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Three Keys to Spotting a Fraudulent Chinese Company

Posted in China Business
Use our three factor test for China company investing and you will avoid becoming a stooge.

Use our three factor test for China company investing and you will avoid becoming a stooge.

I often receive calls from U.S. investors in Chinese companies listed on the U.S. stock exchanges. The investors are concerned with questions about the value of their investment and they want me to assist them in analyzing the legal status of the Chinese entity. My response is that the first step is to determine whether or not the Chinese entity is an empty shell. If the Chinese entity is an empty shell, then there is no value in China to protect and further analysis of the company is a waste of time.

I have done this research so many times that I have developed a three step test to determine whether a Chinese company is a fraud. I take a look at the annual or quarterly report of the Chinese company and if it meets these three tests, it is virtually certain to be a complete fraud, with no operations, no assets and no funds in the bank.

The three indicia of fraud are as follows:

1. The company has a large amount of cash in the bank. I often see supposed cash holdings greater than 50% of the company’s annual gross revenues. Interest rates at Chinese banks is very low and legitimate Chinese companies do not usually keeps large amounts of their cash in interest bearing bank accounts. Usually the supposed large cash account is accompanied by bogus explanations explaining why the Chinese entity is unable to repatriate the funds to its investors as dividends. Later investigation usually reveals that these funds were never actually deposited in the bank. That is, these large deposit accounts are simply falsified. The odd thing is that auditors will normally verify that the accounts are real. Once the fraud has been exposed, I have asked auditors what they did to verify the account. They usually state that they relied on reports from the management of the company. In China, the only way to verify the authenticity of a bank account is to arrive at the bank unannounced and look at the computer screen while standing BEHIND the counter as the clerk makes an unplanned query. Virtually no bank in China will allow this, which means that audit verifications of Chinese bank accounts are typically of no value.

2. The company reports profit margins in excess of 30%. I often see fake companies report profit margins of 50%. China is a very difficult country in which to do business and I have never seen a legitimate Chinese company with profit margins even approaching this level, not even state owned monopoly companies. It is certain that Chinese companies located in rural Fujian, Shaansi or Heilongjiang do not generate margins at this level. These high margins are then the explanation for why the company has so much free cash; they are so profitable they are printing money. The claim is that they have some unique product or some technical monopoly. In my experience, these claims are never true, as just a few minutes of careful thought would reveal.

3. The company is formed as a VIE (variable interest entity) when it is operating in a business sector where foreign investment is not restricted and the VIE structure is not required. A VIE is required only when a foreign invested company intends to operate in a restricted sector such as the Internet. This is why Baidu, Sina, and AliBaba are organized as VIEs. But most Chinese business sectors are open to foreign investment. When a company that operates in manufacturing or retail sales chooses to organize as a VIE, there is typically only one reason: the organizers are planning to commit fraud against the foreign investors.

Anyone can perform this three factor analysis of a U.S listed Chinese company in about 30 minutes and ten minutes is usually enough.

Unfortunately, our China lawyers are usually contacted by investors long after this analysis should have been conducted. We are usually called on when the investors begin realizing that something is wrong and the Chinese company has ceased even to pretend and is now no longer returning investor calls. Don’t let this happen to you. If a Chinese company fails to meet the above three factor test, your answer is clear: don’t invest.

China Litigation and Arbitration, Part 3: China Consultants and the Liabilities THEY Face

Posted in China Business, Litigation and Arbitration
China consultants that provide legal advise are taking big gambles

Don’t gamble on China legal advice

Our China lawyers often work with many really experienced and really good China consultants. These consultants are usually really good for the following reasons:

  • They know the ins and outs of what it takes to succeed in doing business in China and with China.
  • They know the ins and outs of how to find good Chinese companies for whatever transaction it is their clients are seeking to do in China because they know how to distinguish between a good company and a bad Chinese company.
  • They know the ins and outs of how to negotiate with Chinese companies.
  • They know when to bring in a China lawyer to assist.

Of course I had to add that last one, but the truth is that just about every China sourcing consultant I know has violated this last one a few times. And — no surprise — it is on this last one of which I am writing.

