, don’t fight the trend.

2. Using Third-Party Hiring Agencies to Avoid Having to Form a China WFOE. Nope, not going to recommend this. No way, no how. Way back in 2015, I wrote an article for Forbes Magazine, entitled, China’s Tax Authorities Want You. In this article, I talked about the illegality of foreign companies hiring Chinese “independent contractors” directly, rather than by forming a WFOE and having their WFOE do the hiring. This is illegal 999 times out of 1000 and China hates hates hates companies that do this. China hates this because it means it does not collect the approximately 40% of salaries employers are supposed to pay in taxes and social benefits nor does it collect the approximately 25% of salaries that is to be paid by China employees.

Couple the hate with the opportunity to collect large amounts of money and you can see why China is hyper-zealous about hunting down companies engaged in these arrangements. Far be it though for foreign companies to simply comply by forming a China WFOE and using their WFOE to hire employees in China legally. No, they want us to tell them whether it is legal for such and such third-party hiring agency to hire employees for them in China.

The answer is really complicated because it depends on so many factors, including the third party hiring agency (a whole boatload of companies (mostly foreign companies operating outside China) have jumped into this business without being licensed to engage in it and much depends on who you which to see hired, their position, the number of people you wish to see hired, the length of time you intend for your third-party hiring agency to employ someone and then on top of all this, the city and perhaps even the district. In the end, it would almost certainly cost more to 1) conduct due diligence on the hiring agency 2) figure out the legality of the specific situation, 3) pay the 10 to 15% premium/commission these third-party hiring agencies typically require, and 4) deal with the contracts between you and the third-party hiring agency and the contracts between the third-party hiring agencies and the employees you want to be hired (because the third-party hiring agency drafts these contracts to protect itself, not your company).

Most importantly, the odds are overwhelming that what is being proposed is illegal in any event and if it isn’t clearly illegal, it will be so disfavored that you could end up getting in trouble anyway. And again, that’s the point. Don’t fight the trend.

3. China Representative Offices. China does not like them and way back in 2010, I wrote a post, entitled, The Slow Death Of The China Rep Office. They are still alive and China still does not like them and they almost never make sense for a foreign company looking to go into China. China does not like them and our China lawyers do not like them because they are legal only under very limited circumstances. Since the Chinese government does not like them, you are at some risk even if you are just on the legal side of the legality/illegality line and you are also always at risk of China’s tightening its Rep Office laws and shutting you down. The trend says don’t do it.

4. Variable Interest Entities/VIEs. Way back in 2011, in VIEs In China. The End Of A Flawed Strategy, we made clear our distaste for VIEs and why our law firm refused to handle that sort of work. This position angered many (especially those who were profiting off VIEs) but our position was based on the strong belief that China would eventually make clear its prohibition against them and at that time those who had gone into China as VIEs would suffer. It took longer than we expected, but it did happen in 2015 and we wrote about that in China VIEs Are Dead. Done. Over. Stick A Fork In Them and as we had predicted, the consequences were dire for many companies. Again, the trend.

As China attorneys, we see our job as more than just knowing what the law says now. Our job also encompasses our knowing how the Chinese government is likely to view what our clients are proposing to do (both now and in the future) and counseling our clients on that as well.

Our job is to help our clients stay on trend.

Your thoughts?

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

One of the questions our China attorneys pretty much never get is the following: I have been using factory X in China for the last seven years to make our widgets and though it was rocky at the start, we eventually built up a great relationship and they have been doing a great job for us for the last five or so years. But the reason I am calling you is because they have asked us about becoming the exclusive China distributer for our widgets and I was wondering whether you think that is a good idea.

Everything but the final question about whether we think it a good idea happens often; the asking us whether it is a good idea is the part that never happens, but maybe it should.

Let me explain.

We are China lawyers, not China business consultants and for that reason we are not the logical people to ask about something like how to choose a distributer in China. But we have been in the China law business for so long that certain things have become obvious to us even though we lack an MBA. And the issues involved in granting an exclusive distributorship to your Chinese manufacturer is just one of those things that is almost always not the best way to go.

