China employment lawyerChina’s labor laws require employers provide their employees paid vacation days based on their total years of service. Employers are legally obligated to ensure their employees take their vacation days and to the extent the employer fails to do so, it must pay the employee an additional 200% of her normal wages for each unused vacation day.

The law also requires China employers pay their employees for unused vacation days at the time of termination. One question our China employment lawyers are often asked is whether an employer has the same payment obligation when it unilaterally terminates an employee for employee breach. The governing law is silent on this. But since it says that at the time of termination, an employer must pay employee compensation for unused vacation days, a strict interpretation would dictate such a payment must be made. As is typical of almost everything China employment law related, the real life answer depends on where the employer is located and even at which court the labor dispute will be adjudicated. For example, the general view of the Shanghai courts is that an employee terminated for her own fault is not entitled to payment for unused vacation days, because she is at fault for being terminated before she could use all of her vacation days.

This though gets complicated when the unused vacation days are spread among several years. For example, suppose an employee terminated in 2017 due to employee breach did not use any vacation days in 2017 prior to her termination. Assuming the employer’s unilateral termination decision was held to be lawful, the employer will probably not be required to pay the employee for unused vacation days in that year. But suppose that same employee was never paid for unused vacation days in 2016 either. In that case, the employer very well may be required to pay for unused vacation days — assuming the employee did not voluntarily relinquish her vacation time via a clear writing and the statue of limitations has not otherwise run out against the employee.

Employees usually do not pursue labor arbitration just to try to collect money for a few unused vacation days. These claims typically show up as part of a claim challenging the lawfulness of the employee termination. So this is yet another reason why unilateral termination can be so problematic. Employers that unilaterally terminate their China employees often find themselves caught up not just in one lawsuit but in several proceedings—labor arbitration, trial, appeal, and sometimes a retrial and in most of those proceedings, it has to defend itself against not just its termination decision but also against multiple other ancillary claims. “Mutual” terminations with a clear written settlement agreement avoid the employer having to jump (stumble) through so many hoops.

Also, like most aspects of China employment law, vacation time is not an area where it makes sense getting creative. For example, don’t just assume that a provision in your rules and regulations stating that your employees forfeit their unused statutory vacation time by not taking that time. Think twice before you ask your China employees to give up something to which they are legally entitled. If you are unable to secure a separate written agreement (in Chinese) from your employee saying she voluntarily chooses not to take her vacation time (who would, really?), you must pay her for those days or find a way to let her take the paid time off.

Last but not certainly least, we also are sometimes asked whether employees under the flexible working hours system are entitled to statutory vacation time just like employees under the standard working hours system. The answer to that is a resounding yes.

 

 

My first post in this threeChina manufacturing lawyers part series focused on a post entitled The 7 Major Risks You Run With Your China Manufacturers, by China manufacturing expert Renaud Anjouran. In that post, Renaud outlined the business risks foreign companies face when having Chinese factories manufacture their products. I noted how Renaud’s list nicely accords with what our China lawyers tell our clients who retain my law firm to draft their Chinese manufacturing contracts. See China Manufacturing Agreements: Binding Contract or Contract Terms. I noted how our manufacturing clients usually want to focus on a) intellectual property protection/prevention of counterfeiting, ownership of molds and tooling and after sales warranty service. In other words, the sorts of things legal agreements are really good at resolving. But oftentimes, core business issues like price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping are of at least equal importance.

My second post focused on the first four items on Renaud’s China product outsourcing list. In this, my last post in this three-part series on China manufacturing, I focus on the last three items from Renaud’s list.

Risk Five: Subcontracting. Subcontracting of production presents a number of risks often not clearly understood by foreign buyers. Renaud identifies the first and most common risk. The foreign buyer goes to substantial effort to verify that the Chinese factory it has chosen is capable of meeting its quality standards. If the factory then subcontracts the foreign buyer’s product manufacturing to another factory, all of the buyer’s verification work becomes meaningless. This then leads to other issues: How will inspections take place? How will quality control standards be enforced? How will worker safety or worker age rules be enforced? How will anti-bribery and related rules be enforced? Working to the next level, manufacturing by a third party where there is no contractual relationship means that confidential information agreements are automatically breached, and this is a primary way intellectual property gets lost in China. Finally, molds and tooling are often moved to the subcontractor, resulting in loss of control and the inability to retrieve these items when required.

There are three reasons Chinese factories typically subcontract. First, the “factory” is a front for a trading company that actually does no actual manufacturing on its own. This type of trading company will subcontract all of the manufacturing and will limit its involvement to supervising (usually very poorly) the manufacturing process. Second, the factory may be capable of doing the basic manufacturing process, but it requires subcontracting assistance on key elements of the production process. For example, it is normal for Chinese factories to subcontract mold making and electroplating of key components. Finally, the factory may decide that the foreign buyer’s purchases are too small to justify the effort of setting up production and it will subcontract to a factory with the time and the interest. Such a factory is almost guaranteed to be of lower quality, leading to the problems Renaud describes in his post.

Since subcontracting is always an issue when manufacturing in China, it is necessary to confront the issue directly in a formal agreement. The standard approach is to provide that subcontracting is prohibited without notice to and consent by the foreign buyer. The foreign buyer should condition its consent on inspecting the subcontractor and getting the subcontractor to execute a separate manufacturing contract with the same key terms as the foreign buyer has with its original manufacturer.

