China Cybersecurity law
China’s new Cybersecurity Law becomes effective on June 1
China’s new Cybersecurity Law will become effective on June 1, 2017. In addition to focusing on cybersecurity, the law also details how companies are to handle personal information and data. In determining what is allowed and not allowed for handling personal information in China, it is important to examine The Decision on Strengthening Information Protection on Networks (2012), The Guidelines for Personal Information Protection Within Public and Commercial Services Information Systems (2013), and The Provisions on Protecting the Personal Information of Telecommunications and InternetUsers (2013). There are also many industry-specific rules, including such rules for banking and credit information services. China’s new Cybersecurity Law adopts and modifies existing regulations and codifies them.

Under the new Cybersecurity Law, collecting any user’s personal information requires the user’s consent and network operators must keep collected information strictly confidential. Personal information is defined as information that can be used on its own or with other information to determine the identity of a natural person, including the person’s name, date of birth, ID card number, biological identification information (e.g. fingerprints and irises), address, and telephone number. Once such information has been de-identified, it is no longer subject to the requirement for personal information under the law.

According to the new Cybersecurity Law, network operators are subject to the following requirements when collecting and using personal information:

  • Collection and use of personal information must be legal, proper and necessary.
  • Network operators must clearly state the purpose, method, and scope of collection and use, and obtain consent from the person whose personal information is to be collected; personal information irrelevant to the service provided shall not be collected.
  • Network operators shall not disclose, alter, or destroy collected personal information; without the consent of the person from whom the information was gathered, such information shall not be provided to others.
  • In the event of a data breach or a likely data breach, network operators must take remedial actions, promptly inform users, and report to the competent government agencies according to relevant regulations.
  • In case of an illegal or unauthorized collection and use of personal information, a person is entitled to ask a network operator to delete such personal information; when information collected is wrong, an individual can request correction.

Who are the network operators to which the new law will apply? Owners of networks, administrators of networks, and network service providers. Telecom and Internet service providers, clearly, but “network” is broad enough to go well beyond that.

Networks are systems consisting of computers or other data terminal equipment and relevant devices that collect, store, transmit, exchange, and process information according to certain rules and procedures (Article 76 of the new Cybersecurity Law). If you have a couple of computers at home that can share files, and perhaps a printer connected to them, you technically have a network. The law is not likely to go that far, but the generic definitions of network and network operators leave a lot of room for interpretation, which is exactly how the Chinese government wants it.

The new Cybersecurity Law also requires critical information infrastructure operators (CIIOs) store within China personal information and important data gathered and generated within China and conduct annual security risk assessments regarding their data. Though the definition of CIIO is yet to be clarified, we already know China’s yet to be finalized Measures for Security Assessment of Personal Information and Important Data Leaving the Country will likely require foreign companies doing business in China make big changes in how they handle data. The Cyberspace Administration of China (CAC) published a draft of Measures for Security Assessment of Personal Information and Important Data Leaving the Country back in April, raising many concerns for foreign businesses operating in China.

These Measures for Security Assessment would expand the data localization requirement to all network operators. This would mean that pretty much all personal information and important data collected by network operators within the PRC must be stored within China and not leave China, other than for “genuine business need” and after a security assessment. And if you think you may be a network operator, you probably are.

Since the new Cybersecurity Law does not differentiate between internal and external networks, it is broad enough to include any company that owns an internal network. Will your China WFOE be able to transmit employee information back to its overseas headquarters? In China’s Cybersecurity Law and Employee Personal Information, we set out best practices for doing this, but that was written before publication of the Draft Measures. Should the Draft Measures become effective — as expected — our views on data transfers will almost certainly toughen. Foreign companies are already setting up data centers in China so as to be able to keep data local and many of our clients are looking at doing the same.

We have been reluctant to write much about data and privacy protection in China because existing laws are both unclear and in a massive state of flux. But because this is so important and because this reluctance cannot extend to a client who needs to know what it must do now with specific data, we plan to write more often about these topics in the weeks and months ahead.

Please stay tuned.

Editor’s Note: Sara Xia is an experienced lawyer with law degrees from Shanghai University of Finance and Economics and the University of Washington. Sara practiced law in China from 2010 to 2013 and then in 2015 she became licensed to practice law in California and 2016 in Washington. Sara recently joined Harris Bricken to assist our clients with their cyberlaw and corporate matters, mostly while working out of Seattle, Beijing and San Francisco.

Chinese companies in America

We are constantly writing about American and European companies that do business in China or with China without sufficiently recognizing that China isn’t Frankfurt and Chinese law is not British law and Chinese courts are not American courts. In other words, they may give lip service to the idea that they must operate differently in China than in the West, but they are not truly drinking that Kool-Aid yet.

But compared to Chinese companies coming to America, Western companies in China are the gold standard. The way many (most?) Chinese companies operate overseas give lawyers the shivers and ought to give everyone pause.

The following are just some of what our international lawyers have seen:

  1. Chinese company wanted to retain our lawyers to conduct due diligence on a quite expensive commercial building it was buying in California, but refused to pay our rates or any other law firm’s rates and ended up buying the building without a lawyer. We subsequently learned that the  amount they paid for the building nearly dollar for dollar matched the amount they would need to pay to clean up the environmental problems they apparently unknowingly bought along with the building, which pretty much any first year lawyer would have detected.
  2. We are getting countless American (mostly) employees (from CEOs to COOs to Sales Managers to in-house lawyers) at Chinese companies in the United States contacting us, almost pleading for us to “convince the head office back in China” to hire us. We don’t do that because it pretty much never works and even if it were to work, unwilling clients are not exactly what we want. In many of these cases the American (and sometimes European companies that contact our Barcelona office) employees are being told to use translations of Chinese language contracts for things as varied as employment contracts and sale agreements. Trust me when I tell you that using a Chinese contract in the United States makes about as much sense as using an American contract in China, which is none at all.
  3. The head of HR for the American operations of a Chinese company came to us to have us draft an employee termination/settlement agreement with one of its California employees, but the Beijing home office insisted the HR head (who had lived in the United States for only about five years) draft this without any lawyer help and she did. Two months later, the California employee sued the company alleging (100% rightfully) that the settlement agreement was invalid and seeking the full amount already paid to him to get him to sign the first settlement agreement, and more. The thing is this exact same thing has happened twice.
  4. We were involved in a fairly large lawsuit against a Chinese company’s foreign subsidiary and in an apparent effort to cut costs, one of the higher ups at the American subsidiary started emailing our client and in those emails saying things he never should have been saying. I have never seen an American or a European company go so rogue during litigation and I am convinced that the emails from this employee hurt the other side’s case and enabled our client to achieve a better settlement than we ordinarily would have.

