Archives: China Rep Office

Just updated our research regarding China Representative Office rules relating to employees and note the following.

Q.  How many foreigners can work for the Rep Office? What is the proper term for referring to these employees?

A.  A Rep Office may hire no more than four foreign persons, each of whom is called a representative. These people are hired directly by the Rep Office and are treated as normal employees under China’s employment law system. That is, they are to be hired pursuant to a written contract and their taxes and social benefits must be paid.

 

Q.  If four foreigners work for the rep office, can the rep office directly or indirectly hire any Chinese employees?  If yes, how many?

A.  A Rep Office cannot directly hire any Chinese nationals. It instead must hire Chinese nationals indirectly through a Chinese dispatch company such as FESCO. There is no limit to the number of Chinese nationals who can be hired indirectly.

 

Q.  Can the foreigners work directly for the American home office?

A.  All foreign employees of the Rep Office resident in China must be hired by the Rep Office. They cannot work directly for the American home office.

The Rep Office must appoint a Chief Representative. The Chief Representative is not required to be an employee of the Rep Office and is also not required to reside in China. However, if the Chief Representative is not an employee of the Rep Office it must be an employee of the parent company. It is therefor possible to have a situation where four foreigners work in the Rep Office in China as representatives while a fifth foreigner who works for the parent company is designated as the Chief Representative. That is, the Rep Office has four resident representatives and a fifth, non-resident Chief Representative.

 

Q.  Can the Chinese work directly for the American home office?  Or do they have to work for a third party agency, like FESCO?

A.  No Chinese individual can work directly for a foreign Representative Office. The Chinese nationals must work for a dispatch company under a contract between the dispatch company and the Rep Office.

 

Q.  If the Chinese are the Representatives (let’s say there are only 3 Chinese workers and no foreigners), can they work directly for the US home office? Or do they have to work for a third party agency, like FESCO.

A.  As noted above, all Chinese nationals must be indirectly employed under a dispatch agreement with a Chinese dispatch company such as FESCO. They cannot work directly for the foreign parent of the Rep Office. In addition, the dispatch agreement must be between the Rep Office and the dispatch company.

 

It is important to note that the Rep Office needs a good contract with Chinese dispatch company and also must make sure that the Chinese dispatch company has an agreement with the Chinese workers that protects the foreign company.  Just by way of example, if the foreign company wishes to protect its trade secrets, it should make sure that the employment agreement between the Chinese workers and the Chinese dispatch company mandates that the employees not reveal trade secrets of the foreign company.

Just received an email from a friend stating/asking the following (note that I have changed some elements of the email to strip it of any even potentially identifying information):

I am heading off again to work for a few years at our China Rep Office.  My new employment contract with the head office says that [foreign country] law will apply.  Will it?  And what if there is a conflict between [the foreign country] law and China’s laws, which will control?

We get this question far too frequently and we have seen way too many employment contracts written as though U.S. law (it was actually not a U.S. company in the above instance) applies all around the world. The reality is that if you are working for a Chinese company in China (be it a Rep Office, a WFOE, a JV, or whatever), Chinese law is going to apply to your employment relationship.  I know of no country that would allow otherwise.  I mean, imagine if a United States subsidiary of a Pakistani company were to claim in a U.S. court that it should not be required to pay overtime because their contract with the employee calls for Pakistani law and Pakistani law does not provide for that, or that it can discriminate against women because there is no such law prohibiting that in Pakistan?  Even if the employee at issue were a Pakistani citizen, there is absolutely no way in the world a U.S. court would go along with any of those arguments.  In fact, the argument is so bizarre I am not even aware of anyone ever having made it.

Any employer-employee relationship between a Chinese company and an employee working in China is going to be governed by China law, no matter what the contract says.  So in China there would be no conflict of laws because Chinese law would simply apply. This is why we also advocate for drafting China employment contracts and employee manuals with Chinese as the official language.  Chinese courts and Chinese administrative bodies are the only rightful jurisdiction for China labor law disputes stemming from employment in China (yes, this is true for expats too) and so it only makes sense to have these documents in the language they are sure to understand.

Here is a more interesting/complicated related question: what would happen if a U.S. company had a contract with a U.S. citizen and that contract provided that the U.S. citizen would go work at the U.S. company’s WFOE for a few years and that contract called for application of U.S. law.  Now as I have said above, no Chinese court would apply anything but Chinese law to this relationship, but what would happen if the U.S. citizen were to flip around and sue the U.S. company in a U.S. court for failing to abide by some particular U.S. law?  I do not know the answer to this question (any U.S. employment lawyers out there), but I can tell you that if it were to benefit my client, I would argue that Chinese law applies and I think I would prevail on that.  But, I can also tell you that if it were to benefit my client, I would argue that U.S. law applies.

Anyone know how a U.S. court would rule?

This post is essentially a re-running of a post we did at the end of last year. We are re-running it because as China’s economy starts to waver, the Chinese government seems to have stepped up both its tax collection and its closing of illegal foreign businesses another notch. I received two calls just last week from companies who were told that their “Rep Offices” were illegal and that they needed to form a WFOE right away or simply leave China.