Though this approach is best, many Chinese factories insist on an absolute right to subcontract. In that situation, if the foreign buyer agrees, then the normal contract provision is to require (a) the Chinese factory at least identify its subcontractor(s) (b) the subcontractor grant the foreign buyer access to its premises for inspection and c) the Chinese factory agree to be directly liable for any violations committed by the subcontractor. Some Chinese factories will not agree to these conditions. When that happens, our China lawyers recommend the foreign buyer refuse to purchase its products from that factory.

Renaud identifies a more difficult problem: undisclosed subcontracting. This situation is unfortunately quite common. It arises most often during the busy season when a factory simply cannot keep up with the orders it has accepted. The best way to prevent this from taking place, the foreign buyer must regularly inspect the factory operations to ensure that the factory is really doing the work on the premises. Since the high season is the most likely time subcontracting will occur, this is the time when appropriate, unannounced inspections should occur. It is also crucial to enter into a formal agreement that prohibits undisclosed subcontracting as described above.

Way back in 2009, in The Six (Not Five) Keys To China Quality, we wrote about the tremendous value of putting a no-subcontracting provision in your China manufacturing agreements:

We typically put a provision in our OEM agreements (which we nearly always do in Chinese for better enforcement in China against the manufacturer) mandating that the Chinese manufacturer cannot subcontract out the manufacturing. We have been doing this for years and, as far as we know, no manufacturer has ever violated this provision. I know many of you are dubious of this record, but hear me out. Let’s say the Chinese manufacturer has 30 customers for whom it manufacturers product. Let’s say only four of those customers have a no subcontracting provision (my guess is this number is more like to be two, but for the sake of argument, let’s go with four here). The China OEM manufacturer gets really busy and has to subcontract out some of its manufacturing. It can subcontract out the product manufacturing of any of its 30 customers, so why wouldn’t it choose to subcontract out the product for the 26 customers who have no contract provision prohibiting subcontracting? I call this the bike lock theory of Chinese law because the no-subcontract provision operates like a good bike lock. The thief can still steal your bike, but why would he when there are so many easier targets out there?

In our experience, these no-subcontracting provisions work shockingly well.

Risk Six: Failure to Deal with Defective Product. The problem of defective products raises several issues. First, it is critical to identify a factory that will attain and maintain a reasonable defect rate. If the defect rate during production is over an “epidemic percentage” level, it is almost certain success will not be achieved. As Renaud illustrates in his post, the defects in Chinese factories are often at the cosmetic level. The base product is acceptable, but the finish is defective or scratched; fingerprints show up on glass in an enclosed case; greasy footprints are found on well sewn, elegant handbags.

There are two issues relating to dealing with such defects. The first is how to locate the defect. It is best to locate the defect during the production process. Second best is to locate the defect before shipping. Third best is to locate the defect after your receipt of the product. The worst case is to learn of the defect after delivery to the down stream customer.

As Renaud notes, once defects are found, the parties must have in place a formal plan that clearly deals with what will be done with the defective product. It is critical not to allow the defective product to enter into the retail market. Many Chinese factories will sell defective product “out the back door.” When this product gets into the market, the damage to your reputation can be substantial.

But what should be done with defective product? We usually provide that the defective product must be destroyed. However, this is not always the best alternative. In some cases, the defective product can be repaired or otherwise reworked. This is a common approach for complex and expensive cast metal parts for large equipment. In other cases, the defective product can be disassembled so that valuable components, such as precious metals, can be recovered.

Once you resolve how to handle defective products you receive from your China factory, your next issue is how to get reimbursed for the defects. The Chinese side will usually propose that the value of the defective product be applied as a credit against your future purchases. This is a bad system because the foreign buyer can only obtain credit if it makes another purchase. This forces the buyer into a relationship with a factory that makes defective product. Even worse, the amount paid to the factory is going down for each new purchase, which means the factory has even less incentive to do a good job.

The practical solution is for you to inspect your product before making any payments for its manufacture and reducing the invoice price to account for any short delivery resulting from removal of defective product from any given shipment. If the defect level reaches an epidemic failure rate (this rate must be determined on a product by product basis), your manufacturing contract should provide for you to be able to impose additional penalties. Foreign buyers that delay dealing with quality issues until after they have made full payment for their product are virtually never able to successfully resolve their China product defect issues.

The above discussion shows that a detailed, formal system for dealing with quality control and handling of defects is required and the only way to do this is with a formal, written manufacturing agreement. The common one line statement that the Chinese factory will warrant the quality of its products will never work. Manufacturing in China will ALWAYS result in defects. A workable plan for dealing with those defects is therefore not optional. It is required.

Renaud’s post raises an even more important issue. In some cases, the defect level from the factory will be high and will remain high. In that situation, where a defect rate is over 20%, it is normally impossible to develop a workable solution with the factory. The solution here is to monitor the process from the very beginning. In China, factories do not do better work over time. Their performance almost always only gets worse over time. As soon as an excessive defect rate is identified, you should take immediate action. Usually that immediate action means cutting your losses and moving to a new factory. A good manufacturing agreement will make this transition as easy as possible.

Risk 7. Logistics Cost Increases Due to Factory Error. As Renaud notes, you need to beware of increased shipping costs due to your factory making an error in the size of container required to ship your product. This issue arises from a common mistake make by foreign buyers. Inexperienced foreign buyers often do not understand that in international transactions, “logistics” is an integral factor for success. Shipping costs, shipping timing, method of shipment (air/ground/ocean), port of delivery and a host of other factors can have substantially impact the marketability/pricing of your product.

This then leads to the standard mistake. The foreign buyer looks for the lowest China Price. So the China manufacturer provides a product price that does not include the shipping cost: free carrier or the (erroneous) FOB price. Under these terms, it is the foreign buyer’s responsibility to make arrangements for shipping. The illusory concept is that the foreign buyer will then negotiate the lowest shipping rate, making for an even higher profit.