China consultants too often fall short in the legal aspects of their own business. They have been “doing China” for so long that they seem to lose sight of the fact that when push comes to shove (or as lawyers like to say, when a deep and easy pocket needs to be found) they are the American/British/Canadian/Australian company that may need to answer for what happened. If you are a Western consultant hired by a Western company to assist it in doing any sort of business in or with China, you need to understand that if something goes wrong for your client you will be your client’s first choice for legal redress. Not only is there a good chance that you have the deeper pocket (or at least the easier pocket to reach into) but you will almost certainly be easier to sue for the simple reason that you are likely going to be almost right next door, not on the other side of the earth.

What can go wrong for China consultants that can lead to their incurring liability? And what can you as a China Consultant do to prevent or ameliorate such a problem? Our first advice whenever a company comes to us with concerns about protecting against future liabilities is to engage in corporate structuring to protect company and personal assets. This is an absolutely necessary first step. Looking at securing insurance protections is oftentimes a good second step. Beyond that however, and more specifically to China, you can do a lot to protect your client and thereby protect yourself. See yesterday’s post, China Arbitration and Litigation, Part 2: First Check Your Insurance Policy, on how insurance can be relevant in China litigation and arbitration matters even in situations where you would not expect it to be.

We have lately been seeing a rash of problems with sourcing consultants that assist in finding Chinese manufacturers and this post will focus on those consultants, leaving to future posts the issues our China attorneys are seeing with other sorts of China consultants.

A typical China product sourcing project, might go down as follows:

  1. Western company retains a product sourcing consultant to find the best Chinese widget manufacturer, based on cost, quality, and dependability.
  2. The product sourcing consultant requests and secures a sample widget from a number of Chinese manufacturers, many of which it may have conducted business previously.
  3. The consultant meets with countless Chinese manufacturers in search of the best one.
  4. The consultant recommends company Z in China to manufacture 200 million widgets.
  5. The consultant is to be paid a percentage of the manufacturing costs, oftentimes with that percentage set to decline over time.
  6. Company Z starts manufacturing the widgets.

Now let’s deconstruct this hypothetical project above and note where the consultant has potentially harmed the client and needlessly taken on huge liabilities.

The China consultant agreed to find “the best Chinese widget manufacturer.” Is that the best widget manufacturer in China or the best in the world? What if one Chinese widget manufacturer charges one hundred dollars per widget for 200 million widgets, but your client’s competitor finds another widget manufacturer who will do it for ninety dollars. Is the China consultant liable for the ten dollar difference? Even worse, what if a competitor of the China consultant’s client gets the same Chinese widget manufacturer to manufacture its widgets for ten dollars less? Will a U.S. jury believe the China consultant was doing its best on pricing when its fee ended up being larger because the Chinese manufacturer was able to charge more? Is the China consultant responsible for the Chinese manufacturer’s late deliveries? Is the China consultant responsible for the Chinese manufacturer’s bad product? Whose fault is it if 100 people are badly injured due to the widgets being defective? Is it clear exactly on what the China consultant’s percentage is based? Is there anything to prevent the China consultant’s client from entering into a new deal with the China manufacturer the China consultant found and negotiated the manufacturing arrangement?

If you take a product sample to China and start showing it to potential manufacturers without having FIRST put various intellectual property safeguards in place, you are courting disaster. Your sample could be used for counterfeiting and the trademark on the sample (or your client’s name) could also be stolen. In November, I wrote an article for Forbes Magazine, Why Your NDA Does Not Work For China, explaining why a Western-style NDA is usually worthless in these situations. That article alone got me two calls from panicking China consultants in a panic asking whether they could be held liable if their client’s lose their IP to China. My answer was that would likely depend on the contract they have with their clients and the role they play for their clients. The long silences I got in response to this led me to believe that neither had anything in writing with their clients and that both had touted their companies as a complete China solution for their clients.

And that right there is the big trap into which China consultants too often fall. In trying to secure clients they encourage their clients to believe that they are experts on everything China and that is what often can come back to bite them.

Just last week I received emails from two different China consultants regarding extremely complicated and potentially major intellectual property issues faced by their clients. In both cases, I explained very generally the issues their clients would likely be facing and in both cases the consultant wrote me back to tell me how they would be handling the situation in the short term. And in both cases the consultant’s planned advice would not have been appropriate. So I wrote back something like the following:

This is incredibly complicated and what you just said below is not good advice at all. My advice to you would be to stay completely away from ALL of the legal issues and let your client deal with all of these issues itself. They should not expect you to be giving any legal advice and your doing so just increases the odds of your being blamed when things go wrong and of being sued and losing on the same grounds.

