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Four Common China Law Mistakes To Avoid

Posted in Basics of China Business Law, Legal News

I am now writing weekly on China law issues for the Above the Law Blog. In my first post, China Law Mistakes To Avoid — I’m Talking To You, I listed out “four common and egregious mistakes my law firm’s China lawyers often see American domestic lawyers make when representing their clients in doing business with or in China, along with a very brief analysis of what causes American lawyers to make each sort of mistake.”

Those four mistakes are as follows:

1. Many years ago, a lawyer in the Midwest called us to discuss his client’s desire to form a company in China. This lawyer did not even tell us that his client was in the room. The lawyer asked us the minimum capital the Chinese government would likely require his client put into a Chinese bank to be able to start a business (a WFOE) in China. Based on the nature and size of the business, we estimated $6 to $8 million. The lawyer asked us to confirm that a portion of the required $6 to $8 million could come from factory equipment not cash, and we assured him that it could. At that point, he said, “good,” because his client had already purchased $5 million in equipment and shipped it to China.

We then had to tell him those equipment purchases could not count because they had not been previously designated as going to the WFOE. The lawyer then complained about how his client could not afford to come up with another $5 million and how China was putting form over substance. To which we could say little more than, “yeah”…

This is just one of countless instances where an American lawyer has done poorly by his or her client by just assuming that the rest of the world views the law just as we do. China almost always places form over substance and it does that because it views giving its bureaucrats discretionary authority as also giving them the discretion to solicit bribes to influence the exercise of that discretion.

2. A lawyer calls us with an airtight $2 million dollar breach of contract lawsuit against a Chinese company. This lawyer had drafted a contract calling for disputes between her client and the Chinese counter-party to be resolved in Boston Federal Court and she had already sued the Chinese company in Boston and secured a default judgment against it. She was now seeking my law firm’s help in domesticating the judgment in China, and It was clear she expected us to jump at the opportunity to take the case on a contingency fee basis.

That is until we told her that China does not enforce U.S. judgments. Ever.

She then came up with the idea that we start all over by suing the Chinese company again in China. We had to tell her that could not work because the Chinese court would have two strong grounds for throwing out that lawsuit. First, improper jurisdiction because the contract clearly called for the lawsuit to be in Boston. Second, res judicata because the entire case had already been tried (and won) in Boston (the proper jurisdiction). I have no idea how she explained all this to her client.

American lawyers commonly assume that what makes sense for a domestic transaction necessarily also makes sense for an international transaction. Boston would have made sense in the above instance if the counter-party had been in Los Angeles, but the rules and the issues are different when doing business internationally.

3.  Lawyers often call us for “tips” on handling an arbitration in China (usually with CIETAC). We always quickly ask whether the contract calls for the arbitration to be in English or whether the lawyer calling us (or some other lawyer) on the case is fluent in Chinese. This virtually always elicits a really long silence and then they say something about how they had just assumed that their case (usually set for hearing in a month or two) would be in English.

If you do not specify that your China arbitration is going to be in a language other than Chinese, it will be in Chinese. This mistake stems from the American lawyer’s inability to grasp that China is not all that different from the rest of the world. I mean, would anyone ever think that an arbitration in Kansas City is going to be in Chinese even though the contract calling for arbitration there is silent on the language of the arbitration?

4. American lawyers often call us on behalf of their client who has received a product from their Chinese manufacturer, claiming that the product does not meet the contract specified quality. We then determine that the specified quality to which they are referring is “reasonably good quality” in such and such industry. To their surprise, we immediately beg off working on the case and we then have to tell them how there really is no such thing as “reasonably good quality” in a country where you can buy a 30 cent t-shirt that falls apart after its first washing. And/or we tell them of the U.S. company that had us call a Chinese factory from whom the U.S. company received a million dollars worth of laptop bags whose handles were not strong enough to hold a laptop. The Chinese factory’s explanation was that if our client had wanted laptop bags strong enough to truly hold a laptop, our client should have ordered the $6 bags, not the $3 ones.

