Just read a CNN article entitled, China offers big risk, bigger reward.  The article quotes me and a nice range of other attorneys on what it takes for foreign companies to succeed in doing business in China — from a legal perspective.  I really like the article, but I have a beef with its title.

If I had written the title, it would have been something really like, “China offers big opportunities, but hey, it’s gonna be difficult and it isn’t nearly as cheap as it used to be.”  I am just not sure China is all that risky for foreign companies.  I say this because my “sense” is that well over 90 percent of my law firm’s clients that do business in China or with China succeed at it and because every AmCham survey I can remember essentially says that American companies in China are thriving.  Is it difficult doing business in China?  Of course it is.  Just the mere fact that it is a foreign country (make that a very foreign country) with a different business culture, language, and laws guarantees that will be the case.  Is it risky?  Well, yes, in that it is a foreign country with a different business culture, language and laws, all of which increases the likelihood of something going wrong.  But is it physically dangerous?  No.  Are foreign countries at any real risk of having their assets appropriated by the government?  No.

You want risky?  Let me tell you about risky.  Many years ago, a very good client of ours was offered the shrimp farming concession in a small African country.  THE shrimp farming concession.  Like for the entire country, which meant a huge amount of easily caught shrimp. We worked with our client on various aspects of the deal and the most conservative numbers showed that the return on the investment would be astronomical. Like about 300% starting in the first year.  One big problem though was that none of the last three foreign companies that had been given the same concession had lasted even one year without the government taking everything and unceremoniously booting them out.  The government sought to assure us that it had good reason all three times but in the end, our client deemed the deal too risky.

Bad things do happen to good foreign business in China, but as compared to many other emerging markets, China is relatively tame.

But the article itself does an excellent job setting out the core legal issues foreign companies face in China and conveying that dealing with those issues is not going to be easy or cheap.  It starts out talking about a young entrepreneur who found it difficult forming a WFOE because, among other things, he had to first prove that he had office space and a commercial address.  The article said this first meant that this entrepreneur had to make a “significant upfront investment, with no  guarantee of [WFOE] approval.”  This is only sort of true in that many landlords in China these days will agree to what we call a tentative lease.  Under such a lease (which we do literally all the time for our clients), the foreign putative tenant need only start paying if the WFOE is approved.  Landlords typically agree to this and we have never had a WFOE rejected because of this.

It then quotes me as saying that “many” wait for a year to have the paperwork approved.  This too is only sort of true.  We have never had a situation where it has taken anywhere close to a year for our WFOE paperwork to get approved; but we have had situations where it has taken our clients a year or so to complete the WFOE registration process because the foreign company seeking the WFOE was simply not well prepared from a business side to do everything it would take.  For instance, a typical slowdown is when the foreign company has trouble finding an appropriate space to lease.  For more on the issue of leasing space for a WFOE in formation, check out the following:

For more on how to form a WFOE in China, check out the following:

The article then rightly notes that “hiring staff, conducting training, avoiding corruption and protecting intellectual property are some of the biggest challenges they face.”  I completely agree with this, in that probably 80 percent of what we do for foreign companies that are already in China relates to one of these items.

It then talks about the need to find the right hire/right partner — someone , who “can bridge West with East, and East with West.”  This is so true.  In fact, I went to lunch with a good friend/client yesterday and much of the conversation was him telling me how difficult it was going to be for him to find the right general manager for a new business he has been working on in China.  Like everyone else, he seeks someone who understands both the China side and the Western side and can deal with the people on both sides and actually knows the specific business.  Those people are always going to be few and far between.  Janet Carmosky just wrote an excellent article for the China Business Review on this issue, entitled, What a China Team Needs.

The article then (quite wisely) notes how “business in some industries — media, banking and energy, for example — can only be done through a joint venture with a local Chinese partner.”  In other words, these businesses cannot be 100% foreign owned and therefore they cannot be done as a WFOE; foreign companies therefore typically get involved in these industries in China via a joint venture.