And that is the point. As a consultant it rarely behooves you to get in the middle of your client’s complicated China legal issues and they should not expect that of you. Even if you as their China consultant caused your client’s complicated China legal issues, your trying to solve them will more often than not simply compound them.

So what is the solution for China consultants? A written contract between your consulting company and your client before you start work. This contract should make clear exactly what it is that your consulting company will be doing and that these enumerated items will be its only responsibilities.

The problem we consistently see, however, is that product sourcing consultants usually oversee their clients’ OEM agreements with the Chinese manufacturers and by doing so, they subject themselves to major liability issues if that contract is not up to snuff — and it virtually never is.

If your company is selling itself as the “China people” or the “China experts” and your clients are counting on your company to guide it through China’s business minefields, then your company will be expected to know anything and everything about what it takes to do business in China. And if something goes wrong in China, a Western court will likely expect you as the China expert to have been the one to have known better. For example, if your client loses its IP in China because it believed that its US or Canada or Australian or EU patents and trademarks extended to China (they don’t), you as their China consultant may find yourself on the hook for not having warned them otherwise.

Bottom Line: At minimum, China consultants should put in writing with their clients that they do not provide legal advice and that their clients should retain their own lawyers for that. And that stick by that and refuse to provide any such advice.

China consultant, protect thyself.

China Arbitration and Litigation, Part 2: First Check Your Insurance Policy

Posted in China Business, Legal News, Litigation and Arbitration
Looking at being a plaintiff or a defendant in an international litigation or arbitration matter? Check your insurance policy

Facing international litigation or arbitration? Check your insurance policy.  (http://bit.ly/1MbAr8b)

If I were to list out the most common litigation-inducing problems our China lawyers have seen in the last few years, that list would consist of the following:

  1. Bad product received from a China manufacturer
  2. Late product received from a China manufacturer
  3. No product received from a China manufacturer
  4. An investment into a China company or project that never existed
  5. The China Bank switch scam
  6. IP theft (trademark, copyright, patent or trade secret)
  7. Failure to get paid by a Chinese company
  8. The reverse of some of the above. In other words the American/European/Australian company is being accused of having provided bad product, failing to pay, or having engaged in fraud or IP theft.

Because litigating and arbitrating against Chinese companies is rife with so many issues specific to China and to Chinese companies, we have begun an indefinite series on China Litigation and Arbitration. If you have any questions regarding litigating or arbitrating against Chinese companies, please leave them as a comment below or please email us and we will try to incorporate answers in future posts within this dispute resolution series. Part 1 of this series, China Litigation and Arbitration: What we are seeing, provides a very general overview of current trends in China litigation and China arbitration.

The first thing my firm’s international litigators usually do when they get an international litigation or international arbitration matter involving one of the above (or really any international arbitration or international litigation matter) is ask for a copy of our client’s insurance policies. After reviewing the policies, we typically predict one of following three results, fairly evenly spread out:

  1. The insurance company(s) likely will pay our client the full amount of coverage (or close to it) without much dispute.
  2. The insurance company(s) may or may not pay our client the full amount of coverage without much dispute, but if there is a dispute, it will likely be worth our client fighting over coverage because it is likely to secure full coverage or at least enough to warrant the fight.
  3. The insurance company(s) is not likely to provide any coverage (beyond maybe a very minimal amount) and it probably will not be worth it to our client to spend much money or time litigating the insurance coverage.

But here is the important thing: the insurance policies we see are all over the map on just about everything.

By way of one example, many policies have almost afterthought provisions on cyberfraud or computer hacking. The main part of the insurance policy may clearly provide that there will be no coverage for fraud, and yet there will be a provision stating that the policy will cover “computer fraud” up to x dollars per incident. The x dollars is overtimes a very small amount, but because the law is unclear both as to what constitutes “computer fraud” and as to what constitutes an incident, we have used this provision to drive a truck through on behalf of companies we represent on China bank switch scam cases. We argue that because the fraud was induced via a hacked email, it comes within the coverage exceptions provided for either (or both) cyberfraud and computer hacking. We then argue that each payment made by our client (and oftentimes in these fake bank frauds there have been multiple payments) constitutes a separate incident. Let’s just say that insurance companies usually prefer settling to litigating a case that might establish new and unfavorable law on one of their own policies. This is especially true in the more friendly policyholder states.