I have plenty more stories, but only the above are old enough and common enough and can be told vaguely enough so as not to reveal anything the least bit secret.

But what spurred me to write this is the following paragraph I recently received from a very experienced and very international executive at a Chinese company’s U.S. subsidiary in response to my telling him that I keep planning to write something about Chinese companies overseas but that I really do not know what to say beyond talking about how they mostly seem to refuse to adapt.

When the Japanese companies came into the U.S. in the 80s, they started off with the same mistakes as we are seeing with Chinese companies. They tried to operate in the U.S. based on Japanese models. It did not work. So what did they do? They organized research teams, figured out the right way to operate, and on the second wave they did very well. The Chinese companies are completely different. When things don’t work for them they blame the foreigners within their own company. They do no research or thinking. They just double down on their failed strategy. So it is not clear what your post would say, other than to say that these Chinese companies are doomed to fail.

What are you seeing out there? Are Chinese companies adapting better to the United States and to Europe outside the legal arena? Are they really any worse than companies from other countries, or is it just a matter of time?

 

China IP lawyerClients often ask us which of their entities should own their IP (patents, trademarks and copyrights) in China. The basic answer is usually simple: whichever entity will be using the IP in China.

There are some perfectly legitimate reasons for wanting to separate the ownership and exploitation of IP rights – reasons related to tax, liability, or corporate structure. But in the vast majority of situations, the only time IP ownership matters in China is when you are trying to enforce your IP rights. Chinese lawyers are expert at creating delay, and they know exactly how to exploit evidentiary gaps. And if you are attempting to bring an enforcement action in China but the plaintiff is not the registered owner of the IP, expect your dispute to take much longer than usual.

The Chinese lawyer on the other side will likely argue that someone who is not the registered owner of the IP cannot bring an action to enforce the IP rights and the mere fact the companies are under common control won’t be sufficient. A properly drafted license agreement might be sufficient – so long as the agreement is written in Chinese, registered with the appropriate authorities in China, enforceable under Chinese law, notarized, and authenticated by the Chinese Embassy, and so long as you do not run into any use issues. See China Trademarks: When (and How) to Prove Use of a Mark in Commerce. You can probably guess how often all of these things are done and done right by American and European companies. Most of the IP license agreements we are asked to review – no matter whether the company that comes to us is a two-person startup or a Fortune 100 company – are in English and governed by the laws of whatever country the plaintiff is in.

You better believe the Chinese lawyer for the Chinese company you sue in China for infringing on your China IP will be questioning each link in the evidentiary chain of your IP and pointing out each potential problem. If you’re lucky, you’ll have the chance to fix each of these problems in time before you sue, but doing so could add weeks or months or years to the process. And meanwhile, the infringing party will be going about their business using “your” IP. It’s death by a thousand (paper) cuts, and it’s a losing game.

Unless you have a really good reason to split ownership and use of your China IP into different entities, just keep it simple and use one company.

China LawyersLast year we did a five part series on the difficulties in getting money out of China. Since that time things have gotten a little better and a lot clearer. They have gotten better in that China seems to have eased off the brakes ever so slightly and they have gotten clearer in that experience has taught us the kinds of deals almost certainly to go through with money sent and those that have no chance, and what fits in between.

Our original post in this series, Getting Money Out of China: It’s Complicated, we wrote on how incredibly frequently Western companies have been needing legal help in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals. On our China Law Blog Facebook Page, I linked over to the original post and described it as “In which we begin to answer THE question everybody is asking.” That has turned out to be no exaggeration as that Facebook post alone has generated nearly 25,000 views. But as I noted in part 2 of this series, most of the interest in getting money out of China involves purchasing single family homes in the United States or in Europe and those deals are just not going to happen legally if they require money from the PRC.

In part 2, we discussed how the Chinese government seems to apply a three part test in determining whether to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. Part 2 focused on legitimacy. Part 3, focused on the “benefit to China” element and Part 4 on what is/was happening in China that is slowly down payments from China. Part 5, focused on increasing your odds of getting paid.

Since our five part series last year the flurry of companies trying to get money out of China to get paid has slowed down, but our having seen a bunch of the deals that failed have taught us the following two very important and not terribly related things:

Draft your contract with the Bank of China and the Chinese Government in mind. Two similar technology licensing deals. One has no Chinese version and talks about software that can be used to maximize retail sales. The other has a Chinese version and talks about how the software can maximize production line efficiencies. The second one has a much better chance of clearing Chinese government approval than the first one. It’s important that you get this right from the get-go because once you don’t, your odds of the money ever leaving have permanently decreased.

Draft your contract based assuming the money you need will never leave China. In other words, your contract should have a provision(s) making clear exactly what will happen if the funds never arrive.

For instance, if you are seeking equity funding for your company, you must not grant the putative Chinese funder equity in your company before you receive the money required. I know this sounds obvious, but trust me when I say that is not always the case. If you allow a Chinese company to get equity in your company before you receive the money, you will likely be facing the untenable situation of needing to sue (perhaps even in China) and argue for stripping the Chinese company of all equity for non-payment. Structure your deal so equity comes only upon payment!