The article then relays how “corruption carries some of the biggest risks for businesses looking to break into China” and how it is “common practice” in some industries “for firms to give generous gifts and entertain business partners with lavish meals, and companies may lose an edge if they don’t follow suit.”  Unfortunately, this is true and as a foreign company you will need to decide whether you are going to risk jail time for yourself and your employees by violating the law. Needless to say, our advice is always not to do it and to do everything you possibly can to make sure that ethos is made clear and enforced throughout your company. We constantly are working with our clients to help them avoid corruption.

The article then addresses the importance of protecting intellectual property and rightly suggests that foreign companies “register trademarks or patents before entering China.”  It also mentions some non legal steps for protecting IP, such as “setting up offices or plants in different locations, and only taking the most essential core technology overseas.”  For more on registering trademarks in China and the timing of that, check out the following:

For more on how to protect your IP from China, check out the following five part blog post series:
The article then concludes by talking about how “despite the ups and downs” and despite China not being an easy place to do business, it can be a very profitable one.  I can agree with that.
And in that end, that is what matters most, is it not?  What do you think?  Is China worth it for foreign businesses?

We spoke with a software company the other day that has nearly fifteen “independent contractors” in China, who it views as “part of the corporate family.”  This company was contacting us to see about forming a WFOE in China.  They told me that they were not in any rush.

The first thing I did was to ask whether they knew that what they were doing in China is completely illegal. They did not.  I explained to them how there is almost no such thing in China as an independent contractor and that they essentially had nearly fifteen employees and because there was no company actually employing those fifteen people, what they are doing is illegal. I then told them of how China in the last year has stepped up even more its efforts to rid the country of foreigners there illegally and companies there illegally.  I also told them of how their existing structure puts all of their China assets at huge risk. Their China IP assets are at risk for the simple reason that they do not really own them.  A company operating illegally in China is just not positioned to be able to assert IP rights against anyone in China.  Their other China assets are at risk because the Chinese government will likely seize them if and when it cracks down on what they are doing.

They seemed very interested in going legal until I started laying out how doing so would greatly increase their China operating costs.  I told them how their forming a WFOE would necessitate their incurring the following additional costs/expenses:

  • WFOE formation fees and costs.  They expected this.
  • They would need to lease office space from an approved landlord.  This is a requirement for WFOE approval.  This would likely increase their office rent.
  • For every $1,000 in employee salaries, they would probably need to pay about $400 (40%) in employer taxes and benefits.  They were not expecting this at all.
  • In addition to the employer taxes, their employees will need to start paying income taxes. They seemed to think that their “independent contractors” are already paying all required taxes. I told them that I am virtually certain that they are not, and that their going legal will almost certainly lead to their “independent contractors” demanding higher salaries to make up for their take home pay being reduced by having to go onto the tax rolls.

I then talked of the advantages of having a WFOE, including the following:

  • You are operating legally.  Your risk of the government shutting you down tomorrow has essentially disappeared.
  • You are much better positioned to do real business in China, because you are legal.
  • You are much better positioned to protect your IP in China, because you are legal.
  • You are much better positioned to terminate employees because you do not need to keep them on forever for fear of their reporting you to the authorities.

After this phone call, I spoke with China-based co-blogger, Steve Dickinson, for the latest on how China’s government is treating foreign operations with multiple people working for them in China. Steve pointed out how the Chinese government is aggressively pursuing tax evasion claims against both the “independent contractors” and those connected to the illegal business. The government pursues the “independent contractors” for failing to pay their own taxes and it pursues the foreign business for Chinese income tax and related national and local business fees and taxes. Most importantly, the government also seeks to take action for back taxes against any representative (i.e., individuals) of the foreign company who happen to come to China. When the number of illegal employees is large, the claim for back taxes can be quite large. Often, the tax authorities time their raid on the illegal business to ensure that a representative of the foreign company is on site and, in many cities, they will not let the foreign representative leave China until after resolution/payment is achieved.

In other words, doing the “independent contractor thing” without having a registered business in China is asking for trouble.  Big trouble.

What are you seeing out there?