This mistake stems from the American lawyers’ belief that the U.S. way of looking at the law applies universally, when it does not. China is a civil law country and a phrase like “reasonably good quality” is almost meaningless.

What have you seen out there?

How To Handle Chinese Negotiating Tactics. Part Five.

Posted in China Business

It is not unusual when China lawyers get together to talk about Chinese company negotiating techniques. It also is not unusual for at least one person to describe them as inscrutable. In an effort to make them more scrutable (that is actually a word, BTW), we bring you part Five of our series on How to Handle Chinese Negotiating Tactics. Part one is here, part two is here, part three is here, and part four is here.

This part 5 is based on a post by my friend Andrew Hupert, entitled, Negotiating with Chinese in your Home Market, and though it is tilted towards negotiating with Chinese citizens seeking to purchase a house in the United States, its five tips for better negotiating (set forth below with my comments in bold) have some relevance to any sort of deal with a Chinese company, particularly those involving the Chinese company seeking to do a deal in the U.S.

1. Get the lawyers and bankers out of the room in the early stages. Americans tend to lead with the contractual details and legalese. Chinese in the US aren’t as relationship-oriented as they are back in the mainland, but it’s still intimidating and off-putting to them. Relationships lead to transactions. I agree, which is why our China lawyers usually advise our clients not to have us in the room for early stage negotiating. Chinese companies do use lawyers on bigger deals and you too should have your own China attorney working for you as well but it does generally make sense to keep him or her in the background.

2. Don’t ask where the money comes from (until you have to). Due diligence is important, and you will have to check out your Chinese counter-party when transacting in the North America or Europe. But tread carefully on the “sources of income” issue. A lot of the money showing up to buy US real estate and high-value assets comes from corruption or money transfers that bend or break PRC capital control laws. When the counter-party is from mainland China, you have to find other ways to qualify buyers, and put off the due diligence until later. Very true. 

3. If there are kids involved, it’s all about education. If you are involved in real estate, then know your schools. Good public schools in the neighborhood a huge plus – since mainland Chinese are the last known people on earth to respect the US education system. Know the stats, be familiar with extracurricular options and have detailed info on private and public options in the neighborhood. Don’t worry so much about parks, recreational and athletic facilities. Even if the kids plan on making use of them, the parents still feel they gain face if their kids look like studiholics. In The Chinese Are Coming, Part XII. To A Public School Near You, we wrote about how a U.S. education can be a big factor in whether or not a deal gets done.

4.  They see themselves as international elite but still want access to Chinese stuff. Don’t go too heavy on the Chinese culture available in the area. Mainlanders with money see themselves as part of the global elite, so their buttons are aspirational purchases and acceptance by the dominant group. They respond to “you are joining the 1% status” much more than they do to “familiar Chinese masses in Manhattan.” Your job is to know where other Chinese 1% shop and access familiar services (particularly if they are traveling or living with elderly parents), but spend your time talking about the European and Ivy League neighbors and colleagues. Good cultural tip, overall.

5. Be a real American. When Japanese money came to the US in the 80s, all the brokers and headhunters took Japanese lessons and treated their counter-parties like trauma victims who would were about to break down from terminal culture shock. Chinese clients and buyers aren’t like that. They know they’re overseas, and probably worked hard to get here. When Westerners pretend to be Chinese, they dilute their value and risk embarrassment. Chinese clients come from a society where insider knowledge and connections are tied to success and effectiveness. When you are competing with an American-Chinese or mainland Chinese agent or salesman, your advantage is that you are a “real American” and can steer your mainland client through this strange and hostile market environment. Very good advice.

What do you think?  More tips?

China Product Sourcing. How To Check On Your Potential Supplier.

Posted in China Business

Had a long conversation with a client this morning about what we as China lawyers can do to quickly and cheaply try to figure out whether a China manufacturer is on the up and up. This below is essentially a rehash of that conversation as it is a list of the steps we typically take to smoke out the fake manufacturer or a broker claiming to be the manufacturer.