In fact, however, foreign buyers are normally unable to effectively manage shipping in China. So even though they specify free carrier terms, they in fact end up needing to rely on their Chinese factory to make all the arrangements for shipping. But under this scenario, the foreign buyer has taken on all liability for mistakes and yet it has no effective control to prevent those mistakes. This then is a perfect setting for the kind of disaster that Renaud describes.

From a legal perspective, resolution of this problem is simple. The foreign buyer’s contract with its China factory should reverse impose all of the responsibility and liability for shipping on the China factory. This is done with a manufacturing contract that provides for the product price to include shipping fees. The standard CIF (cost insurance freight) shipping term will achieve this goal. Use of CIF terms does not mean that your China factory will not make mistakes, but it does mean that your factory (not you) will be liable for those mistakes. Your China manufacturing agreement should also include a provision that requires your factory ship by air freight if delivery of your product will be delayed beyond a certain number of days. The only way to ensure that your China factory treats your key business issues as important is for your manufacturing agreement to impose an immediate penalty on your factory that does not require a cross border lawsuit to enforce.

 

China employment lawyers
Do not flick off your China employees!

The old saw, “hire slow fire fast” does not work for China. This is because China employee terminations require far more careful legal handling than in the United States. When it comes to employee terminations, China is still very much a Communist country. Think France not the United States. I estimate botched terminations cost foreign companies on average around five times as much as a well-handled termination that includes severance, and yet our China employment lawyers spend more time trying to fix badly done terminations than providing legal consulting on how to achieve one correctly.

This is largely because in disputes arising from an employee termination, the employer bears the burden of proving its termination was both handled properly and justified. This means that for an employer to prevail in a termination dispute, it must have the evidence/records to support the termination.

A recent employee-employer case out of Shenzhen nicely highlights the importance of the employer have good evidentiary support, and what can happen to an employer lacking that support. The facts of this case are not terribly complicated and I have simplified it even more for this post. A Shenzhen employer issued a written notice to an employee immediately terminating the employment relationship. At trial, the parties did not dispute the termination date (even though this issue is often contested) or that the employee actually received the termination notice (even though this is often contested by the employee). The termination notice essentially said nothing more than “we are unilaterally terminating your contract.” The employer contended that it had fired the employee for a series of breaches of the employer rules and regulations and alleged it had orally explained the reasons for the termination to the employee when it delivered the employee’s termination notice.

The Shenzhen intermediary court basically said that the employer had failed to specify the grounds for termination when it served the employee with the termination notice because oral communications of those grounds do not count. Since the employer never gave its terminated employee the grounds for termination, the court deemed the termination to have been unlawful and it awarded the employee the full amount of statutory severance, doubled.

Complain all you like about this court decision, but recognize that if you should find yourself in the same situation as the Chinese employer who lost this lawsuit, you too will probably lose 999 times out of a 1000. This court handled everything “by the book,” which is 100% par for the course in China employer-employee disputes. The employer lost because it got lazy and failed to do something the law required it to do and because it had no good evidence that it had done it. Had this employer merely provided its employee with a written explanation for the termination and made the employee sign for having received that written explanation (it does not hurt to videotape the providing of notice), it no doubt would have prevailed. In other words, all the employer needed to have done was to have strictly complied with the law.

All the employer needed to have done was to have fired slow, by first determining all necessary steps to a proper termination under all applicable China and local laws, and then done all that it needed to do to act accordingly.

WeChat and China WFOEAnyone who pays attention to China knows WeChat is the biggest name in Chinese social media. But the extent of WeChat’s dominance, and the way it has integrated itself into nearly every aspect of daily life in China, has significant implications for foreign companies doing business in China.

More than 95% of Internet users in China access the Internet via mobile devices at least part of the time. And of those mobile users, about 80% use WeChat. That is a stunning number, especially when you consider that WeChat is not just for sending messages and sharing news, pictures, and video; it also offers online shopping, mobile payments for everything from groceries to Lunar New Year “red envelopes” (gifts of cash), and Uber-like vehicle for hire services. More than 300,000 retail stores have already integrated WeChat Payment into their point-of-sale systems.

Given the ubiquity of WeChat, numerous companies have opened up official WeChat accounts and regularly use them to share information about products and promotions. Companies do exactly the same thing on Facebook in other countries, but because Chinese consumers can do so much more on WeChat, dispensing information via an official WeChat account is just the bare minimum. Chinese consumers have come to expect more.

A recent story about Starbucks becoming the first foreign company to become integrated into WeChat’s Wallet feature highlights the extent to which companies can benefit from WeChat. WeChat’s Wallet feature allows people to purchase Starbucks items and give them to their friends, all within WeChat. Given the love of social gifting in China – it’s how streaming celebrities earn money – I would expect this feature will increase Starbucks sales and it’s a great example of a foreign company adjusting its business strategy to take advantage of the idiosyncratic Chinese economy.

An official WeChat account can be opened by any company. But if you want Chinese consumers to be able to access that account – which is really the main reason to open an official WeChat account – the account must be formed by a legally formed Chinese entity.

That brings us to an old China Law Blog chestnut: do you really need to form a WFOE in China to sell your products? Of course not. There are a number of perfectly good reasons why companies might want to enter the Chinese market without forming a WFOE. But the more WeChat matters, and the more you want to control your company’s message to Chinese consumers, the more important it will be to have a China WFOE (or even a Joint Venture) to take advantage of all WeChat has to offer.