Now is really not the time to be operating in quasi-legal mode in China. It just isn’t. 

Every couple of weeks my firm gets an email or a phone call from a small business that is seeking to justify forming a Rep Office in China instead of a Wholly Foreign Owned Enterprise (WFOE). These small businesses typically go into advocacy mode explaining why their business can and should be a Rep Office in China. They then go on to explain that they simply cannot afford to form a WFOE in China due to the minimum capital requirements, the legal fees, and the taxes. 

They then want me to condone their Rep Office plans but I never do.

In fact, the increasing number of these requests has caused me to get even blunter than usual, and my most recent response exemplifies this: 

What you are describing doing as part of an RO [Rep Office] is definitely not proper for an RO. Not even close. 

In terms of minimum capital required, because it is Dongguan, it is likely to be pretty high. Sorry. 

You pretty much have two choices. You can operate completely off the grid and risk getting shut down, or you form a WFOE. Probably the worst thing you could do would be to form an RO that operates illegally because they you are just drawing attention to yourself.  

I get the sense that the people contacting us on these things are hoping that they somehow have found THE loophole that nobody else has found and that if only they can get the blessings of an attorney for what they are doing, that their operating illegally will somehow not be illegal. I wish I had some magic oil I could sell (for a helluva lot of money) that I could sprinkle on illegal China businesses to make them legal, but I have no such thing.

Those who think they are going “sorta” legal by forming what is clearly an illegal Rep Office in China are very similar to those who think they are “sorta” protecting themselves legally by doing a “sorta” joint venture with their girlfriend. I wrote about those people in a post, entitled, “Operating Illegally In China. Half-Assing It Does Not Help.” In that post, I described the following email I had recently received from my co-blogger, Steve Dickinson:

We had one of these the other day and it precipitated an email from my co-blogger, Steve Dickinson, to me, which went as follows:

If these people are going to go illegal in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don’t work in China, because you and I have won enough China contract cases to know that they do.

It is because the Chinese judges are totally on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking that somehow they are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember John Smith’s [yes, it is an alias] company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His US LLC [and with it, the China WFOE] were just purchased by _______ [a pretty big name U.S. company]. The reason the purchase was successful is that the whole company was “clean” and therefore it could be purchased by a foreign public company.

I then concluded that post with the following:

As lawyers we are never going to tell our client to go full illegal, but in my role as a blogger, I have to think going full illegal would probably make better sense than paying a lawyer to draft a void contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.

The same holds true with respect to forming a Rep Office when a WFOE is required. Forming the Rep Office in that situation will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE. On top of that, as I am always saying, you should not form a Rep Office with plans to form a WFOE in a year or so “if everything works out.” You should not do this because you will end up paying THREE times as you will pay for forming the Rep Office, pay for shutting down the Rep Office (and this is not cheap), and then pay for forming the WFOE.

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written me to tell me that “so and so” company formation company is willing to form the Rep Office for them, as though this mere fact means that my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE.

For more on what is involved in forming a company in China, check out the following:

Doing business in China? Don’t do it half right because you are only increasing your risk. 

Get legal now.

A consultant friend of mine is leading a very large group of American businesses to China for a big exhibition. He is putting together a short manual for these businesses and he asked me to help put the bug into the ear of these businesses that they should not be ignoring China legal issues.  

I came up with the following:

Here are my thoughts regarding the legal issues companies face in China. Please let me know if this will work or if you want more. 

Nearly every company that does business with China needs to face and resolve the following four issues: 

1. Is my company operating in China legally? Is my company able to operate as a foreign company or must it form a Chinese entity (such as WFOE, Rep Office or Joint Venture) to comply with Chinese law?

2. Is my company’s intellectual property (such as trademark, copyright, patent or trade secret) in China going to be protected? Should I register my company’s intellectual property in China so as to give it protection in China? Should I require the Chinese companies with whom my company does business sign contracts mandating they protect my company’s trade secrets? 

3. Does my company need to hire employees in China and, if so, what sorts of agreements does it need with them? 

4. What should I put in my company’s China contracts? In what language should they be? In particular, how should my company’s contracts provide for resolution of any future disputes so as to provide the most protection? 

What do you think?

I am always saying that for every 100 China WFOEs and Joint Ventures my law firm helps set up in China, it does one representative office. Why so few, when it is generally agreed that representative offices are the easiest type of offices for foreign firms to set up in China? Because the inherent limitations on China Rep Offices mean they seldom make sense.

Rep Offices “represent” in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing “liaison” activities. They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. NOTE: This post does not discuss branch offices for banks, insurance companies, accounting and law firms, that are permitted to engage in profit-making activities.

Rep Offices are pretty much limited to engaging in the following:

  • Conducting research.
  • Promoting their foreign company.
  • Coordinating their foreign company’s activities in China.
  • Other activities that do not and are not intended to generate a profit.