1.  A Chinese language internet search. This oftentimes is enough to determine that the company is not likely to be real or that if it is real, it is not a good company with which to do business. It is amazing how often the fake China company has a website in just English, with no Chinese. This is a tell. We also sometimes can learn a lot by

2.  We call the phone number on the Chinese company’s website and/or send a fax to the fax number, to see if those check out. If they do not, we have learned a lot.

3. We search government records to make sure that the company is actually registered. Depending on the town in which the company is located, this is not always possible, but most of the time it is. Some people simply ask the Chinese company to provide its business license, and that no doubt can be helpful. But we have seen so many fake licenses that we usually prefer to simply bypass that and go right to the government source.

4. If the company registration checks out, we send someone to look at the factory to make sure that it is still there and, if possible, ask people in the area about that factory.

The above will not definitely tell you that the factory produces good product, but it will at a very low cost increase your odds. If more is needed either because our own research is inconclusive or because so much is at stake, we bring in a consultancy specialized in China due diligence.

What do you do to scope out your China manufacturers?

China Income Taxes For Expats

Posted in China Business, Recommended Reading

One of our China lawyers got an email from a loyal reader today, suggesting that we write about expat income taxes in China, and including a link to a site that did exactly that. The site is that of SJ Grand, a Financial and Tax Advisory Service with offices in Beijing, Shanghai, Shenzhen and Paris.

The article is entitled, Individual Income Tax for Expatriates in China: Overview of PRC Individual Income Tax and that is exactly what it is: a really good and helpful and surprisingly comprehensive overview of the income taxes expats face these days in China. If you want to know more about China income taxes for expats I urge you go read it.

China Law Enforcement Efficiencies Rising

Posted in China Business

Just read an FCPA Blog post, entitled, China law change would blacklist work safety offenders. The post is on how “China’s lawmakers have reviewed a draft amendment to the workplace safety law that will increase oversight, impose harsher punishment, and slap a ban on new projects for offenders.

And it got me to thinking. About how computerized China is becoming and on how what foreign companies do in one arena/location in China can have a lasting (lifetime?) impact on what they do in another.  Let me explain by using a concrete example.

Ten years ago, if you were the Managing Director of a WFOE and your home office told you to close that WFOE by walking away from it without paying any outstanding taxes, outstanding wages, or outstanding debt, you as an individual would almost certainly be able to continue living and working freely in China. Sure, if the WFOE had been in a small town, you would have had to move to some other city in China to continue doing business in China, but once in that new city, you would have been able to pretty much do as you pleased. Indeed, you almost certainly could have opened another WFOE, with you as Managing Director.

But things have changed, and this draft amendment on workplace safety is just another example of that change. China is sick to death (pun intended) of its workers getting injured or dying and it is cracking down on unsafe employers. This crackdown consists of increasing fines for unsafe workplaces and stepping up criminal prosecutions. But more importantly (at least for purposes of this blog post), this amendment also includes a “plan to blacklist offenders of work safety rules and make their offenses public. Blacklisted companies will be restricted from obtaining land-use permit, project approvals, bank loans, and insurance.”

That’s what I’m talking about.

Whereas a company shut down in one city might have once been able to re-open elsewhere in China without much problem, that has become more difficult, both for the company and for its owners/officers/directors. Sometimes for legal reasons and sometimes for reputational reasons.

Our China lawyers are seeing this sort of thing in various sorts of situations. Where we most often see the Chinese government acting against individuals for what their previous company did is in the tax arena. In the last year, we have gotten a couple phone calls from Americans denied entry to China for a company at which they held a high level position having failed to pay its company taxes. We recently negotiated a settlement for an individual who headed up a China WFOE that required the American parent of that WFOE to pay its outstanding WFOE taxes in China. Our client (the individual) wanted that deal so that he would be free to return to China to work.