China manufacturing contractMy first post in this three part series focused on a post entitled The 7 Major Risks You Run With Your China Manufacturers, by China manufacturing expert Renaud Anjouran. In that post, Renaud outlined the business risks foreign companies face when having Chinese factories manufacture their products. I noted how Renaud’s list nicely accords with what our China lawyers tell our clients who retain my law frim to draft their Chinese manufacturing contracts. See China Manufacturing Agreements: Binding Contract or Contract Terms. I noted how our manufacturing clients usually want to focus on a) intellectual property protection/prevention of counterfeiting, ownership of molds and tooling and after sales warranty service. In other words, the sorts of things legal agreements are really good at resolving. But oftentimes, core business issues like price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping are of at least equal importance.

The source of the problems for Western companies that manufacture in China is the pervasive use of the purchase order approach to purchasing contract manufactured product from China. In China Manufacturing Agreements: Binding Contract or Contract Terms, I wrote how there are two basic ways to structure a China contract manufacturing agreement.

Option One is to enter into a legally binding contract (in Chinese!) that addresses all of the basic manufacturing issues. The agreement on price binds both the Chinese factory and the foreign buyer, and even if costs change, the parties remain obligated to pay and sell the product at the agreed-upon price, no matter which party benefits or loses from the changes. This sort of contract is common in much of the world, but less so in China. China, however, the entire risk tends to be loaded on one side or the other. The same applies to the other key business terms in China manufacturing agreements, such as the terms for payment, quantity, delivery date and quality. Foreign buyers who do not want to be bound or who cannot be bound due to lack of resources will follow Option Two. Under Option Two, the contract terms and conditions are binding on the parties only after a purchase order is presented by the foreign party and then accepted by the Chinese party. It is this lack of a binding agreement that is the primary cause of the seven manufacturing risks Renaud discusses in his post.

The obvious path to contract certainty  is to enter into an Option 1 manufacturing contract that formally commits both parties to the basic business terms for a specific period of time. However, the lure of China for many foreign buyers is that Chinese factories are willing to do small runs on a purchase order basis. The purchase order system is oftentimes THE reason why the foreign company is having its product developed and made in China. For this reason, our primary task as lawyers is to develop contract manufacturing agreements that deal up front with the risks that come from using the purchase order approach. Our job as China attorneys then is to make sure that our foreign buyer clients understand the risks and then to work on mitigating those risks in a practical way.

I explain below and in Part 3 of this series how our China manufacturing lawyers do that with each of the seven risks Renaud identified.

Risk 1: Lack of “Motivation.” The major risk we see stems from the foreign buyer loading the development costs onto the Chinese side with no incentive for the Chinese side to follow through on development. Renaud calls this risk “loss of motivation” and we see this all the time. The foreign side relies on the Chinese factory to do the product development, normally loading the cost on the Chinese factory. After two years, the development is not completed and the market has moved on, leaving the foreign side high and dry with no marketable product. The Chinese side assures the foreign buyer that they are “working on it,” but in fact the product development project is a low priority as compared to their ongoing manufacturing that pays their bills and so they are “working on it” only when times are slack. It is also common for Chinese factories to agree to take on a development project when they do not actually have the capability to do the work. In this situation, the delay results from the Chinese side being pushed up against the limits of what it can actually do.

The best way to address this lack of motivation risk basic method is to enter into a legally binding product development agreement with the Chinese factory that includes the following:

  • Milestones: hard dates for development of prototypes or samples.
  • Allocation of costs. If all costs are loaded on the Chinese side, the chance of success is dramatically reduced.
  • A real incentive for the Chinese side to succeed. This incentive can be payments for the Chinese factory hitting its milestones or it can be a commitment to purchase reasonable (but predetermined) quantities of the developed product at a fair price.

Few foreign buyers follow this approach, with the predictable results described by Renaud.

Risk Two: Quality Failure at the Production Stage. The Chinese side agrees to manufacture the product at the “China Price.” Initial samples are acceptable in terms of quality, but once production starts, the quality is consistently bad. When pressed, the Chinese side says: “We gave you the China Price and you knew that at that price we would never be able to produce a quality product. It is your fault: you have to choose. If you want the China Price, you don’t get assurance of quality, quantity or delivery date. If you want all those items to be acceptable to you, we need a binding contract that covers all four issues in a manner that works for us too. But if you insist on the China Price and you do not provide us with a binding commitment for orders, you will have to accept what we provide.”

Price is not the only issue; there are four key factors involved in having your products made in China: price, quantity, delivery date and quality and if you fail to hold your Chinese factory legally accountable for all four of these things, you are likely to have problems. If your Chinese supplier takes all four factors seriously, its pricing must increase. Foreign buyers who are not willing to accept such an increase will continually face the Chinese factory failing to comply with the other factors. Quality will suffer, delivery will be short or late, or the factory will suddenly quit accepting orders right at the height of the delivery season.

Risk Three: Low Priority in Production Schedule. The Chinese side accepts your purchase order for a small run of product at a low “China” price. Then another buyer shows up and offers a slightly higher price for a larger quantity of product. The Chinese side then pushes your order down the line for priority and your delivery is delayed. In some cases, the delay extends to the point where delivery never takes place. The Chinese side is not concerned about failing to deliver on the purchase order, since the litigation risks are extremely low because you do not have a Chinese language contract that works. See China Contracts: Make Them Enforceable Or Don’t Bother.