Because forming a Rep Office in China is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), companies oftentimes consider forming a China Rep Office as a way of “putting their toe into the water” there. These companies typically intend to switch over to a WFOE once it becomes clear China will be viable for them.
My firm generally discourage this “Rep Office and then a WFOE plan” because “switching” from a Rep Office to a WFOE is not really a switch at all. Making that switch in China will involve both shutting down the Rep Office and then forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and forming a WFOE, will be considerably more than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE does not usually make sense and most companies will be better off just biting the bullet and forming the WFOE straight away.

Other times, companies have come to my law firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes these companies can sell their product into China without having to create any in-china footprint at all. So long as they are not going to have much need for people in China, they oftentimes can get away without forming a company in China at all.

But there are definitely times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious about China.

China Rep Office applications typically go through the Administration of Industry and Commerce (“AIC”), though some industries (banking, insurance, legal, accounting, airline, media, and some others) also require an additional approval from the Chinese government agency with jurisdiction over that particular industry. All applications must be submitted by a designated/authorized Chinese agent (often known as a Foreign Enterprise Services Company or “FESCO”) in the locality where the proposed representative office is to be established.The application involves submitting fairly standard corporate documents from the foreign company, along with a copy of the lease agreement showing the Rep Office is leasing legitimate business space in China.

MOFCOM usually takes around thirty days to approve a Rep Office. One interesting feature of China Rep Offices is that they are not permitted to hire employees directly; they must be staffed indirectly through a FESCO. Nonetheless, it remains the responsibility of the Rep Office to make sure its FESCO employees have signed off on Rep Office company policies, including on such things as confidentiality. In all instances where we have formed a China Rep Office for our clients, we also have drafted the employment agreements the FESCO must use with the employees. That way we can be certain the agreements best protect our client.

For more on Rep Offices in China, check out the following:

For every roughly 100 China WFOEs and Joint Ventures (combined) my firm helps set up in China, it does one Representative Office. Why so few Rep Offices, when it is generally agreed they are the easiest entity for foreigners to form in China? Because the inherent limitations on China Rep Offices mean they seldom make sense.

Rep Offices “represent” in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing “liaison” activities. They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. They simply cannot earn any money in China or take any payments from a Chinese person or business for any reason.

NOTE: This post does not discuss branch offices for banks, insurance companies, accounting firms or law firms, all of which are permitted to engage in profit-making activities in China.

Rep Offices are pretty much limited to engaging in the following:

  • Conducting research
  • Promoting their foreign company owner
  • Coordinating their foreign company owner’s activities in China
  • Other activities that do not and are not intended to generate a profit

Because forming a Rep Office in China is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), companies oftentimes consider forming a Rep Office in China to test the waters there, with the intention of switching over to a WFOE once it becomes clear China will be viable for them. We generally discourage this because “switching” from a Rep Office to a WFOE is not really a switch at all. It involves both shutting down the Rep Office and forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and then forming a WFOE, will be considerably higher than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE seldom makes sense. Companies will usually be better off just biting the bullet and forming the WFOE straight away.

Other times, companies have come to my firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes though, these companies can sell their product into China without having to create any in-China footprint at all.

There are definitely times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious enough about China to commit to having an office there.

There are three basic requirements for forming a Rep Office:

  • The most important requirement is that there must be a lease on an approved space for a period of at least one year beyond the approval date of the Rep Office. Care should be taken with this requirement, since many jurisdictions accept leases only from a small group of approved office buildings. Shanghai, for example, is one such jurisdiction. The lease must be registered, which can also cause problems in some jurisdictions.
  • There must be a designated Chief Representative who will manage the affairs of the Rep Office.
  • There must a foreign entity (typically a limited liability company or a corporation) that the local office represents; private individuals and partnerships cannot establish a Rep Office in China. In addition, some jurisdictions in China do not allow newly formed entities to form a Rep Office.

The local approval authorities usually issue their decisions on Rep Office approval within around thirty days, at which point the Rep Office must do many of the other things typically required of businesses in China. However, in some areas, the decision can take much longer, depending on the whims of the local officials.

There are two major issues that make working with Rep Offices unattractive:

  • Even though Rep Offices are not permitted to earn income in China, they are nevertheless subject to taxation. There is a 10% tax on the GROSS EXPENSES of the Rep Office. If the Rep Office is large and has a number of employees, this tax can be quite high.
  • A Rep Office is not permitted to directly hire Chinese nationals. All hiring of Chinese nationals must be done indirectly through contracting with a Chinese employment agency such as FESCO. Recent changes in the Chinese labor contract law have made such contracts extremely unattractive. Rep Offices can directly hire foreign nationals.

The bottom line on Rep Offices is to think before you leap and not get seduced by their relative ease of formation. Every once in a while my firm will get called by someone who formed a Rep Office (usually through a formation company) within the last year or so who tells us they are now ready to “switch over” to a WFOE so they “can start making money” in China. These people believe this “switch” will involve little more than a one page notice of change and are shocked to learn that it will actually involve an expensive shutdown and a brand new WFOE formation. Do not let yourself become one of “these people.”