Our China attorneys also often see “nationwide” problems in the product sourcing arena. What happens there is that an American company gets bad product from its China product supplier and therefore does not pay the remainder of the amount owed (usually 30 to 70% of the total product price) to is China supplier. The China supplier then submits a claim to Sinosure (this is the insurance company that insures pretty much all exports from China. Sinosure then contacts the American company in an effort to seek payment for the remainder that is owed. The American company then tells Sinosure that it has not paid and will not pay because the product quality was bad. In turn, Sinosure then refuses to provide export insurance coverage for any exports to that American company from any Chinese manufacturer/supplier. As you can imagine, this scenario presents all sorts of problems for the American company. Note: if you ever face this sort of situation, do not do nothing, thinking it will all just go away.

What is happening in China to cause this better/braoder enforcement?  Better data management. Now if you fail to pay taxes in Dalian or Qingdao or Chengdu, the guy who approves your visa through San Francisco has a much better chance of knowing about it. And these improvements in data management are only going to accelerate.

Bottom Line: What you do in one place in China is simply far more likely to have permanent repercussions on you everywhere in China. It is that simple.

What are you seeing out there?

China Film Event. Beijing, April 18.

Posted in Events

On April 18, from 8:00 a.m. until 10:00 a.m., AmCham China’s Media & Entertainment Forum and The Motion Picture Association of America will be putting on a “briefing with Chris Dodd,” former senator from Connecticut and now chairman and CEO of the Motion Picture Association of America.  Senator Dodd will be giving his “unique insight into US-China relations in the film business.”

Mathew Alderson, co-chair of the AmCham China Media & Entertainment Forum and a China entertainment lawyer with my law firm, will be the moderator of this event, which is being titled, “Big Screen, Big Markets: US-China Relations In The Film Business.”

Senator Dodd’s talk will take place at the China World Hotel, 1 Jianguomenwai Street, Chaoyang District, Beijing. 北京市朝阳区建国门外大街一号 and the schedule will be as follows:

7:45-8:00 AM – Registration
8:00-8:40 AM – Presentation
8:40-9:00 AM – Q&A
9:00-10:00 AM – Discussion and networking

For more information, please contact Serena Liu at sliu@amchamchina.org.

Doing Business In China Without An Anti-Corruption Compliance Program? Are You Crazy?

Posted in Legal News

Sorry for the strong title on this post, but a recent Department of Justice (DOJ) case and China’s recent relentless crackdown on corruption mandates it.

The recent DOJ case was against Marubeni, a large Japanese trading company. The DOJ secured jurisdiction over Marubeni because some of the money used to bribe Indonesian government officials passed through the United States via a consultant who sent some of it on to Indonesia. We mention this to show the extreme jurisdictional reach of the FCPA, which makes countless foreign companies subject to its reach.

The DOJ treated Marubeni quite harshly by securing a guilty plea to criminal activity from the parent company (not just the subsidiary that actually paid the bribe) and by requiring Marubeni cough up 88 million dollars for a $357,000 bribe payment. Marubeni was treated so harshly for the following reasons, as set forth in the DOJ press release announcing the plea agreement:

The plea agreement cites Marubeni’s decision not to cooperate with the department’s investigation when given the opportunity to do so, its lack of an effective compliance and ethics program at the time of the offense, its failure to properly remediate and the lack of its voluntary disclosure of the conduct as some of the factors considered by the department in reaching an appropriate resolution.

Marubeni (the parent) received enhanced punishment because, among other things, it did not have an effective anti-corruption compliance program in place and because it failed to alert the DOJ to the bribe payments after learning of them. If you are a foreign company doing business in China, you should above all else take two things from this press release: you need to have an “effective compliance and ethics program” in place, starting now, and you should immediately report any FCPA violations of which you become aware.

In China and the Foreign Corrupt Practices Act, we talked about the need for companies (particularly American companies) that do business with China to have a corruption plan and policy in place:

Both China and the US (and England too for that matter) are cracking down on corruption.  If you do not have a corruption plan AND a corruption policy in place, you just increased your chances of being in a world of pain at some point.  To put it bluntly, which of the following do you want to be able to say to the Chinese authorities/US federal prosecutors if your company is ever accused of having engaged in corruption?