Companies seeking to form a WFOE in China are often confused about Chinese law regarding the minimum registered capital requirements for forming a WFOE.  Part of the confusion stems from disreputable entity formation companies that encourage their hiring by claiming they know exactly how much will be required and that they have the ability to get the Chinese government to agree to a really low amount.

Under Chinese law, anyone forming a WFOE typically must put up a minimum of about USD $15,000 as a registered capital requirement.  What exactly does this mean?  Well, first off, the $15,000 is a minimum, but many Chinese cities have their own, much higher, minimum threshold.  In fact, virtually every city in which foreign investment is common has a much higher minimum capital requirement.  We just did a consulting WFOE in Qingdao and the capital required was about USD $80,000.  We also just did a consulting WFOE in Shanghai for which around USD $150,000 was required.  Our most recent Beijing WFOE needed around USD $300,000, but that was for a software development company.  The amount of minimum capital required is going to depend primarily on the city and the nature of the business.  Just by way of example, we did a WFOE not that long ago in not all that big a city but because of potential food safety and transportation risks, the minimum capital required was in the millions of dollars.  To a certain extent you just never know and anyone who claims to know before engaging in serious and substantive discussions with the right governmental authorities is just guessing.

But here’s the most important and least understood thing you need to know about China’s minimum capital requirements: the lowest amount possible is not necessarily what you will want.  Contrary to what many believe, the minimum capital required to go into a Chinese bank to secure a China WFOE is not frozen; you can use that money to fund your operations almost right away.

And that really matters. It matters because instead of seeking the lowest minimum capital required, you should be seeking the “just right” amount of minimum capital. In other words, the disreputable entity formation companies that seek to woo you with promises of securing you an ultra-low minimum capital requirement will almost certainly do you a disservice if they actually succeed — which they might as there are some cities in China where USD $15,000 will be enough.  But what can be so bad about only having to put in a small amount?  Surely you can put more in later if you need to do so, right?  In theory, you can, but it will no doubt cost you a lot, either in legal help in getting approval for a new registered capital amount or in taxes.

If you do not have sufficient capital to operate, you mind find yourself having to shut down. For good.  I have heard of that happening. The problem is that getting money over to China is not always easy and if you send that money over as anything other than registered capital, your China WFOE will get taxed on it as income, which is exactly what it will be. Alternatively, you could apply to have your registered capital increased and then send the money over as that, but we hear that takes at least two months, usually considerably more.  My firm has actually never been involved in such a transaction (knock on wood), in large part because we make sure that our clients understand registered capital ramifications when we first register their WFOE for them.

In fact, there are all sorts of things that some local governments tie to a WFOE’s minimum capital, including the following:

  • Temporary Residence Permits. Some local governments do not allow WFOEs with “too low” minimum capital to sponsor temporary residence permits for their local employees that have their Hukou in another city.
  • Expat Employees. Some local governments link the registered capital amount to the number of foreigners allowed to be employed by the WFOE.
  • Future Branch Office. The potential for securing approval to open a branch office is oftentimes lower if the registered capital is “too low.”

Calculating the registered capital for your WFOE at its inception is the key to avoiding costly problems with it down the road. For more on the minimum capital requirements for a WFOE, check out How To Start A Business In China — The Minimum Capital Requirements For A WFOE.

 

A couple of years ago, we did a post on the difficulties in using “independent contractors” in China, entitled, Hiring A Chinese Employee Without A Chinese Entity. Good Luck With That. We wrote that post (and this post too) because forming a WFOE in China can be so difficult, expensive, and time-consuming, and because so many companies are looking for some way of hiring a Chinese employee without a China company.

This is our even grimmer follow-up.

In our first post, we listed out the following ways to “employ” someone in China without forming an entity there:

1.   A foreign company could have its proposed employee hired by a Chinese company and then pay the Chinese company the equivalent of the Chinese employee’s wages and taxes, plus an administrative fee. The problem with this is that if the “employee” is not going to be doing at least some work for its Chinese employer, it probably is not legal and if the foreign company gets caught, it may never be allowed to conduct real business in China again. If the “employee” does not actually do work for the Chinese company, it is nothing more than an attempt to get around the laws that require foreign companies with an employee in China to be a legitimate Chinese entity (be it a WFOE/WOFE, a Joint Venture/JV, or a Representative Office).