I wrote on this previously in Cheated By China. Check Your Insurance:

This insurance coverage lawyer told me that he is building up a cottage industry representing companies that have been hit with this scam. He said that he alone has taken on about a half dozen of these matters in just the last six months. And if he has taken on about a half dozen of these, that almost certainly means that he has reviewed about a dozen. What he is doing is going to the insurance company of the company that has been scammed and demanding it reimburse his client for the money his client lost. This lawyer tells me that the insurance company’s initial reaction is to essentially call his client an idiot, but as I pointed out, even if true (and I vehemently deny that it is), I have yet to see an insurance policy with an “idiot exclusion.” This lawyer then convinces the insurance company that what happened is plain and simple employee negligence and that the insurance company must provide coverage.

The same can hold true for companies that order a product from China that never comes. There is a an argument to be made that this is fraud and that this is theft and since many policies provide some coverage for fraud and many provide a lot of coverage for theft, it usually behooves us to make an insurance claim on behalf of those companies that ordered product from China and never got anything but a runaround. The same holds true for companies that send product to China or provide a service for a Chinese company and never get paid. They can argue that they are victims of a fraud or a theft. These are not simple arguments, however, as they usually involve inherently inconsistent provisions within the insurance policy contract. An insurance policy may provide coverage for theft on the one hand while excluding breach of contract damages on the other.

Some general business insurance policies — typically called a Commercial General Liability (CGL) insurance policy — may provide a little (or even sometimes a lot) of coverage if your intellectual property (be it your trademark, your patent, your copyright or even your trade secret) gets stolen in China or anywhere else. Beyond that some companies purchase IP protection policies that provide specific protection against IP theft. More common is to have advertising coverage in your standard business insurance policy that will oftentimes provide you with insurance coverage in a dispute involving allegations that you are using someone else’s intellectual property.

Bottom Line: Massive books have been written on insurance coverage. Indeed, massive books have been written on insurance coverage for specific losses like fraud or intellectual property theft. So there is no way a blog post can do anything but touch on the issues. And that is the point of this post. Just to put into your head that you have been paying insurance premiums for years just so that it will be there when you suffer a loss or get sued. So next time you are looking at litigating or arbitrating against a Chinese company or your company is facing a lawsuit or an arbitration for something it is alleged to have done in China or involving China, have your lawyer check your insurance policy for coverage. Because unless you have that done, you just never know.

China Litigation and Arbitration: What we are seeing

Posted in Legal News
The above always holds true, but sometimes litigating or arbitrating is the best option.

But sometimes litigating/arbitrating IS your best option.

Had a nice conversation yesterday with a bunch of my firm’s China lawyers and litigators, mostly on what is causing the increase in litigation and arbitration against Chinese companies and about some of the pitfalls peculiar to suing Chinese companies. The impetus for this discussion was my having signed on to speak (twice) about how to avoid litigation against Chinese and how to deal with litigation and arbitration against Chinese companies if it occurs.

Because litigating and arbitrating against Chinese companies is rife with so many issues specific to China and to Chinese companies, I am going to make this the first post in an indefinite series on China Litigation and Arbitration. If you have any questions regarding litigating or arbitrating against Chinese companies, please leave them as a comment below or please email us and we will try to incorporate answers in future posts within this dispute resolution series.

My first litigation related talk is going to be at the Los Angeles Athletic Club (in Los Angeles) on February 25 at 3:15 and though entitled, Manufacturing in China/Asia: Keep Your Eyes Wide Open, its focus is going to be almost exclusively on preventing and handling litigation with Chinese companies. Its “official” bullet points are as follows:

  • How to source products from China and other emerging Asian economies
  • How to source products so as to avoid product liability lawsuits
  • How to prevail in litigation against your Asian manufacturer
  • Cross-claiming against your Asian manufacturer

Immediately following my speech I will be participating on a stellar panel discussing “Claims and Coverage Involving Foreign Products.” For more information regarding this seminar, go here. And to secure a really good discount to this event, please contact me at my firm directly. My next China litigation talk will be in Chicago in May and I will provide more information on that shortly.