  • Oh, sorry, I didn’t realize that corruption might be a problem.
  • We did everything we could to try to prevent this.  Here is our policy manual which we require our employees to sign when they join our company and re-sign to acknowledge every year thereafter.  And here is a record of the full day mandatory anti-corruption training we give to our employees every six months and the written materials we provide to them each time.  As you can see, the employees implicated in this case each attended x number of these sessions.  I really do think we did everything we could do as a company to try to stop this sort of thing and I think you will find that we do take stopping corruption very seriously.

Pretty obvious, right?  The FCPA and China is a hot topic these days not only because of the traditional Chinese culture of gift-giving and the sensitivity of allegations of government-related bribery and corruption, but also because of the complicated question of whether or not executives at state-owned enterprises (which are common in China) can be considered “government officials” for purposes of FCPA enforcement.  Based on our own quasi-empirical evidence — based strictly on companies contacting our China lawyers — the FCPA worry level for companies doing business in China went way up right about when GSK started having its problems.

For more on China’s own crackdown on corruption, check out How To Do Business In China Without Jail Time? Kill A Chicken.

And if you want even more information about on China corruption issues, I urge you to attend the Dow Jones Global Compliance Program, which will be taking place in Washington D.C., on April 22 and April 23. I will be on a panel there, entitled, China: Making Sense of the New Bribery Crackdown, which according to the program guide, will focus on the following:

China’s anti-corruption campaign has highlighted risks for Western companies in their choice of business partners and hires and how they monitor third parties. Our panel of experts will apply their expertise from working in China to take the temperature of the nation’s business environment and how companies should approach it.

Because corruption obviously matters….

Our comment lines (as always) are open.

China: Your Enemy, Can’t Do You No Harm….

Posted in Uncategorized

Just about every month I give a talk on how to protect IP from China and just about every speech I start off with something like the following:

If you are doing business with or in China, you have to plan on someone in China making a play for your intellectual property.  It’s not a matter of if, but when. It may be your partner, your distributer, your manufacturer, your sales manager, your top scientist, your supplier, or your customer who seeks to take and then use your IP.  Big Chinese companies steal IP.  Small Chinese companies steal IP.  State owned Chinese companies steal IP.  Privately owned Chinese companies steal IP.  And despite the beliefs of many Americans just starting out in China, Chinese companies with people who speak great English and invite you to their family weddings also steal IP.

In the last few weeks, I received two calls involving companies whose excessive trust led to their getting burned in China. The first call went something like the following:

Caller:  My husband is very trusting. He met the seller and looked him in the eye and the guy spoke really good English and my husband just knew that he could be trusted. They had dinner together two days in a row. We sent him $60,000 and now he is not even responding to our emails. My husband has found another supplier and I am wondering if there isn’t something we can do to make sure that he does not do the same thing. My husband insists this guy is also honest.

Me: Reminds me of what Bush said about Putin and look what Putin has been up to lately. I much prefer the Ronald Reagan’s  ”trust but verify.” Here’s the thing. My law firm’s China lawyers get at least one call or email pretty much every week from someone who got ripped off or cheated or maybe just shortchanged by someone in China. And probably 99% of those cases, the people calling or emailing us started out trusting their Chinese counter-party. In fact, I don’t remember a single instance where the caller or the emailer told us that they knew from the get go that they were doing business with a crook.

There are a lot of things we can and should be doing to verify that your potential supplier is legitimate. Let’s talk….

The second call was from a company that had spent hundreds of thousands of dollars setting up a subsidiary in China, hiring employees, and hunting down business, only to have its entire team leave the company to form their own.  That conversation went something like this [by the way, I secured approval from both parties to discuss their situations here -- in fact, both encouraged that we do so]:

Caller: But I set them up. I gave them good jobs. They owed me. They were my friends.

Me: Did you have a formal written employment agreement with them that set out trade secret protections? Did you have a non-compete agreement with any of them?

Caller: No, because I had worked with all of them for years before I started my China company.