Where we also often see problems is in licensing deals where the American or European company will provide some or all of its technology before receiving payment. As we wrote way back in 2011, in On Licensing your Software to China, this made sense well before China put the clamps on money leaving:

How do you plan to make arrangement for payments? I note that your normal system is 30 days net. In general, this is not a good idea in China the Chinese government has made it progressively more difficult for Chinese entities to convert RMB into dollars for payment to foreign software and service providers. The restrictions come in two forms: 1) unreasonable demands for contract registration and then delays and unreasonable documentation requirements for contract registration, and 2) imposition of withholding and other taxes, often in unreasonable amounts. All of these burdens must be met before the Chinese party is permitted to make payments. The demands and requirements vary from district to district and from bank to bank with no predictable pattern. This process can often delay payments for many months or even years.

Because of the above, it is not usually prudent in China to deliver software product or to provide services until after you have been paid or at least until after you have been paid for a significant amount of your fee. These payment problems are entirely beyond the ability of the Chinese customer to control, so even customers acting in good faith may be in a position where they cannot pay.

For more on why it always makes sense to get paid upfront when licensing your technology to a Chinese company, check out Three Myths of China Technology Transfers

Your Chinese Counter-Party Should Figure out how to get the Money out of China, not you. Our China lawyers are nearly always contacted by the American or the European side for help on getting their Chinese counterparty’s money out of China. This does not make much sense and our response is usually to tell them that my law firm’s role should be to represent the foreign party in overseeing what the Chinese party does to try to free up its own money and if the Chinese party is serious about wanting to get its money out of China, it should hire its own Chinese lawyer in China.  Guess what, if your Chinese counterparty is unwilling to hire and pay for its own lawyer to help it get the money it owes you out of China it must not want to pay you nearly as much as it claims.

China contract templatesI wrote last week on China contract templates in China Contract Templates: the Cons and the Cons. That post essentially stated that China contract templates range from worthless to dangerous. I put that post on Linkedin where it has received the following comments:

  • I could not agree more with your article. I suppose you should have also thrown in the often bragged about claim from business folks, that “hey, they signed our standard contract with no problems!” Great news! Maybe it is unenforceable against the Chinese party so of course they signed it!
  • Templates are easy to come by. They can cost you big, though, in the long run. I have seen a few such cases. Professional guidance is worth the investment!
  • Highlight: Going in-house as a ‘cost saving’ technique rather than because a team has any real China expertise can end up costing firms big time. It’s still surprising how many Western companies recognize China is a big step, but then figure they’ll learn as they go along without any major screw ups.
  • Been doing business in China for a very long-time. You are one of the few people I follow. This is because you consistently provide realistic quality advice. Everything you say about Liquidated Damages is 100% correct. Can’t emphasize this enough. However, it is very tough to get the Chinese side to sign and you must not capitulate on this term. This is coming from experience. I have been talked out of it a couple of times for various reasons and have been burned. Also, agree about diligence. If you are doing any long-term transaction requiring a significant amount of investment, you’d better make sure you know your Chinese partner. Figuring out the true ownership, power structure and financial condition of a Chinese entity can be very difficult. Thanks for the Great Read.

I also received an email from a lawyer friend who chided me for failing to provide specific real world examples of templates used to a company’s detriment. Great point. In Forum Selection Clauses. Do NOT Try These At Home, I talked about how my law firm had “made well over $100,000 the last couple of years fighting over badly written forum selection clauses in international contracts” and in all of those cases, the clients had drafted their own contracts using template provisions on forum selection. And as I stated in that post, “our clients (who consulted us for the first time only after they had signed these agreements and right before they were ready to sue on them) could easily have avoided the entire expense had they only done things right with their forum selection clauses in the first place.” The below are some of their mistakes dealing just with arbitration:

  1. One had a provision calling for arbitration before the Geneva Chamber of Commerce. Problem was that the Geneva Chamber of Commerce did not do international arbitration. In this case, our client had taken a contract my law firm had written for them and made a few changes and simply re-used it on another deal. The contract my firm had written had called for disputes to be resolved before the Arbitration Institute of the Stockholm Chamber of Commerce (at least I think that was what it said), which at that time (and today) was a very common forum for resolving disputes between Russian and American companies. So when my client went off and did an agreement with a Spanish company and the Spanish company refused to have the disputes handled in Stockholm, my client just switched “Geneva” for “Stockholm” and called it a day. Back then, the Geneva Chamber of Commerce did no arbitration. Zero. So when it came time for my client to pursue arbitration my firm’s arbitration lawyers had to conduct massive research to determine how even to commence arbitration before an arbitral body that did not exist. We ended up deciding to file with the Swiss Arbitration Association in Geneva, figuring we could argue that is what the parties meant and that arbitral body would want to keep the case. The opposing side vigorously contested our choice of forum and only many briefs and many dollars later did we prevail.
  2. A company once came to us with its “standard form contract” calling for all disputes arising out of the contract to be resolved by arbitration in the United States. This provision makes good sense sometimes and makes terrible sense other times and in the case they brought us, it made terrible sense and experienced international counsel would have instantly recognized why. Our client’s biggest risk would be non-payment by the company that was buying our client’s products. Korea is one of the best countries in the world to seize a defendant’s assets immediately upon filing your lawsuit, but we were concerned that we would not be able to do so in this instance, because the contract said all disputes needed to be resolved in the United States. When we tried to seize assets in Korea belonging to the opposing party, it made this argument to a Korean court. The Korean court did not buy it, at least not completely, as it allowed us to seize assets in Korea, but it also required us to post a much higher bond than usual for doing so. The other side made the same argument before the U.S. arbitrator, seeking damages from our client for having wrongfully seized its assets in Korea, rather than abiding by the contract that called for all disputes to be resolved via United States arbitration. We eventually prevailed there as well, by arguing that we were just seeking to protect any eventual arbitration award, not seeking to have anyone other than the US arbitrator rule on the merits. But we could have avoided all of this by explicitly putting into the contract the right to seize property as security, anywhere in the world.
  3. Then there is my all time favorite: the company that came to us with an arbitration clause that called for arbitration in South Carolina, in Chinese, under British law. When I talked about how much it would cost to get three Mandarin-speaking arbitrators to South Carolina (assuming the other side doesn’t argue for some other Chinese language) and the need to use two lawyers (one arbitrator and one lawyer fluent in Chinese) and the added costs of researching and arguing British law, they — wisely — chose not to pursue the case. When I asked them how they came up with such a provision they explain that they had taken it from one of their previous agreements. I didn’t say a word, but what I will say now is that a provision like this is a great way to discourage arbitration and sometimes that makes sense, but such a provision is a disaster if you are the one to sue. 