And if the foreign company’s goal is to have its “own person” on the ground in China, how much of “its own person” is someone employed by and paid by another? And how this foreign company protect its trade secrets from the Chinese company? There are definitely situations where this can work, but not every situation will.

Then there are all the issues for the Chinese company, which is likely going to have to lie to the Chinese government as to why it is receiving monthly foreign currency payments.

UPDATE ON THIS OPTION:  Since writing the post, we have received calls from a foreign company that was caught doing this and then effectively kicked out of China and from a couple other foreign companies that were doing this whose Chinese company stopped going along with this program out of fear of getting caught.  This has led us to conclude that this is, at best, a very temporary remedy, if even that.

2. A foreign company can hire the Chinese “employee” directly and just wire that “employee” his or her paycheck every month. Years ago, this sort of arrangement was pretty common, but it is becoming far less so as word is spreading that the Chinese government and tax authorities are very much on to this scheme and are quashing it. The problem with this set-up is that the foreign “employee” is at some point going to have to explain to the Chinese government why it is that he or she is monthly depositing foreign currency into his or her bank account and why no taxes are being paid on it.

In our last post, we noted the following big flaw with this sort of arrangement:  “We have received a number of calls in the last year from companies seeking our help in keeping their Chinese ’employee’ after they were told by their ’employee’ that the existing relationship must be discontinued. We told them that their best solution would be to form a China WFOE, but that we were very concerned about their WFOE application being rejected because of what they had already done.”

UPDATE ON THIS OPTION. Since we did our last post, we have heard from many more foreign companies that have gotten into trouble with the Chinese authorities for having employed this option.  Perhaps more importantly, we are finding that the trend is for Chinese prospective employees (particularly those with a high level of experience or skill-set) to flat out refuse this sort of arrangement.

3. The third and maybe best option (at least from a legal standpoint) is for the foreign company to have its Chinese “employee” form his or her own domestic Chinese company and then simply contract with that Chinese company for the services it is seeking from this Chinese person. This is going to require a fair amount of initiative by the Chinese employee and the downside of this is that when all is said and done, your client has an independent Chinese company out there with which it is conducting business, and not an employee.

UPDATE ON THIS OPTION.  We are unaware of anyone ever having tried this option as every foreign company has either deemed it too risky from the perspective of protecting its intellectual property or the prospective employee has simply been been unwilling to go through this convoluted process for the “job.”

4. Have your potential employee hired by a China-based staffing agency.  Under Chinese law, Representative Offices are not allowed to directly employ anyone; they must do so via a third party staffing agency.  Because of this, there are plenty of such staffing agencies in China and up to a few years ago, many of them were (for a somewhat reasonable fee) willing to hire someone for a company based overseas. Today, we know of only one such agency that will do that for  foreign companies without their own entity in China (be it a WFOE or a Rep Office) and that agency charges a 15% monthly commission on the salary to do so.  On top of that, come July 1, 2013, all of this will almost certainly be impossible as on that date, China’s labor law will be revised to make third party hiring for anything but “temporary, supplementary and backup jobs” illegal. For more on this, check out this article, entitled, “Newly amended PRC Labor Contract Law imposing stricter control over the use of seconded employees.”

At this point, I am not sure that the one remaining agency that will employ someone for a foreign company without an entity in China will remain willing to do so, but I doubt it.

For years, China has sought to force foreign companies seeking to hire in China to form a company in China. It appears that come July 1, it will have achieved this goal, which really is part of two much larger goals of increasing its tax revenues, particularly from foreign companies, and improving the lives of its working citizens. There is not going to be any going back on any of this. If you want someone working for you in China, you are going to need to form an entity — almost certainly a WFOE — to accomplish this.

What do you think?