People, I really hate to sound cynical here, but the reality is that if you are doing business in China (or anywhere else in the world for that matter) the most likely people to do you wrong are those whom you trust. The people you do not trust are usually not going to get access to your money or your secrets.

So, yes, you do need contractual protections against even those you trust. Check out Chinese Contracts. Because They Really Do Make A Huge Difference.

What do you think?

Where To Locate Your China Business. Nike? Starbucks? Intel?

Posted in China Business

Back in the mid-1990s, Jardine Fleming Securities (now part of JP Morgan Chase) came up with the Swoosh Index, which was its theory that once Nike selects a country for its newest factory site, economic growth, rising stock markets, and other foreign companies follow. A Business Week article, entitled, The Swoosh Index for Emerging Markets, explains it:

Nike first started using Japanese plants in 1964. When labor costs there climbed in the mid-1970s, it gave South Korea and Taiwan a run. In the 1990s, production jumped to Indonesia and China, which now account for two-thirds of Nike output. Nike pulled back from Thailand recently ahead of a collapse in stock and property prices. Next up: Vietnam. While production there is now only 2% of Nike output, that’s expected to double within a year.

When choosing factory sites, Nike looks for cheap labor. However, it also picks countries with stable–usually authoritarian–leadership, decent infrastructure, a pro-business government, and a liberal trade regime.

When it decides to leave, that doesn’t signal the end of prosperity. It often means that countries are ready to move on to high-end manufacturing. And democracy.

Many companies watch Nike and then follow Nike into whichever country Nike locates.

Starbucks has this same effect. There is even a rival Northwest coffee shop, Tully’s Coffee, that used according to Wikia, used to locate its stores next to a Starbucks:

Tully’s Coffee is well known for once following an expansion strategy of opening stores adjacent to the opposing coffee giant Starbucks, also based in Seattle. There’s a running joke in Seattle that the easiest way to find a Tully’s is to stand in front of a Starbucks and turn around.

I once sat on a plane next to a hotel chain executive who told me that his company did no independent research on where to locate within Asia: they simply considered new countries in Asia only after learning that the Westin/Sheraton had done so.

For more on choosing your China location, check out the following:

So what companies should others be following in determining where to locate within China? Nike? Gome? Intel? Starbucks? Tiffany’s? And what about elsewhere in Asia?

And what do you think of this strategy at all? I have to say that I hate it as it both fails to weigh the factors that might really matter to the company looking at where to locate and it fails to account for the huge differences between one company and another.

China Imports And Exports. “One Window” Process Coming Soon.

Posted in Legal News

This is a guest post by Chris Priddy, an international trade and compliance lawyer with our firm.

If your company is engaged in U.S.-China trade, you know that clearing goods through Customs is the critical factor for on-time deliveries and realized budget projections. Streamlined border clearance procedures are in companies’ and governments’ mutual best interests.

President Obama has prioritized a U.S. “single window” process under which companies importing products into the United States from China (or anywhere else) or exporting product from the United States to China (or to anywhere else) will be able to submit nearly all required import/export information on standardized forms. These forms will be accessible to U.S. government agencies through a “single window” computerized system and this will mean that companies will no longer need to complete and file duplicative, multiple forms with different agencies. U.S. government agencies will be able to more efficiently evaluate shipments and work with companies to address issues with particular shipments of goods.

President Obama specified a December 31, 2016 deadline by which U.S. federal agencies must finalize capabilities for using a “single window” system. In addition to the “single window” system, a U.S. federal interagency group has undertaken efforts to evaluate using international classification codes so companies will not need to use multiple identification codes on U.S. import/export documents to reference the same commodity.

Centralization of import and export data under a “single window” system will allow U.S. government agencies to more effectively identify dangerous, prohibited, and non-compliant shipments. It also will better position the United States to better coordinate with other countries to ensure that shipments comply with applicable import or export regulations, applicable duties, and export controls.

Companies involved in shipping goods between China and the United States should seek to stay current on U.S. efforts to implement the “single window” system as doing so will help ensure compliance with all U.S. regulations and cost savings, and as the situation warrants, I will be back with updates.