It is not just in arbitration provisions where disasters happen. Many years ago, I had a very large client that made vehicles and it at one point needed to engage in a large vehicle recall due to a defective part. The part had been provided to them by a small local supplier. The client sent me the contract between them and their supplier and it was incredibly unfavorable to me client; it essentially said that the small local supplier could not be held liable no matter how bad the product and my client would have to fund every bit of any recall. I asked my client why it had agreed to such a contract and they told me that they had used it because they thought it was very well written and it came straight from their largest and best and most professional part supplier. I said that the contract was exceedingly well-crafted and that was the problem: it was exceedingly well written to favor the part supplier and since my client was the part buyer, this should have been the last contract it should have ever used as a template for other suppliers. The recall cost my client millions of dollars and the company is no more.

I could go on and on….

 

 

 

China employment law
China employment law — Watch your local regulations

Our China lawyers are always getting a slew of emails from both employees and employers doing business in China. The questions typically involve employees who are questioning their treatment or who want to change jobs or employers who want our quick confirmation of something they are planning with one or more of their employees. We can rarely provide instantaneous answers to their questions. This is because in addition to the complexity of Chinese employment law at the national level, there are seemingly endless legal twists and turns and variations at the local level.

For example, one of our regular blog readers asked “just a few quick questions” about issues related to volunteering for a company that was not his employer. He worked for a U.S. Wholly Foreign-Owned Enterprise (WFOE) and had a residence permit and the following questions:

  • Do I need a certificate or other documentation to allow me to volunteer at the company one day a week?
  • Do I have to ask my current employer for permission to volunteer at another company?
  • If the company decides to start paying me for my work, would that interfere with my relationship with my existing employer?

Though these may seem like straightforward questions, here’s a sampling of the information we would need to gather before being able to provide any meaningful guidance:

  • We’d need to know the name and location of his employer. We would also need to run a conflict check on that company because it would not be good for us to be advising an employee of one of our clients on how to work elsewhere, even if only on a volunteer basis.
  • Since employment laws in China can vary greatly from city to city (sometimes even by district within a city), simply understanding the laws in an unfamiliar city can require extensive research.
  • A key aspect of understanding local laws and regulations is actually discussing them with the appropriate governmental authorities. This is especially true when the written laws are not as clear as they should be, which is quite often the case.
  • The specific contract with the employer would also have to be reviewed in detail. What if it forbids any outside work without written permission? Our giving this employee the okay to volunteer could get him fired.

As you can see, there’s almost no such thing as an easy question when it comes to labor laws in China.

For more on this, check out this Forbes article, China’s Hourly Work Week: Think Locally, explaining how something as seemingly simple as the 40-hour workweek can trip up employers who don’t take the time to learn the ins and outs of local employment laws.

 

China Mexico economicsIn part one of this series, I discussed former Mexican Ambassador to China Jorge Guajardo’s opinion piece on what he saw wrong with the China-Mexico economic relationship. In this, the conclusion, I will present Guajardo’s proposed solution and offer my own advice on how Mexico should deal with China.

Ambassador Guajardo’s analysis of the China-Mexico economic relationship is misguided, but his proposed solution is even worse. Explaining that Mexico should focus on “defending access to the markets we have got, endeavoring to open new ones and fostering the domestic market,” he then calls for “a campaign in the U.S. promoting the benefits of free trade” under the argument that “China is the problem and Mexico is the solution.” Guajardo does not specify the details of such a campaign, other than that it should be carried out “with dollars and cents” by hiring lobbyists in America who will be “clarifying the lies” in order to restore Mexico’s image in the US.

In other words: Mexico should now lecture the U.S. on the benefits of NAFTA and explain why it should be kept in place. Does anyone think this is a good idea? At this point in history, and for a variety of reasons, the U.S. is deeply conflicted about the benefits of globalism. Mexico’s response should not be to double down on free trade, but to craft a strategy that protects Mexico’s interests in the U.S. regardless of what happens with NAFTA. This doesn’t mean rejecting all U.S. deals; it means using the current economic situation as a prod to (1) develop Mexican industries and (2) expand Mexico’s presence in other markets, markets that have been underdeveloped for far too long because NAFTA has made it so easy for Mexican companies to rely on the U.S. market.

Without any solid facts or arguments, Ambassador Guajardo’s article borders on anti-China sentiment and does not offer any constructive advice on how to deal with a country that, whether we like it or not, is here to stay and bound to become one of our major trading partners and investors alongside the U.S.