In the meantime though, back to why we are seeing such a rapid increase in litigation and arbitration involving Chinese companies. Why is this occurring? We see two obvious reasons for this increase. First, the mere fact that the relationship between so many US and Chinese companies has become more mature. Ten years ago, Chinese companies didn’t want to rock the boat by suing American and European companies and American and European companies believed (generally rightly) that many of their Chinese counterparts did not have sufficient assets to pay any judgment anyway. On top of this, the contracts between the Chinese companies and their Western counterparts were so often so poorly drafted as to make prevailing on a lawsuit a crapshoot.

In the last few years, however, as both Western and Chinese companies want good international contracts to protect themselves, the risks of litigating (though always present) have declined. On top of this, many Chinese companies have become more financially stable and some of them now even have assets outside China.

The second reason for the recent uptick in litigation and arbitration involving Chinese companies is the economic downturn in China. Companies that are making money hand over fist on their core business often view litigating or arbitrating as a time-sucking nuisance that can impede their growth trajectory. But companies with economic problems are often more open to pursuing new ways (like litigation and arbitration) to acquire funds.

Quick Question Friday, China Law Answers, Part XII

Posted in Basics of China Business Law, China Business, Legal News
How can I get my money out of China without paying taxes on it?

How can I get my money out of China without paying taxes on it?

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

The following question tends to come to us by phone and is never from our existing clients:

Question: I have _____ dollars of cash in my apartment in China. Can you tell me how to get it to the United States/Canada/Australia/Europe without having to pay taxes on it?

Answer: No.

Come on. Did you really think that a lawyer is going to engage in criminal tax fraud with you. What is amazing about these callers is that at least half the time after one of our China lawyers makes clear that we are not going to help them, they tell us of their plan and ask what we think of it. Our response is that is illegal and you could end up in jail either in China or in the country in which you live (for bringing money into a country multiple times to try to get around the incoming country’s money reporting laws)  if you try that.

Usually their plan consists of taking the money back to their home country in chunks just small enough to avoid the money reporting laws of their home country. Sometimes the plan involves taking the money to Hong Kong. Sometimes it involves giving the money to someone shady to take it out for them and put it in a bank account in some other country and sometimes (but we also get plenty of calls from people wanting to sue when the courier keeps all of the money) the courier actually returns some small portion of the money.

Our advice: pay your taxes as you go along and then taking out your money out of China ought to be relatively easy, at least until recently. See Getting Money Out of China: What The Heck is Happening?

 

Copyright Takedowns in China, Part IV: Whatever you do, register your copyrights first

Posted in Basics of China Business Law, China Film Industry
This definitely holds true for China copyrights takedowns.

This definitely holds true for China copyright takedowns.

 

This is the fourth in a series about online copyright takedowns. Copyright Takedowns in China was a general summary of the regulations that establish the takedown procedures. These regulations enable enforcement of the “right of communication through an information network” as it applies to sound recordings and audiovisual recordings. Copyright Takedowns in China Part II: Searching, Linking or Storing? looked at how providers of storage space encounter more liabilities than those merely providing searching or linking services. The application of the takedown regulations to cloud service providers was covered in Copyright Takedowns in China Part III: Audiovisual and Sound Recordings in the Cloud.

Our China lawyers are handling more and more takedown work these days and one thing is very clear: if you ever expect to have infringing content taken down the single most important thing you should do is register your copyright in China in advance. The reason for this is simple. If you attempt to invoke China’s notice and takedown system the internet service provider will put you to proof. If you don’t have a Chinese copyright registration certificate ready to go you will need to prove your copyright ownership. Though Chinese network service providers all have their own requirements for this, all of them will require you to provide a bunch of chain of title documents that have been translated into Chinese. These documents will be essentially the same as those required to obtain a registration anyway. Once you have proven your ownership to a network service provider, you will have nothing to show for all the work, except, we would hope, the taking down of the infringing content in one instance. You will need to repeat the exercise again and again if numerous sites are involved or if your content goes back up again on a site from which it was taken down.