This situation regularly occurs when the relationship is based on “one off” purchase orders. See How To Get Bad Product From China With No Legal Recourse. The way to deal with this issue is to have a contract manufacturing agreement that clearly incorporates your purchase orders into the legally binding contract and that provides specific monetary penalties if your factory accepts a purchase order and then either delays or fails to deliver. When pressed to enter into this sort of agreement, Chinese factories will treat accepted purchase orders seriously and their delay/default rate goes way down. In our experience, factories that intend to take a relaxed view towards their legal obligations under an accepted purchase order will simply refuse to execute a formal contract manufacturing agreement, which is exactly what you want. See How To Write A China Contract. Liquidated Damages.

Risk Four: Sudden and Unpredictable Price Increases. Under the standard scenario, the Chinese side agrees to manufacture your product at a goal price, without ever having undertaken any serious examination of what it will actually take to manufacturer your product. The Chinese side then does the product development and the production implementation. The samples are acceptable and it is time to begin production. The foreign buyer then submits the first purchase order at the goal price. The Chinese side refuses to accept the PO and announces a substantial price increase. If the price increase is not accepted, the factory states that it will not accept any future purchase order.

There are two reasons China factories do this. The first and most common is that the factory never understood the price issue and never planned to meet the proposed price. The factory merely accepted the goal price to prevent you from going to another factory. The Chinese factory assumes you will be compelled to accept a purchase at the “real” price (whatever that price is) because you will be unwilling or unable to spend another 6-12 months (or whatever it will take) to start over with another factory.

The second common reason Chinese factories will take on a product development project with no intention of giving you the product you want at a price and delivery schedule that can make sense is that the factory is treating you as its outsourced R&D center. The idea comes from the foreign side, the implementation comes from the Chinese side. But the ultimate goal is for the Chinese side to make and sell the product on its own. The Chinese factory never planned to make the product for the foreigner. So they offer a very high price. If the foreigner accepts, they make the product for the foreigner at a price higher than they ever imagined. If the foreigner refuses the price, they move on to make and sell the product on their own. This sort of thing is incredibly common and hardly a week goes by without someone calling one of our China lawyers for our help to “require the Chinese factory to get its price in line with the market.” But unless you have a written contract that works for China and made pricing clear, there is nothing we can do to help at that point.

If the foreign buyer is purchasing an off the shelf product that is part of the Chinese factory’s standard inventory, the risk of any price issue is low. If you are engaging the Chinese factory to make minor customization of its standard product (maybe just adding your logo or changing the color), the risk is also low. But if the Chinese factory will be modifying/customizing its existing product, you should have a legally binding contract that the Chinese factory feels compelled to honor. The way to deal with this is under a product development agreement that includes the following three key components:

  • A strict timeline for developing the working prototype.
  • A provision that makes clear you own the prototype and all data, drawings and tooling required to manufacture based on the prototype.
  • A provision that states that if the factory meets the target price, you will purchase exclusively from the factory, but if the factory cannot meet the target price, you are free to take the prototype and have it manufactured at any other factory.

Without an agreement like this, you should expect a price increase as an almost a certain result of the product development process.

In part 3 of this series (coming later this week), I will examine how best to deal with the last three business risks inherent in having your product made in China, including one of my favorites, subcontracting.

 

Myanmar Thailand VietnamRobert Walsh, sometime Seattle resident and long-time friend of our law firm (we worked on a number of China deals together and we — Dan and Steve — met up with him on our last trip to Myanmar), has spent the last four years in Myanmar, where he operates a vibrant business consultancy. Robert is fluent in Chinese and Korean and, amazingly enough, Burmese (multiple dialects), having learned Burmese while working in the U.S. Embassy in Yangon many years ago.

Robert has been sending us email updates from Myanmar for some time and we post some of them on here. Back in 2014, it was Myanmar: Open For Business? and in 2013, it was Myanmar Foreign Investment. Difficult And Expensive, But Opportunities Are There. In our 2013 post I mentioned that my law firm had “been involved in a few Myanmar matters, but truth be told, Myanmar is a difficult place in which to do business and many of the companies going there are bigger companies mostly looking to get in now and make money later. In the last year.” Since that time, our Myanmar work has actually shrunk as interest in Myanmar by SMEs has greatly waned and their non-China Asia focus these days seems to be more on Thailand and Vietnam.

It was nevertheless great to get a bolt out of the blue from Robert this week in the form of a brand new Myanmar update, set forth below.

 

4 years water is under the bridge since we opened up shop in Rangoon.

A bunch of things have changed:

-Sanctions were relaxed, then finally revoked in toto back in October of last year. Now any foreign company that desires to do so can work with any of the formerly blacklisted military crony companies, jade/gems barons, or groups associated with narcotics trafficking. We’re seeing indications that this is happening already.

-Millions more cars on the road, newer Japanese for the most part, but Korean cars have moved in as well, and offer financing. Ford and Chevy are here with local or regional partners; not selling a lot.

-Supply of electricity has gotten steadily better, but this was achieved by a series of band-aid solutions using quickly built gas turbine or heavy fuel oil facilities.

-More places to stay, more restaurants for rich white people. Prices for hotels and rents on apartments have eased up now that supply roughly equals or exceeds demand.

-The November 2015 elections went off without a hitch, with the National League for Democracy (NLD) taking the lion’s share of seats. Daw Aung San Suu Kyi was not permitted to become president, but loopholes were found to allow her an equally powerful position. The finder of that set of loopholes, U Ko Ni, NLD’s senior lawyer, was gunned down outside the arrivals hall at Mingaladon airport last Sunday (January 29, 2017).

-The American Chamber of Commerce has a Myanmar chapter with over 100 members, but I’d say less than a dozen are really active. Sanctions or none, American business has not shown a tremendous interest in this place. Oil & Gas are here, but their presence and local footprint is no larger than it has to be to administer the constellation of service companies that follow in their wake. The only American manufacturer to date is Ball Corp, and they’re here just to make cans for Coke. Coke came in back in 2012 by acquiring a local soft drinks bottler.