Accordingly, I would like to offer the following as a corrective to Ambassador Guajardo’s piece:

  • If Mexico is to attract Chinese investment, it must insert Chinese companies into its value chains in a way that transfers technology and know-how and enables local growth. As an initial step, Mexico should stop seeing China as either a factory of cheap goods, a faceless market for products, or a source of deep pockets. The latter point is particularly important now that Beijing is tightening its capitol controls.
  • To compete successfully in China, Mexican companies must internationalize. This means becoming more sophisticated in all respects, and developing the capacity to comply with China’s laws and regulations and its written and unwritten standards. I keep hearing calls for Mexican companies to diversify in light of the potential closure of the U.S. market, but no one seems to be asking whether Mexican companies even have this capability. In my experience, Mexican companies are too used to having an essentially captive market in the U.S. that will buy products regardless of quantity or quality. And they have become accustomed to receiving foreign investment that is specifically and exclusively geared toward making products solely for export – which means these investments aren’t helping to enhance local industries. In this regard, treaty promotion is a necessary part of designing sensible business strategies and the Mexican government needs to do more to raise awareness.
  • If Mexico wants to compete with China in the long run, it should invest in innovation to create value-added products, and not just invest in making processes more efficient and cutting costs. According to a recent article in a major Mexican newspaper, “[d]ue to uncertainty over … Donald Trump’s economic policy, 80 percent of companies in Mexico prefer to compete by reducing costs and streamlining their processes, rather than by innovating.” This means Mexican companies usually engage in downward competition (margin and cost-cutting to attain permanence), instead of upward competition (investing in long-term innovation conducive to growth). As Peter Thiel would say, Mexican companies are failing to “go from zero to one” even in the face of increased American protectionism. As the article pointed out: “There is no lack of money in Mexico; it is not a problem of [lack of] resources, but of ideas.”

I couldn’t agree more. It is for the sake of these new ideas that I also say Mexican business groups should partner with their American counterparts and push our respective governments for a joint response to our mutual China issues. Of course, this would involve knowing how to deal with each other first. Our finding common cause with U.S. companies would provide more far-reaching benefits than attempting to enter new markets in a rush, as a hastily concocted strategy to whatever Trump comes up with next.

Ironically, the China threat (whether real or perceived) might ultimately lead to even greater North American integration. Given the current state of the world, you don’t need to be a geopolitical expert to conclude it better for allies to stick together.

The above is a guest post by Adrián Cisneros Aguilar. Adrián is the founder and CEO of Chevaya (驰亚), an Asia-Pacific internationalisation services company. Adrián has a Doctor of Laws from Shanghai Jiao Tong University and an LL.M. in International and Chinese Law from Wuhan University.

 

En el post anterior, hablé acerca del artículo de opinión escrito por Jorge Guajardo, ex-Embajador de México en China, en el cual señalaba lo que veía mal en la relación ecónomica entre México y China. En este post, concluyo presentando la solución propuesta por el ex-Embajador y ofreciendo mis propias sugerencias acerca de cómo debería México tratar con China.

El análisis de la relación económica bilateral que realiza el ex-Embajador Guajardo está equivocado, pero peor está la solución que propone. Tras explicar que México debería enfocarse en “defender el acceso a los mercados que tenemos, buscar abrir nuevos e impulsar el mercado interno,” llama a “una campaña en Estados Unidos promoviendo las bondades del libre comercio”, que use el argumento de que “…en materia de comercio internacional, China es el problema y México es la solución.” Ahora, Guajardo no especifica el contenido de dicha campaña, fuera de mencionar que ésta debería llevarse a cabo “con pesos y centavos,” contratando despachos de cabilderos y publirrelacionistas que “aclaren las mentiras” para así recuperar la imagen de México en EE.UU.

En otras palabras, para el ex-Embajador, México ahora debería sermonear a EE.UU. sobre los beneficios del TLCAN y explicarle por qué debería permanecer en vigor. ¿Alguien creerá en verdad que ésta es una buena idea? En este momento en la historia, y por razones muy diversas, en EE.UU. se hallan sumamente confundidos acerca de las ventajas de la globalización. La respuesta de México no debería ser, por tanto, insistir en el libre comercio, sino crear una estrategia que proteja sus intereses en EE.UU. independientemente de lo que ocurra con el TLCAN. Y esto no significa rechazar todo negocio con EE.UU., sino utilizar la situación económica actual como un trampolín para (1) desarrollar la industria mexicana en general y (2) expandir la presencia de México hacia otros mercados, mismos que por mucho tiempo se han dejado de lado porque el TLCAN ha hecho muy fácil para las empresas mexicanas depender del mercado estadounidense.

Sin hechos o argumentos sólidos, el artículo de Jorge Guajardo raya en un discurso anti-China y no ofrece ninguna sugerencia constructiva para tratar con un país que, nos guste o no, ha llegado para quedarse y está destinado a ser el principal socio comercial e inversionista de México, junto con EE.UU.

Así pues, me gustaría presentar aquí las siguientes sugerencias, como una rectificación a la opinión del ex-Embajador Guajardo en el artículo que nos ocupa:

  • Si México quiere atraer inversión china, debe insertar a las empresas de ese país en sus cadenas de valor, de forma tal que transfieran tecnología y know-how y posibiliten el crecimiento económico endógeno. Como un primer paso, México debería dejar de ver a China como una fábrica de productos baratos, como un mercado más que recibirá sus productos, o bien, como una fuente de dinero a raudales. Este último punto es particularmente importante ahora que Pekín está endureciendo sus controles sobre la salida de capitales.
  • Para competir en China con éxito, las empresas mexicanas deben internacionalizarse. Esto significa que deben volverse más sofisticadas en todos los aspectos, y desarrollar su capacidad para cumplir, tanto con la legislación china, como con sus estándares escritos y no escritos. Sigo escuchando exhortos a las empresas mexicanas para diversificarse, de cara a un potencial cierre del mercado de EE.UU. Nadie parece preguntarse, sin embargo, si las empresas mexicanas son siquiera capaces de efectuar tal diversificación. En mi experiencia, las empresas mexicanas están demasiado acostumbradas a tener en los Estados Unidos un mercado esencialmente cautivo, que compra sus productos sin importar su cantidad o calidad. Se han acostumbrado, también, a recibir inversión extranjera única y exclusivamente destinada a fabricar productos para exportación-lo que significa que dichas inversiones no ayudan a potenciar las industrias locales. En este sentido, la promoción de tratados internacionales es un elemento necesario para desarrollar estrategias de negocios sensatas y el gobierno mexicano debe hacer más para crear conciencia acerca de sus beneficios.
  • Si México quiere competir con China a largo plazo, debe invertir en investigación y desarrollo para crear productos con valor agregado, en lugar de invertir solamente en optimizar sus procesos y reducir costos. De acuerdo con un artículo publicado recientemente en un periódico de circulación nacional, “[d]ebido a la incertidumbre por la política económica [de]…Donald Trump, el 80 por ciento de las empresas en México prefiere competir reduciendo costos y haciendo más eficientes sus procesos, en vez de innovar.” Esto quiere decir que las empresas mexicanas recurren normalmente a una competencia hacia abajo (recortar márgenes y costos para conseguir permanencia), en lugar de recurrir a una competencia hacia arriba (invertir en innovación y desarrollo a largo plazo, con miras a lograr crecimiento). Como diría Peter Thiel, las empresas mexicanas no están “yendo de cero a uno”, ni siquiera frente a un creciente proteccionismo estadounidense. Como se señalaba en el artículo: “[n]o está faltando dinero en México, no es un problema de recursos, sino de ideas, es lo que está haciendo falta en estos momentos.”