The United States Chamber of Commerce recently came out with a report comprehensively detailing what it takes to get a foreign investment approved in China.  I started skimming it, but stopped becuase it caused a sinking feeling in my stomach as it hit too close to home.

But for anyone wondering why it takes so damn much time and takes so damn long to form a WFOE in China (figure on 4-6 months), read the report.  No wonder I use words like “slog” and “excruciating” and “unending” to describe to our clients what it is going to be like as we secure their WFOE registration in China.

Enjoy.  And don’t let anyone tell you that forming a WFOE in China is easy.

One of the things we are always writing about and always trying to get a handle on is what the attitude is in China towards foreign investment.  That attitude is never static for long, always shifting with the economy and sometimes shifting due to other factors such as politics.

We are in the midst of forming a WFOE right now for a couple of companies in somewhat difficult businesses.  Our advice was that they first form a Hong Kong entity as that likely would make WFOE formation go more smoothly. We told these clients that we have in the last six months or so been seeing Chinese governmental authorities increasingly throw minor roadblocks in the way of American and European companies seeking to form a WFOE in China.  One of these clients said that they had talked with someone who claimed not to have noticed any such tightening by China’s governmental authorities. All I could say was that we are seeing otherwise. I also talked of how China is even making getting visas tougher.

I thought about this today after reading a Variety Magazine article, “China: Market loosens quotas, but still cautious.” The article quotes Mathew Alderson(our lead China entertainment lawyer) on how China’s State Administration of Radio, Film and Television (SARFT) has stepped up its reviews of Sino-foriegn co-productions in an effort to make sure there is adequate China content to constitute a co-production.

A purely foreign film entitled to share in box office revenue must be imported into China as part of China’s annual quota. An official Sino-foreign co-production will be regarded as a domestic Chinese film, to which the quota does not apply. The distinction between foreign imports and Sino-foreign co-productions is also significant because they yield different box office shares. When films are imported on a revenue-share basis, the foreign distributor now gets 25% of box office takings under the new deal announced earlier this year. In a Sino-foreign co-production, around 38% of box office is available to the producers. The share available in a co-production is the same as it is for a purely domestic production.

The Variety article highlights the Chinese government’s increased vigilence:

The country’s State Administration of Radio, Film, and Television recently highlighted that its rules for co-prods require at least one third of production funding coming from China, along with one third of the main cast, while scenes must also be shot in China.

Co-prods help boost China’s image overseas while benefitting from learning expertise.

“Co-productions were definitely not intended as de facto quota busters, which is how they are often regarded in Hollywood,” says Alderson. “The authorities are now more vigilant about what they call ‘stick-on’ productions in which the Chinese elements are contrived and insubstantial.”

The Chinese are sensitive to the idea that Hollywood might be cynically taking advantage of its booming film market. Zhang Peiming, deputy head of SARFT, accused “Looper” and “Cloud Atlas,” accusing them of making superficial attempts at co-prod status.

“These co-productions get around the quota system and take domestic investment away and threaten Chinese movies,” Zhang said at the time.

For more on China co-productions and the China movie business, check out the following:

For more on the pros and cons of using a Hong Kong entity to form your China WFOE, check out How To Form A China Company (WFOE or JV). Hong Kong Entities. They’re Baaaaack.
Are you seeing what we are seeing in terms of China getting tougher on foreign business?

 

If you’re in a creative industry like graphic design or filmmaking or advertising, you want a suitable space for your China WFOE (Wholly Foreign Owned Entity). A sea of cubicles in a nondescript office park isn’t going to impress your clients, and isn’t going to inspire your employees either. You want a building with character and style – a grand old mansion, a funky warehouse with exposed beams, maybe even a classic Chinese courtyard. The problem is, most of these places are not suitable locations for a WFOE.

We have written before about the leasing requirements for a WFOE-to-be (see here, here and here). Among other things, the proposed leasing space in China for a WFOE must be owned by the landlord and approved by the government for the use intended by the WFOE. All too often, leasing agents in China will elide these requirements with a sophisticated bait-and-switch. They show a beautiful space to the client, and then, just when the client is ready to sign a lease, they present two documents. One is a lease for the beautiful space. The second is a lease for another space, often in a completely different part of town, which will be the official address of the WFOE.