-Japanese and Korean business are still by far the biggest foreign presence. Our best guess is that more than 3000 Korean families are here, not all coming out of Chaebol companies, most doing business on their own accounts. If we exclude Americans working for the embassy and USAID contractors, the number of hard-core American expats is probably less than 50.

-The largest sector in which American and European business is represented is what I and others term the “Aid and Development Industrial Complex”. An emerging sub-sector is the “Peace Process Participation Industrial Complex,” which attracts many nicely paid foreign consultants.

The lyrics are different, but the tune’s the same:

-Although the government has supposedly changed hands to civilians, many upper-level ministries out in the provinces don’t seem to have gotten the word, especially if they are headed by ex- (or not so ex-) military people. The farther away from the Naypyidaw flagpole, the more clearly this is evident.

-Laws may pass, but implementing instructions are slow to make it down to where the rubber meets the road.

-Doing anything land intensive requires one take up the diligent study of various land documents issued to owners over the past 160 years. In the fringe border areas, especially where there has been a lot of fighting since independence, land documents are especially puzzling.

-The IFC/World Bank has hosted a “Myanmar Business Forum” (MBF) with eight working groups along industrial sector lines. Its aim was to engage lawmakers and ministries to draft and pass law through the Union of Myanmar Federation of Chambers of Commerce and Industry (UMFCCI). I sat on the agricultural/forestry working group and we were actually able to get things done, in terms of getting implementing instructions for laws passed as long as 20 years ago. The most active working groups were for anything related to land tenure or hotels/tourism. Missing or poorly represented were agricultural finance and inputs (fertilizers, agrochemicals).

– A second set of refinements to the Foreign Investment Laws were passed, but they do not help much. It still costs a lot of money to set up a business here. We have been doing a lot of work setting up companies as rep offices, once we were absolutely sure what the rules were, and what a rep office could/could not do. Most of our clients want our help in establishing a presence, opening a local banking account and administering expat immigration, and setting up shop. NGO’s are our biggest customers, as they now realize that registration as an NGO (as opposed to just a normal for profit company) rarely offers them anything and indeed adds restrictions on their movements and activities — in other words, not so different from China).

-Right now a fairly nasty set of visa and foreigners laws is up for passage. If pass as written, I think many foreigners will stay away or leave if already here. As it stands, many of the laws are currently on the books, and few expats are compliant because the government does not strictly enforce them. Should the government wish to do so, it can deport anyone and everyone who is not compliant, and do so at a moment’s notice. And we do see the government deporting foreigners who do things that excite their ire, usually for political or religious reasons, and occasionally for criminal behavior.

-Like it or not, there is plenty of unrest in this country, and large swathes of Kachin and Shan state are low-boil combat zones; the Kachin Independence Army (KIA) is still far from considering entering the National Ceasefire Agreement. A number of ethnic armed groups have signed the NCA and are now lapping up greenmail money and other territorial benefits, but the majority of them have not in fact been combat effective for a long time, decades in most cases. The KIA has formed a 5-member alliance of other groups that are equally belligerent and unwilling to sign the NCA under the government’s terms.

-In Rakhine state the slow-motion train wreck that is the Rohingya situation shows no sign of resolution anytime soon, and if anything, Trump’s election and anti-Muslim rhetoric has reduced inhibitions on the Burmese taking harsher action to force these people back into Bangladesh. Incidentally, slain NLD lawyer U Ko Ni was himself a Muslim, albeit from a family with generations-back residence in this country. The American embassy used to be pretty shrill in denouncing bad behavior towards the Rohingya, but since Trump’s election the United States has not said so much.

 

 

China Lawyers

Commercial real estate company Jones Lang Lasalle (JLL) has come out with a ranking of cities worldwide by “momentum.” JLL researchers use 42 factors to evaluate world cities on the move and their rankings do at least somewhat jibe with the sense I have regarding the cities I know. Their ranking of the top 30 cities is as follows:

1 Bangalore
2 Ho Chi Minh City
3 Silicon Valley
4 Shanghai
5 Hyderabad
6 London
7 Austin
8 Hanoi
9 Boston
10 Nairobi
11 Dubai
12 Melbourne
13 Pune
14 New York
15 Beijing
16 Sydney
17 Paris
18 Chennai
19 Manila
20 Seattle
21 San Francisco
22 Shenzhen
23 Delhi
24 Raleigh-Durham
25 Mumbai
26 Hangzhou
27 Los Angeles
28 Dublin
29 Nanjing
30 Stockholm

So as you can see, Shanghai comes out on top among China cities at #4, Beijing clocks in at #15, Shenzhen at #22 and Nanjing at 29. I was a bit surprised not to see Shenzhen at the top of the China list, because without a doubt, our China lawyers have been seeing a greater increase of work from there than from any other city in China. See Shenzhen, China, 24/7, and the Internet of Things. But who are we to quibble.

What most struck me (but did not surprise me one bit) is how well Vietnam’s two largest cities did in this ranking, with both Ho Chi Minh and Hanoi in the top ten. Beyond China and Vietnam, India and the United States do best in the rankings overall, with India contributing two cities in the top ten (Bangalore at #1 and Hyderabad at #5) and four more cities ranked between 10 and 30. The United States has three cities in the top ten and an additional eight cities ranked between 10 and 30.

What are your thoughts regarding the above ranking?