No podría estar más de acuerdo con este último punto. Es por el bien de estas nuevas ideas que también digo que los grupos empresariales mexicanos deberíamos hacer equipo con nuestros homólogos estadounidenses y presionar a nuestros respectivos gobiernos para que den respuesta conjunta a las cuestiones con China que nos afecten mutuamente. Por supuesto, esto implicaría saber primero cómo tratar los unos con los otros. El que hagamos causa común con las empresas de EE.UU. derivaría en beneficios de una trascendencia mayor que los que nos podría traer el intentar entrar a nuevos mercados a la carrera, como producto de una estrategia “sacada de la manga” para lidiar con lo que sea que Trump tenga en reserva para México.

Irónicamente, la amenaza china (real o percibida), podría ser la que lleve a una mayor integración de América del Norte. Dada la situación mundial actual, no necesita uno ser experto en geopolítica para concluir que es mejor, para países aliados, mantenerse unidos.

Esta entrada es una participación invitada de Adrián Cisneros Aguilar, quien es fundador y Director General de Chevaya (驰亚), una empresa de servicios de internacionalización para Asia-Pacífico. Adrián es Doctor en Derecho por la Universidad Jiao Tong de Shanghái y Maestro en Derecho Internacional y Chino por la Universidad de Wuhan.

China WFOE LawyersI was carbon copied on the below email the other day between one of our China lawyers and a client for whom we just started working on forming their WFOE. I am posting the below email because it nicely sets out the basic first pass of information we seek from our clients when forming a WFOE under China’s new WFOE rules, which came out on October 1, 2016. Please note that even this first pass email has been tailored a fair amount to suit the particular circumstances of our client and the city in which it will be doing business. Once we know the district, we will tailor the questions even more.

1. We will need to determine what business the WFOE will conduct in China. From your previous emails, it appears you have the following two alternatives:

a. Business consulting WFOE that will engage in providing basic support services to the U.S. parent of the WFOE.

b. Trading company WFOE that would engage in __________________ in China.

If you are uncertain about which of these options to choose, we will need to work with you to examine the 1.b. option. Please advise and we will work with you on that issue.

2. With respect to registered capital, China no longer has a strict registered capital requirement. What is required is that you provide enough capital to the WFOE to cover its expenses up until such time as the WFOE is fully up and operating and is able to earn enough income to cover its expenses without capital infusions from the parent. So the question on capital is: how much capital do you need?

To determine how much capital is required, you will need to generate:

a. Estimated costs for the first two years of operations.

b. An income statement for the first five years of operations.

You can prepare this financial statements in-house or in consultation with the accountant who will be providing your accounting services in China.

Of course, the financial statements for the WFOE will depend on the type of business you end up choosing for China. Financials for a service WFOE are normally quite simple. Financials for a trading company WFOE are considerably more complex.

3. In connection with 2 above, you will need to identify the sources of income for the WFOE. For a service company WFOE, it is normal for the WFOE to bill the parent for services in accordance with a standard service contract. Capitalization comes first, and then later payments from the parent are treated as service payments which are income to the WFOE. For a trading company WFOE, the income stream depends on the structure of the trading system.

4. It is normal to provide for the shareholder of the WFOE to be the U.S. corporate parent. For you that would be ________. Please therefore provide me with the following information:

a. Registered complete company name.

b. State of formation.

c. Registered address and business address (if different).

d. Copy of most recent information statement submitted to the state of formation (if any).

e. List of directors and officers of the corporation.

f. We are required to report the name of the individual who is the “actually controlling person” of the shareholder corporation. If the chairman of the board is also a shareholder, that person will be the actually controlling person. If not, we will need to designate someone who fits that role.

4. Before we can determine the precise rules for company formation, we need to know the district in which the WFOE will be formed. It is not sufficient to provide [name of China city]. We will need to specify the specific district within __________.

5. You will need to enter into a lease for the WFOE office. The precise lease rules depend on the specific district of formation. In general, however, you can expect the basic rules will require the following:

a. Two year lease.

b. Executed before the WFOE application begins. We will need to provide a formal address for the WFOE as part of the application process.

c. Some districts require the initial tenant to be the U.S. shareholder and some require the tenant be in the name of the WFOE.

d. Premises authorized to be used as an office for a WFOE and that is of sufficient size to accommodate the number of proposed employees.

6. Please state the number of employees for the WFOE for the first three years of operations. Please state the number that will be Chinese citizens and the number that will be foreign nationals. Please also provide job titles and basic salary ranges.

With respect to employees, it is my understanding that some or all of the WFOE employees are individuals who have worked for you in an independent capacity in the past. Do you want to treat their employment as a carry over from past work done, or do you want to start fresh with these persons? By carry over I mean do you want to carry over their past work history for seniority purposes? Since much of Chinese employment law is based on the number of years of employment this is an important issue and we may want to bring on our lead China employment lawyer to discuss all this with you.