So speed up the takedown process, and have something to show for your work, by registering your copyrights in China. If you have your chain of title ducks in a row it will be quick and inexpensive to get a registration. You will then be ready to strike.

China Law Blog Commenting Policies

Posted in Recommended Reading
Nothing is written in stone.

            Rule No. 1. Nothing is written in stone.

Not sure why, but we have gotten a rash of questions lately from readers wanting to know our policy on comments. Let me start by saying that we do not really have a formal policy and that much depends on who is monitoring the comments on any particular day. I guess if I had to sum it up, we strive not to be arbitrary and capricious.

But if we were to be forced to analyze our commenting policies in writing, I suspect it would look a lot like the below (in parts borrowed heavily from multiple other sites):

We strongly encourage you to comment on our posts as we very much want to be an open forum for discussion and debate. We do expect you to keep the discussion civil and we generally do enforce the following basic rules.

  1. No hate speech.
  2. No selling anything.
  3. No spam. 99 times out of 100, if you give a “selling link” we will delete it even if we keep the rest of your comment.
  4. No slamming anyone by name unless for something someone said. In other words, if you say that so and so owes you $50,000 and is a deadbeat, we delete it. If you say that such and such Chinese company gave you bad product, we delete that. We just don’t think it fair to allow one side in a dispute to provide their facts on our blog.
  5. There are a few people we find so terminally obnoxious or dishonest that we have banned them permanently for this reason and when they post comments under fake names (yes we can usually tell) we delete those also, oftentimes just because we feel like it.
  6. We sometimes (and trust us when we say we hate this) will “modify” or even delete a comment if we believe it could lead us being taken down in a particular country (one guess) that does that from time to time with websites it does not like. This is very rarely done, but sadly, it is every once in a while necessary. Our view is that it is more important to keep that channel open than to have it be closed and we have heard from a large number of people, especially Chinese lawyers who have expressed this same opinion about our blog to us.

We never delete a comment just because we disagree with it or do not like it. Dissenting opinions are not only welcome, they are very much appreciated as they enliven the discussion. It pains us at times to post comments when we know the advice given in them is wrong, but we post those as well, both here and on our China Law Blog Linkedin Group (please consider joining as it’s great!). We long ago decided that our readers are adults capable of making their own decisions.

As you have no doubt noticed, we utilize Disqus for our commenting system and we do this for the following reasons:

  1. It just works. It makes discussions easy to follow and to share.
  2. It puts Disqus in charge of maintaining user information.
  3. Disqus has a good spam filter.

We hold ALL comments for moderation and so there is no need for you to post your comments twice (or eight times either) and unless it has been longer than 24 hours since you posted your comment, there is also no need for you to write us accusing us of having censored your comment. We review all comments before they go live and we generally do this only 1-3 times per day. the comments two or three times per day. What this means is your comment might sit for a couple hours before I can review it. Your patience is appreciated.

We seldom comment ourselves or respond to individual comments simply because we don’t have the time. We also think it best to let our readers control the discussion.

Above all else, please always feel free to contact us with any concerns or suggestions.

China Employment Laws: Dealing With Pregnant and Nursing Employees

Posted in Basics of China Business Law, Legal News

 

China Employment laws Now that China has amended its Law on Population and Family Planning, it is a good time to review how China’s employment laws treat pregnant and nursing employees. As I wrote previously, Chinese labor law generally takes a pro-employee position regarding such employees.

The first thing you as an employer in China must keep in mind when dealing with a pregnant or nursing employee is that you are prohibited from unilaterally such an employee without cause. This means you cannot terminate the employee by giving thirty days written notice or by paying an additional one month of the employee’s salary even if you could ordinarily have done so under the permissible grounds for unilateral termination, nor can you terminate the labor contract of the employee by initiating a mass layoff.

This, however, does not mean you are absolutely prohibited from terminating a pregnant or nursing employee. Termination is still possible under one of the following circumstances:

  • The employee does not satisfy the conditions for employment during the probation period.
  • The employee materially breaches the employer’s rules and regulations.
  • The employee commits a serious dereliction of duty or practices graft, causing substantial damage to the employer.
  • The employee has established an employment relationship with another employer that materially impacts completion of her tasks with her existing employer, or she refuses to terminate her employment relationship with the other employer after being required to do so by her existing employer.
  • The employee uses deception or coercion, or takes advantage of the employer’s difficulties, to cause the employer to conclude the labor contract, or to make an amendment thereto, that is contrary to the employer’s true intent.
  • The employee has criminal liability imposed against her.