If this sounds fishy, it should. When forming a WFOE, the official address should be the location where the WFOE will actually operate. In most cities, and especially in big cities like Shanghai and Beijing, the authorities will check the official address as part of the approval process. Even if they don’t check, the WFOE’s official address will be critical throughout the life of the WFOE. Why would you have the official address be some random address across town? It is of course possible to have two full-fledged offices, but that is usually not what the leasing agent is proposing (the proposed “registered” space is often only one room) and even if it was, that would mean double the expenses for the WFOE.

The underlying message of the two-lease proposal is this: the beautiful space cannot be leased for the formation of a WFOE. You will need to move on and find a new space that will work. There is no other alternative. If you’re going to form a WFOE, do it right.

Though we often talk generally about what it takes to form a company in China, a reader recently pointed out to me that we have never set out the basic steps one must take to do so. The following sets out the basic steps a foreigner usually must take to form a Wholly Foreign Owned Entity (WFOE) in China. For more information on what is required to form a company in China, check out How To Start A Business In China — WFOE and How To Start A Business In China — The Minimum Capital Requirements For A WFOE.

 Forming a WFOE in China typically requires the following:

1. Make Sure Your Business is Legal For Foreigners. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. For example, until recently, China prohibited private entities from engaging in export trade. Be sure your business will be legal.

2. Provide The Proper Documentation. The investor in the WFOE must provide the documentation from its home country proving it is a duly formed and validly existing corporation or Limited Liability company, along with evidence showing who from the investor is authorized to execute documents on behalf of the investor. The investor also often must provide documentation demonstrating its financial adequacy in its home country. 

3. Investor Documents Needed. The Chinese government normally requires the following documents from the investing business entity:

  • Articles of Incorporation or equivalent (copy)
  • Business license, both national and local (if any) (copies)
  • Certificate of Status (original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)
  • Bank Letter attesting to the account status of the investor company (original).
  • Description of the investor’s business activities, together with added materials such as an annual report, brochures, website, etc. The first four of these must be in Chinese. The last one may be submitted in English, with a Chinese summary.

4. Consider Forming a Special Purpose Company to Own the WFOE. Many investors create special purpose companies to serve as the investor in China. China’s company regulators have become accustomed to this process. However, the Chinese regulators will often still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. It is common to form a Hong Kong company for this purpose and there are often tax benefits in doing so. 

5. Secure Chinese Government Approval. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the company registration process. If the project is not approved, the company will not be registered. 

6. Compile and Provide These Documents for Chinese Government Approval. The following documents must usually be prepared and then submitted to the Chinese government:

  • Articles of Association. This document will set out all the details of management and capitalization of the company. All basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.
  • Feasibility Study. The project will not be approved unless the local authorities are convinced it is feasible.This usually requires a basic first year business plan and budget. We typically use a client produced business plan and budget to draft up the feasibility study (in Chinese).
  • A Lease. An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into into account in planning a budget because the governmental authorities will be expecting this.

7. Compile and Provide These Additional Documents for Chinese Government Approval. You will also usually be required to provide the following documents:

  • Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from around 30% to 40% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these benefit amounts. The required initial investment includes an amount sufficient to pay salaries for a reasonable period of time (usually one year or more) during the start up phase of the Chinese company. These documents must be in Chinese.
  • Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.

8. The Approval Process. It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. Large cities like Shanghai tend to be slower than smaller cities. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital. On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory may have serious land use or environmental issues. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset.

if you comply fully with the above, your chance of getting your WFOE approved is nearly 100%.

A few weeks ago, a client asked my law firm to handle a relatively routine domestic matter for them. We told them we do not handle such matters and we gave them a short list of excellent attorneys that do. The client expressed surprise at our unwillingness to take on their matter and remarked on how this area of law is “so easy.” I told them that it is “easy” 90% of the time, but difficult the other 10% of the time and that we only knew enough to be able to know half the time when we would be delving into the other 10%. In other words, we would probably have a 5% error rate and that precluded us from taking on such matters.