7. You will need to determine a Chinese language name for the WFOE. WFOE names are complex because they have 4 components: ABCD. “A” is the location. “B” is the company name. “C” is the type of WFOE, which in your case will be either consulting or trading. D is the type of corporation: Company Limited in this case. What we need you to select at this time is “B”: the descriptive part of the name. You may wish to consult with your Chinese staff on the name. We can assist if required.

Please advise on the above. If you need more information to respond, please let me know.

After I hear back from you on the above, I will provide you with questions that will take us to the next layer of issues relating to the WFOE formation process.

China attorneyIn talking with a China lawyer friend recently, we got to talking about some common mistakes we see foreign companies making in their China deals. Among other things, we talked quite a lot about how foreign companies too often either fail to understand the need to conduct due diligence on their China counter-party, or have no clue about how to do so.

Two of the more common misunderstandings stem from China’s registered capital and personal liability rules and foreign companies oftentimes wrongly believe the following:

  • The amount of a Chinese company’s registered capital is the minimum amount of funds that company has in the bank at any given time.
  • Shareholders of Chinese companies are personally liable for the debts of their company.

Like I said, wrong on both counts.

Nearly all Chinese companies are limited liability entities. And though each Chinese limited liability company is required to initially put up a certain amount in registered capital, that amount very quickly becomes relatively meaningless for determining the company’s financial viability. The amount of a company’s registered capital can, with varying degrees of difficulty, be determined and that number can be at least somewhat helpful in giving you some read on the size of the company with which you are dealing. But once a Chinese company has been capitalized, there is no way to know what will happen or has happened to the capital. Even if all the registered capital was actually put into the business, it may or may not still be there. And even if the Chinese company still has all of its registered capital in a Chinese bank somewhere, the company might owe fifty times that amount in debt.

Shareholders are required to contribute to the company the amount of capital stated in the company’s registered capital and their failure to do that is a crime. However, there is still no way for a creditor to do anything with that in terms of pursuing an action against a shareholder. The limited liability designation in China means what it says and means what it means outside China: except maybe in extreme situations, the shareholders of Chinese companies are not liable for the debts of the Chinese company.

There is no infallible way to determine the credit-worthiness of any company with which you are looking to do a deal, much less one in China. But in China, like just about everywhere else, the best way is to conduct a full-on due diligence review of the company. That due diligence can and should include a review of the company’s registered capital, but that information should be just one small factor in any risk analysis you do on the company.

Be careful out there.

China contract templatesWe are often asked to draft China employment contracts for WFOEs and Joint Ventures. Our first response is to ask the potential client whether their Chinese entity already has a set of Rules and Regulations (sometimes called employer manual or employee handbook). If the answer to that question is yes, our lawyers will use those Rules to determine what should go into the employment contracts.

If the answer is no, our response is to say that we cannot draft the employment contracts standing alone; we need to be retained to draft both the employment contracts and a set of Rules and Regulations (and sometimes more). Our reasoning on this is three-fold. One, nearly all locales in China now require employers to have Rules and Regulations, especially those locales with more than a handful of foreign companies. Two, having an employment contract without any Rules and Regulations is like having a car without an engine; it just doesn’t work. Without such Rules and Regulations you cannot discipline or terminate your employees and you are at great risk of your employment policies and decisions being fodder for employee-employer disputes. The third reason is both more personal and selfish: we do not want our law firm’s name associated with an imminent disaster.

Many times the potential client will respond with something like the following: “In doing our Rules and Regulations, would it be possible to use a standard template to keep costs low?” Our typical response to this is something like the following:

Every time we draft Rules and Regulations, we begin by reviewing our own Rules and Regulations to find the best one to use as a model for what you will be doing in China. This requires we gather up all sorts of facts from you even to be able to figure out which of our existing Rules and Regulations will most closely fit your situation. If you are a factory in Qingdao, do we use the Rules and Regulations we did for a an accounting firm in Qingdao two months ago? Or do we use the Rules and Regulations we did for a factory in Suzhou three months before? Or do we use the Rules and Regulations we did for a factory in Yantai six months prior, since Yantai and Qingdao are in the same province? Actually in this sort of situation we would probably research the relevant laws for factories in Qingdao and probably end up using parts of all three Rules and Regulations to create a new one that will work for a factory in Qingdao today.

An employer’s Rules and Regulations will always vary depending on the type of company, the type of employees, and, usually most importantly, its location. Just by way of an example, the overtime rules are going to vary greatly for a CEO as compared to factory workers and those rules are also going to vary greatly as between Chengdu and Shanghai. We have many Rules and Regulations that can serve as an appropriate starting point but we must first make sure everything in that document is current (the relevant laws and regulations constantly change in China) and fits your location and your exact situation, and then we must modify it in English and in Chinese accordingly.

We get the “template question” a lot on the licensing and manufacturing side too and many times in those situations, the potential client will ask whether it would save them money to have their in-house lawyer or their less-expensive local domestic lawyer draft it first and then have our law firm use that draft contract as our template. Our response to that question is usually something like the following:

We have drafted literally hundreds of China licensing agreements and manufacturing agreements and we do not really use any of them as a “template.” Instead, we spend hours gathering up the facts from our clients and then we figure out which of our many contracts — if any — make sense to use as a model in creating what will essentially be a new contract for you. Our agreements have been specifically drafted for use in China and that means they are dual-language agreements with Chinese as the official language. We draft them under Chinese law and we make sure to draft every provision to benefit you as a foreign company that is licensing its products or services in China or having its products manufactured in China. Our existing contracts are as close to ready as you could possibly find and it makes no sense for you to pay another lawyer who knows nothing about Chinese law to create a brand new English language contract which will not even be close to what makes sense for China. Not only would the money you pay that lawyer go to waste, but my law firm’s fees would soar as well, because instead of our starting with our own Chinese and English contracts as the model (not as a template, and there is a difference), we would start with an English language contract that is not even going to be close to what makes sense for what you are looking to do in China. We would have to revise nearly every provision to make it China-appropriate, and it would take twice as much time as if we just used one of our own previously drafted contracts as the model for yours.