In addition to the above, the employer may also terminate the labor contract by reaching a settlement agreement with the employee. It could get messy if the employee claimed she did not know about her pregnancy until after her labor contract was terminated. The employee might go back to the employer seeking to revoke her earlier decision because it was made due to a “serious misunderstanding.” Unfortunately, for China employers, the court decisions on this issue are contradictory, with some holding against employers (and reinstating the employee’s positions) and some holding in favor of them.

Moreover, Chinese employment law requires that when the term of a labor contract with an employee expires while the employee is pregnant, the contract must be extended until the employee is done nursing. Consider this question: what if a pregnant or nursing employees refuses to enter into a new written contract after her existing one has expired? Can the employer end its relationship with that employee?  The answer is somewhat unclear. Some Chinese courts have held that an employer that acted in good faith and the employee refused to sign the contract without justification, the employer has the right to end the labor relationship. But a second view insists on strictly applying the Labor Contract Law and requiring the labor contract be extended even if the pregnant or nursing employee refuses to execute a written labor contract with the employer. The employer should proceed with caution, because letting an employee continue working after the initial labor contract expires may lead to employer penalty (for not having a written labor contract with the employee).

Bottom line: If you are an employer in China, start studying China’s laws on pregnant and nursing employees so that you know them before you need them.

Chops For China, Sorry But No

Posted in Basics of China Business Law, Legal News

 

Don't ask a lawyer to shut your barn door after all the animals have left.

Don’t ask a lawyer to shut your barn door after all the animals have left.

 

One of our China lawyers attended a Continuing Legal Education Seminar (CLE) last week to pick up needed credits before the bar fines start setting in. The seminar was on Law Firm Management for the 21st Century (or something like that) and one of the things discussed there was how it is our job as lawyers to discern what it is our clients actually need and then instruct them on that. In other words, clients oftentimes think they need A when in reality they need B.

This is all so true. And in deleting old emails this past weekend, I came across countless examples where this was the case, but my favorite ones are always those where someone writes us (and I apologize in advance for making this post so heavy with bad analogies but I’m in the Midwest United States right now and that just always seems to get me in an analogy mood) very calmly and knowingly asking us for a band-aid without realizing that they have already lost both arms and legs.

The below is a composite of a couple of those, with the email from the potential client and my dream response:

We’re an Australian company and we’ve just been asked by a vendor in China to provide our chop to be added to our contract. Is this something you can help us acquire?

Thanks

My responses (modified slightly for blog purposes) were essentially as follows:

Sorry but no and the reason for saying no is somewhat complicated, but I feel compelled to explain.

Asking us as a law firm for help in getting a chop is the equivalent of giving us a twenty-page contract and asking us to sign it without looking at it. If we sign it (or give you the chop) our law firm is tied in with the contract and no law firm would permit that. No exaggeration, but nearly all of the contracts we see between American companies and Chinese companies do not protect the American company at all. This is because these contracts were either drafted by the Chinese side, which knows exactly how to draft a contracts that leave their US counter-parties out in the cold, or by an American lawyer unfamiliar with Chinese law. For just one example of where domestic lawyers so often go badly wrong on these contracts, check out number two in this post on China mistakes to avoid.

If you want a non-legal analogy, think shutting the barn door after all of the animals have left.

I gave a quick look at your website and I see that you provide services. This is a particularly risky arena for us because service companies are constantly not getting paid by the Chinese companies for which they perform the service, either because the Chinese company chooses not to pay or because (and this is happening constantly these days) the Bank of China itself chooses not to pay. For more on both of these things, I urge you to read the following:

Without knowing what you have done so far, I cannot give you any specific advice beyond that you take real stock of where you are right now as compared to where you should be.

Bottom Line: Don’t wait until the last minute to reach out to a lawyer for help.

 

China Tax Audits: The Day The Music Died

Posted in China Business, Legal News

The China times they are a-changin

Come gather ’round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone
If your time to you is worth savin’
Then you better start swimmin’
or you’ll sink like a stone
For the times they are a-changin’

Things are changing for foreign companies doing business in China.