China manufacturing lawyersIn a post entitled The 7 Major Risks You Run With Your China Manufacturers, China manufacturing expert Renaud Anjouran outlines the business risks foreign companies face when outsourcing their product manufacturing to Chinese factories. Renaud’s list nicely accords with what our China lawyers tell our clients for whom we draft Chinese contract manufacturing agreements. See China Manufacturing Agreements: Binding Contract or Contract Terms. When we first talk, our manufacturing clients usually want to focus on the following: a) ownership of intellectual property, b) prevention of counterfeiting, c) ownership of molds and tooling and d) after sales warranty service. This is the kind of thing legal agreements are really good at resolving and it is easy to allow the discussion to center on these issues.

But in my 25+ years of working in China, it is rarely these issues that result in bankruptcy of the foreign purchaser. The matters that result in bankruptcy are usually on the list provided by Renaud. That is, the most serious issues are the core business issues tied to outsourced manufacturing: price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping.

Renaud describes the basic issues, but, we should ask at the outset: what is the source of these issues and what can be done to address them. The source of the problems is the pervasive use of the purchase order approach to purchasing contract manufactured product from China. In China Manufacturing Agreements: Binding Contract or Contract Terms, I wrote how there are two basic ways to structure a China contract manufacturing agreement.

Option One is to enter into a binding contract with the China factory that directly confronts all of the basic manufacturing issues in a manner that is legally binding on both the parties. Under this option, the agreement on price binds both the Chinese factory and the foreign buyer. If material costs change, if labor costs change, if production costs change, the parties remain obligated to pay and sell the product at the agreed-upon price, no matter which party benefits or loses from the changes. Both parties are taking the price risk. If the agreement is long term and if the various input costs are likely to change over time, then the parties either take the risk or develop a detailed system for adjusting in response to the change. In most of the world, this is what is done. In China, however, the entire risk tends to be loaded on one side or the other. The same applies to the other key business terms in China manufacturing agreements, such as the terms for payment, quantity, delivery date and quality.

The issue for many foreign buyers is that under Option One, both parties are bound. Foreign buyers who do not want to be bound or who cannot be bound due to lack of resources will follow Option Two. Under Option Two, any form of contract manufacturing agreement is little more than terms and conditions. Such terms and conditions are binding on the parties only after a purchase order is presented by the foreign party and then accepted by the Chinese party. If the Chinese manufacturer does not accept your purchase order, there is no binding agreement you and your Chinese manufacturer. It is this lack of a binding agreement that is the primary cause of the seven manufacturing risks Renaud discusses in his post.

Consider for a second why that is the case from the perspective of the Chinese factory. Under the purchase order approach, the factory has no assurance that its foreign buyer will place even a single order. During a fiscal year, the Chinese factory has no assurance on price, quantity or delivery date. The Chinese factory is expected to develop the product, taking on the risk and expense of commercialization. The Chinese factory is then expected to turn over to its foreign buyer the plans, molds and tooling so the foreign buyer can move production to a lower cost factory down the road. In this type of situation, the factory really has nothing solid in the relationship with the foreign buyer. So the factory acts in the manner described by Renaud. This is perfectly natural and it is to be expected. That is, any foreign buyer that expects a Chinese factory to act differently under the purchase order approach option is living in a dream world.

So what is the solution? The obvious solution is to follow Option 1 by entering into a binding agreement with the Chinese factory that formally commits both parties to the basic business terms for a specific period of time. However, the lure of China for many foreign buyers is that Chinese factories are willing to do small runs on a purchase order basis. The purchase order system is oftentimes the reason why the foreign company is having its product developed and manufactured in China. To tell these buyers to follow Option 1 is unrealistic.

For this reason, our primary task as lawyers is to develop contract manufacturing agreements that recognize that the purchase order approach will be used and deal up front with the risks that come from that. The key here is that the foreign buyer understand the risks and work actively with the Chinese factory to deal with mitigating those risks in a way that is practical and fair.

We can now consider the situation in China in relation to the risks Renaud identifies. In my follow-up post (on Sunday) I will discuss the first four of these risks and how best to mitigate against them. In part 3 of this series, I will conclude by examining how to deal with the last three of these risks.

China employment lawyerEvery China employer should have a set of rules and regulations setting out employee and its employer duties and obligations. This document should cover all types of employees, including part-time employees. It also should at minimum, cover the following:

Many foreign employers wrongly assume that whatever they use in their home country is good enough for their China employee manual. This is virtually never true as the reason for having employee manuals is so different as between China and Western countries. Western companies often learn too late about these differences when one of their employees leaves or is terminated.

The following are seven common myths our China lawyers often hear about China employer rules and regulations:

Myth 1: It need not be in Chinese. Though having your rules and regulations entirely in English will not necessarily invalidate the entire document (this depends on where you are), it needs to be in Chinese so your employees can understand it. If you do not have a Chinese language version of your rules and regulations, you run the risk of a Chinese court finding it not binding on your employees because they could not understand it and you didn’t bother explaining it to them. Also, the local labor authorities may require a Chinese translation for audit purposes and you don’t want to be caught flat-footed when that happens. And whatever you do, do not just take your English language version and pay a translator to put it into Chinese. Your Chinese language rules and regulations are what the courts will be looking at to determine whether you acted properly or not, so you want that document to be written clearly (and in Chinese) for this purpose.

Myth 2: It need not be in English. You really should have an English translation done and make sure that too is good. You as the employer will need to refer to this document in making employee decisions (especially termination decisions). Unless all of your people who will be making these decisions are fluent in written Chinese, you need a well-written English version to serve as your roadmap on how to handle all sorts of decisions regarding your employees.