And then there are the requests to buy one of our law firm’s templates, to which our response is always something like the following:

We never sell our templates and that is for multiple reasons. First off, it would be a huge disservice to you because we have literally hundreds of contracts for everything we do and unless you were to first retain us as your lawyers, we would not have any real basis for determining which of these contracts makes sense for you even as a starting point. Our making that determination is itself providing you with legal advice and to do that we would first need to run a conflict check and then onboard you as a client and then work with you in determining the appropriate model contract. And here’s another thing: around half the time when a company thinks it needs a particular contract for what it is doing in China, it actually needs an entirely different one, and we only discover that after gathering up all the relevant facts.

Second, whichever of our contracts we end up giving you will not be right for what you are doing and whatever changes you make to it will only make it even less right. There is a lot more to doing a deal with a Chinese company than simply sending it a contract and getting it to sign it. You first need to do at least basic due diligence to make sure the company you have been negotiating with is the same company signing the agreement and to make sure you have the company’s name and address correct. This is often far more complicated than people think. At least 30 percent of the time the contracting party is actually a Hong Kong or a Taiwan entity and in those cases a PRC contract does not make sense. At least another 30 percent of the time we find irregularities in the company information and we need to investigate further to clarify. And then there are the times we determine there is actually no company at all and the Chinese “company” was actually a complete fraud. See China Fraud Season Starts Early This Year.

And what will you do when (not if) the Chinese company says it agrees with 11 of the 16 provisions you propose in your contract, but it wants you to make specific changes to the other five? You not only won’t know how to make those changes (remember the official version of this contract is in Chinese), you very likely won’t know whether it makes legal or even business sense for you to do so.

Just by way of one example: the contract damages provision is a critically important element of nearly all China contracts. More than anything else it is what will make your Chinese counter-party abide by your agreement. See The Effective China Contract: Liquidated Damages for why this is the case. And yet we never know what to fill in as the amount of contract damages until the very last minute because that amount must be determined on a case to case basis, using all sorts of factors in making the determination. How will you fill in that amount when you do not even know the factors to use in determining it? And even if you had a list of those factors how would you know how to apply them? We could spend a few hours trying to teach you the factors and how to apply them, but in the end your choice of an amount could never be nearly as good as ours because ours is based on decades of experience and thousands of China contracts. See China Contract Damages: More Art Than Science. A bad decision on this alone would weaken or even nullify the value of your even having a contract.

So no, we won’t sell you one of our contracts as some sort of template. The last thing we want is our law firm’s name associated with something we know cannot work.

When I asked one of our China lawyers to review this post before publication, I got the following response:

We don’t use “templates” for our agreements. After a lot of analysis, IF we find what the foreign buyer is trying to do fits into a pattern from a previous transaction, then we will of course use an agreement from a previous transaction as a model. But even in the most basic transactions, what we do is to customize it for the current transaction.

In drafting pretty much any contract for China there are literally dozens of variables that can in turn be combined in a nearly infinite number of configurations. So the final contract from one transaction may have no application to any other transaction. This is why providing a contract from a past transaction will have no benefit to the Western side and would likely only harm it.

As you note, our clients also need at least one of our China lawyers involved in dealing with the Chinese response. Did the Chinese side change the Chinese and not the English as they so often do? Did they redline in a way that the changes to the Chinese portion are even apparent? More important is whether their changes are the normal technical changes that are part of normal business practice (45 days to deliver a product instead of 30 days) or are their changes destructive to the whole approach, such as: “no, you do not own the technology, we do.” Or, “no, we won’t provide any warranty at all.” Or, “no, we own the molds, not you.” I do not see how anyone without a deep understanding of Chinese law and Chinese business could even begin to deal with these sorts things.

In drafting our contracts, we do of course usually pull some language from other contracts, such as confidential information language. However, the core agreement is almost always completely unique to the specific client before us and when we do use prior language, we nearly always revise it to customize it for the specific client and the specific transaction.

From our having written thousands of China agreements we know there are certain issues that need to be resolved pretty much every time. So we work with our clients to identify those issues and then we work them on how they want to deal with those issues and then we put the agreement together to achieve the goals our client has told us it has. Of course, for some of these components we use as a base some of the language that has worked in the past in China. This is the benefit of working with us: we know what works and we know what fails. But the resulting contract in each case is unique.

So in that sense, there is no template. There is just decades of experience in drafting agreements for doing business in China or for doing business with China. This is why whenever someone asks me to send them a “template” agreement I tell them I cannot because I have no way to know which of the nearly infinite number of alternatives they should follow. How will they pick and choose from a dozen options for a relatively simple provision? What is unique about their situation? Will the most common solution we have used in the past even make sense for them? Does it make sense for their industry? Their business? Their product? Their location? What if the law has changed? What if the law changes two days after we start drafting?

I usually propose to each client three options for every important issue and I usually come up with those three from about a dozen possible. Say there are ten critical issues for their contract. Each selection of an option affects all of the other options, often in ways we have previously  encountered. Before the client answers the questions, we don’t know even what structure to use. After they answer the questions, the agreement that meets all their needs does not exist.

It is also true that in-house counsel cannot write an agreement that can serve as a basis for what our client wants us to craft. Our approach to China contracts is based on three supports: 1) Decades of China experience, 2) A deep understanding of the Chinese civil law system and the Chinese court system, 3) A deep understanding of how contracts actually work in China. Any company with an in-house lawyer who combines all three does not need to come to us for a contract and they don’t. It is not helpful to us to have a common law contract [China is a civil law system] based on a highly idealized and impractical American/European practice that has no applicability or use in China.

More succinctly, you get what you pay for.