But what I usually am thinking (and often say) is something like the following:

I understand that you have a really good relationship with your widget manufacturer and I am not in any way downgrading the value of that, because that is of huge value. But if you are truly serious about maximizing your widget sales in China you maybe should consider whether using your manufacturer as your exclusive distributer is the best way to do that. I say that for two reasons. One, the typical Chinese manufacturer knows zero about consumer marketing, distribution or sales. They know only how to manufacture which is not the same thing. They are usually engineers, not businesspeople or salespeople or logistics people. Two, it is rarely a good idea to grant anyone an exclusive distributorship in China for the simple reason that China is a big country and the odds are slim that the company best at marketing and selling your widgets in Shanghai will be the same company as the company that would be best at doing those things in Chengdu. See China Distribution Agreements: Exclusivity Is NOT Required.

But if you do not want to spend the time and money to find another possible China distributor because all you want is either to keep your manufacturer happy or just make a few extra dollars, then what you are proposing should be fine.

Your thoughts?

China employment lawyer
Buy the paperback version. NOW.

China employment law is technical and getting technicaler (yes, I made up that last word but you know what I mean). See China Employment Law: Local and Not So Simple. It is one of the most consistent problem areas for foreign companies doing business in China and it has become a massive growth area for our law firm.

Our typical attorney-client interaction usually goes something like this:

  1. Foreign employer company contacts my law firm because it has terminated an employee and that employee has either sued or threatened to sue, oftentimes over a technical violation by the foreign employer.
  2. One of our China employment lawyers looks at the case and determines that the foreign company employer did in fact violate Chinese law in the termination and in that investigation learns that the foreign company employer committed multiple violations and if the employee were to pursue litigation or his or her administrative remedies, he or she would no doubt prevail.
  3. We explain the above to the foreign company employer and learn that the problems we enumerated hold true for all employees.
  4. The foreign company employer asks our law firm to remedy its problems and we explain that before we start remedying just the problems that came to the forefront from this one termination, we should conduct an employer audit to determine what other employment problems need fixing. See China Employment Compliance and Audits: THE New Big Thing.
  5. We conduct an employer audit and that invariably (like every single time) generates a laundry list of problems and then we fix them, one by one.

Why do foreign company employers have so many employment problems in China? Think about how the typical small to mid-sized companies starts in China. They go into China with maybe one or two foreign employees and one or two Chinese employees, none of whom is remotely knowledgeable about Chinese employment laws (on the local, regional or national level) and all of whom are — naturally — more focused on getting the business off the ground than on complying to the letter of the multiple sets of employment laws. And anyway, at this point they are usually a tight-knit group of founding employees who view themselves as much as founders as they do employees. But when the company grows, little changes on the China employment compliance front, mostly because nobody realizes how important it is to make the changes and because even if they did, there is nobody in-house who knows how to do it. So it gets kicked down the road until there is an expensive and embarrassing employment problem.

Our firm is then called more often by someone high up in the U.S. or the Europe or the Australia office than by someone on the ground in China. The person who calls us (might be the head of HR, the CFO or the CEO) has started to look at what is going on in China and sought answers from China and received inadequate responses and has now started to worry, rightfully so.

All of the above is my incredibly long-winded way of saying that foreign companies need to get on top of their China employment situations and stay there. Employer audits are the way to go in most situations, but in the meantime and as a supplement, it is critical that someone at your company understand China employment law basics. Someone at your company needs to know enough not to be able to solve every issue, but to spot the issues before they blow sky-high.

And we have just the book for that and I am writing about it today because it just came out in paperback (the Kindle version came out a few weeks ago).

Our lead China employment lawyer, Grace Yang recently had published The China Employment Law Guide and you really really really should buy it and put it on your shelf. And when I say put it on your shelf, I mean you should buy the softcover version (not the Kindle version) so you can literally put it on your shelf. Heck, get more than one copy and give it to everyone in your company who manages your employees or plays any role in their hiring or their firing. This is a book that is meant to be used for background and for reference and as a decision-making guide. Get it now!

Just a little bit about Grace Yang, its author. Grace grew up in Beijing and excelled at and graduated from China’s best law school there — Beijing University. She then came to the United States to attend the University of Washington law school where she again excelled and graduated. Grace is my firm’s lead China employment and labor lawyer and she is the lawyer at our firm to whom everyone else goes for China employment and labor law questions. Grace is a licensed U.S. lawyer (she is licensed in both Washington and New York) and she splits her time between Seattle and Beijing.

Anyway, did I tell you that you should buy the book? Of course I did and you should.