Myth 3: It need not be updated because it has a provision that says the outdated sections will automatically be replaced and superseded by then-current laws. Wrong. Both nationally and at the local level, China’s employment laws are constantly changing. It therefore behooves you to do an annual internal audit of the key elements of your employer-employee situation and this yearly employer review should include a review and an updating of your rules and regulations. You could be exposed to huge risks if you have been relying on a section that is contrary to the law. More on this in Myth 5. We also fairly often see rules and regulations that made sense for a company that had employees in just one China city, but no longer do now that the company has employees in three cities.

Myth 4: Employers do not need to follow any procedures in implementing the rules and regulations. You must make your rules and regulations available to every employee so they have an opportunity to read it before signing off on it. And if there is a worker’s union at your organization, you should hold meetings with them and obtain their comments and suggestions before implementing your rules and regulations.

Myth 5: By signing an acknowledgment of receipt, the employee agrees to everything in your rules and regulations, so it doesn’t matter if it conflicts with the law. Not sure why, but our China lawyers have been hearing this myth more frequently of late and it too is just plan wrong. Very wrong. Having a section in your rules and regulations that contravenes the law probably will not invalidate your entire document (though it conceivably could), but many China employment laws must be followed and cannot be contracted away. It does not matter that the employee gives his or her written consent, and it also does not matter that the employee acknowledged that he or she executed the written consent as a free and voluntary act.

Myth 6: Once published, employers can change anything they want at anytime without any notice because the employees are responsible for keeping up to date with the amendments. First, if your rules and regulations document sets forth an internal procedure for amending the rules and regulations, you should follow that. We usually recommend our clients give notice to their employees of any proposed change before implementation. For important issues concerning employees’ interests such as compensation, working time, rest and vacation time, labor security and health, insurance and benefits, employee training, labor discipline, the safest route is to give them prior notice before amending the rules, especially if the changes may have an adverse impact on them. At the very least, provide the employees with notice of the change and give them an opportunity to comment and ask questions. Doing this simple thing can only help you down the road.

Myth 7: The employment contract between the employer and the employee always takes precedence over the rules and regulations if there is any conflict between them. Wrong. Like so much else related to China’s employment laws, the legal interaction between your rules and regulations and your employee contracts depends on your location. The local law may require that the employment contract prevail over the rules and regulations even if the employer and the employee have a written agreement stating otherwise. Or the law may say that the employee gets to decide which to apply based on which the employee believes is more favorable to him or her and the employer has no say on that. The key here is that you know the legal situation in your relevant jurisdiction(s) and to the extent allowed by law, you make clear in both your rules and regulations and in your employment agreements how your rules and regulations interact with your employment contracts.

For more myths about China employment laws, check out:

 

China trademark lawyersOur China lawyers do a lot of work for clients seeking to remove listings of counterfeit goods from Chinese e-commerce sites. Most of these listings are for obviously, sometimes extravagantly counterfeit merchandise, offered in vast quantities at far-below retail prices, with pictures either lifted from the real manufacturer’s website or showing products of dubious quality, and often featuring product variations beyond those offered by the real manufacturer. The sellers are usually unsophisticated trading companies trying to make a quick buck, and we have no trouble removing these listings.

But for some listings, it’s not so clear the merchandise is counterfeit. The quantities are sometimes limited. The prices are not unreasonably low. And the goods appear to be genuine. Many clients still want these listings removed because the sellers are unauthorized resellers, but an Aliprotect takedown request may not be the appropriate strategy.

These goods are by and large “parallel imports” or grey market goods – authentic products legally purchased in a foreign country, imported into China, and then offered for sale. China does not have a clearly articulated position on the legality of parallel imports for trademarked goods, but courts have generally held that selling such goods in China does not constitute trademark infringement.

China follows the “international exhaustion of trademark rights” standard, which means that once trademarked goods have been sold overseas, a brand owner’s exclusive rights to those goods in China have been exhausted, and a reseller’s use of that trademark in China does not constitute trademark infringement. The contrasting standard would be “national exhaustion of trademark rights,” which would only allow resellers to use the owner’s trademark if the first sale of the goods was in China.

But just because China has a de facto policy of allowing parallel imports does not mean that trademark owners are powerless to stop sellers of parallel imports on JD.com or Tmall. Sure, it may not be possible to stop the occasional seller of small lots brought over from America. But it’s the sellers who claim to be authorized dealers or exclusive resellers who are the real problem. And though a trademark infringement claim probably will not work against those companies, it may be possible to succeed with other claims. In the cases where the plaintiff has been able to stop parallel imports, the courts have ruled based on grounds such as unfair competition and consumer protection.

In a 2009 case before the Changsha Intermediate People’s Court, French tiremaker Michelin was able to stop the sale of parallel imports by showing that the defendant that was selling its tires had not properly obtained China health and safety certifications. And in a more recent case, French cosmetic company Pierre Fabre was able to stop the sale of parallel imports by showing that the defendant was improperly holding itself out as the “Chinese official website” and “China shop” for Pierre Fabre, and had used Pierre Fabre’s trademarks and copyrighted material on its own website in a manner suggesting a formal business relationship.

On the other hand, in the past four years courts in Shanghai, Tianjin, and Beijing, respectively, have ruled against Victoria’s Secret, the French wine group Les Grands Chais de France, and the German beermaker Köstritzer Schwarzbierbrauerei in their efforts to stop the sale of parallel imports, because in each case the seller had purchased genuine products, distributed them through standard channels, and sold the products as is without suggesting any relationship between the seller and the plaintiff.

In other words, the appropriate response to e-commerce sales of parallel imports is fact-specific and usually requires additional investigation. Needless to say, before trademark owners even consider taking action, they better make sure they have properly registered their own trademarks.