A lot.

Take taxes. Yes, we are always writing about how China has begun cracking down on foreign companies that have China-based employees without a China company (see this Forbes Magazine article, China’s Tax Authorities Want You) and also how China has caught the transfer pricing bug (see this Forbes Magazine article, China’s Tax Authorities Want You, Part 2). But what I am talking about below is different than these two things.

Very different.

Please forgive me for having to be less than direct in this post but those who are familiar with China’s Internet, more particularly, with how it can sometimes be difficult to stay “on the air” on China’s Internet ought to fully understand.

What has been happening of late is really interesting and until I spoke with a leading China reporter who is doing a story on something similar, I did not understand what was happening. I will explain by first telling you what exactly it is that we have been seeing.

Over the last ten years our China lawyers have received probably tens of thousands of calls and emails from foreign companies (mostly North American, European and Australian) companies doing business in China. During these ten years, we have seen many changes in China, some of which come and go and then return again. The closing down of foreign businesses in China for not having a WFOE is one of those (btw, this one is back with a vengeance and we will be writing on that very shortly). But this one is brand new for us I am pretty sure. This one is something we have received five calls on in the last three months or so and I do not recall us ever having received such a call in the previous ten years. Here is the situation prompting the call:

Foreign company operating “legally” in China, or at least legally to the extent that it has a WFOE there, calls us because it is in the midst of a China tax audit. Now to set the stage here, we are a law firm that focuses on helping foreign companies navigate Chinese legal issues; we are not an accounting firm. So when we get China tax calls, they are usually not for help with the basics, but rather when someone realizes that they are in serious legal trouble in China arising usually from a Chinese government accusation regarding a failure to pay taxes. Here is a composite of the recent calls we have been getting:

I am at home in [fill in the blank here with an English language speaking country] and I am not sure whether to go back to China. My company is in the middle of being audited and we are being questioned regarding fake Fapiao. My accountant convinced me that everyone in China uses fake Fapiao and I went along with this. What should I do.

Now a bit more stage setting. In every single instance of the above (but one), the company calling us has never spoken with anyone in our law firm previously, much less retained us as their China attorneys. No, they are calling us totally out of the blue. IN the one case where we spoke previously, I had in my notes that this person “chose not to use us because I made very clear we would not be willing to cut legal corners.” Now to be fair to the recent callers, about half said that they didn’t know that their WFOE had been using fake Fapiaos. And to be fair to the “accountants” mentioned in the call, my pressing in every case revealed that what the callers were talking about was someone more on the level of a bookkeeper in their own company.

Let’s talk for a minute about fake Fapiaos. At their most basic, a Fapiao is an official receipt that allows a Chinese company, such as a WFOE, to take a deduction for an expense. Fake Fapiaos are rampant in China and it is true that a number of companies use them to reduce the amount they need to pay in China taxes. The below comment (left on our blog post, On Being a China Lawyer and on Doing Business in China) describes the prevalence of this practice:

Great interview. You said, “Americans need to start realizing that what American companies got away with five years ago, that era is no more. And the things Chinese companies down the street are getting away with? Well, you’re not a Chinese company.” My consulting company works hard to operate legally in China and we end up paying a lot of taxes. Periodically our our Chinese accounting firm warns us that we will be making a profit and should turn in more FaPiaos (official receipts) or else be taxed. Our General Manager, who is Chinese, tells me that most companies (>80%) try to not show profits in China and practice illegal accounting tactics and bribes to get around paying taxes. It can really bother me at times but it is a reality we must accept. I am comforted at the end of the day knowing that whatever other companies might do, I can sleep with a clear conscience and can stand behind our accounting practices.

Okay, but now, all of a sudden, foreign company after foreign company is being hit with the reality of Chinese tax authorities being unwilling to look the other way. Why is this happening? I think it is because the Chinese tax authorities that might in the past have been happy to look the other way in return for receipt of their own rewards (perhaps from the so-called “accountants” who had allegedly advocated for using fake Fapiaos) have recalculated the risk to reward ratio of doing so and have chosen to fly straight. In other words, what was okay (for a price) in the recent past is no longer okay now.

Like I said, things are really changing in China. But you tell us, are you seeing these things too?