Yesterday, the client called to thank us because its matter was one of the ten percent. Though both the client and I had assumed the client needed A, it turned out that it was actually in the 1% that actually would be much better off going with B.

The percentages above are guesstimates used to prove the point that many things lawyers do appear to be and in fact are fairly routine But for any given project there is usually the ten percent, and it is that ten percent that can cause the problem.

Law firms tend to see a large number of the ten percent because we virtually never get calls from someone saying, “I just did this and it all worked out fine, can you help me?” Our typical call is more along the lines of “the Chinese government just did this to me, is there any way you can help me?”

Forming a WFOE or a Rep Office in China is an excellent example of the 90-10 rule, both because many people are not aware of the 10% and because the problems that arise from this lack of awareness can be absolutely huge.

Ninety percent of the time (a guesstimate), forming a WFOE or an RO in China is not all that complex. But it is the ten percent that will kill you.

Here are some of the ten percent issues relating to China company formation on which we have been called:

  • American company that had been locally approved for its WFOE to do X was being shut down by Beijing 15 months after its formation because X cannot be done by WFOEs in China. The “funny” thing about what this American company was doing was that had it actually defined it a bit differently in its WFOE application, it would have been legal and it almost certainly would not have been shut down.  For more on how important it is to get the right scope when applying to form a WFOE, check out “How To Form a China WFOE. Scope Really Really Matters.
  • An American company that had formed an Representative Office in China and then was told around three months later that it was operating completely illegally and would need to shut down. The American company explained to me what it was doing in China and without any doubt what they were doing was absolutely illegal for Rep Offices. I asked why this company had opened the RO in the first place and their response was that they had done so because it was cheaper than opening a WFOE. They had never consulted an attorney on the differences between Rep Offices and WFOEs; they had simply gone to an entity formation company with the instructions to form a Rep Office. For some very basic information on the differences between Rep Offices and WFOEs, check out “The China Representative Office (RO). Got WFOE” and “How To Form a Representative Office In China.
  • Then there are the countless calls we have received from companies who have had their WFOE or RO application declined or stuck in the system. We consider these people lucky because what has happened to them beats getting approved locally and then getting shut down by Beijing. For them we formulate a plan either to reinvigorate their existing application or to start all over. Once a company starts having approval problems, a red flag gets attached to them and so even if they completely clean up their act, they will likely be subject to increased scrutiny. For this reason, we often recommend starting all over, using a new foreign company as the ownership entity. We cannot usually do this with Rep Offices because they require ownership by a company that has been existence for at least two years.

Are you the ten percent? How do you know?

In deleting old emails over the weekend, I came across one from co-blogger Steve Dickinson to a client looking to lease a factory in China and use those operations as the basis for forming a Wholly Foreign Owned Entity (WFOE or WOFE). I am reproducing Steve’s email below because this is obviously not an uncommon desire and the tie-in between leasing space and forming a WFOE is frequently either misunderstood or just plain ignored. The bottom line is that to form any sort of WFOE in China, one must have an appropriate space (be it an office, warehouse, factory, or whatever) that can qualify for WFOE formation.  

Here’s Steve’s email:

The only way a foreign company can rent and operate a factory in China is to create a Wholly Foreign Owned Entity (WFOE or WOFE). Creation of a WFOE is a standard process. The factory lease is a separate matter from WFOE formation and it can range from easy (typically the case if you are renting from an industrial zone with substantial experience renting space to foreigners) to difficult.

The main problem our clients encounter is that they often try to rent factory space that cannot be used for a WFOE. For factory space to work for a potential WFOE, it must be legally owned by the landlord, it must have all proper documentation and the landlord must be willing to register your lease with the local government real estate office. Though this sounds simple, it is not uncommon, especially with cheap space, for there to be problems with the documentation that make use of a particular space not possible for a WFOE.

What do you think?