A few weeks ago, a China risk consultancy contacted us regarding their own China legal matter.  During our conversation, the caller went off and said that he really liked our posts on how to avoid getting kidnapped in China.  He then told me that so far this year, not a single week had passed without his company having been called in to deal with a “hostage or hostage-like situation.”  He told me that such incidents are way up this year from 2012 and that 2012 had double the incidents of 2011.  He said that nobody seems to believe how prevelant this incidents are but that we should keep writing about them because they are “happening like crazy and with China’s economy continuing to soften, they will only increase.”

I forget about that phone call until today, when I received my second “hostage” call in two days.  Both are very similar to each other and both are very similar to those we have handled in the past.  I am going to merge the facts surrounding these two recent ones and throw in a bit of the previous ones so that nobody can be recognized.  Those two and pretty much all of them go as follows:

  1. US company gets into some sort of dispute with Chinese company involving money the Chinese company claims it is owed by the US company.  Usually this “debt” has arisen after the Chinese company has provided the US company with terrible quality product and for which the US company refuses to pay.
  2. The Chinese company makes all sorts of threats against the American company, typically including the threat that the Chinese company will make is so that the American company will no longer be able to do business in China ever again.
  3. The American company becomes convinced that the Chinese company is acting unreasonably (because it is) and that if it can simply meet with the Chinese company, reasonableness will prevail and a compromise can be reached.  This is somewhat encouraged by the Chinese company, who goes along with the plan of at least having a meeting.
  4. The American company agrees to go to the Chinese company’s hometown for a meeting.
  5. One person from the American company goes to the Chinese company’s hometown for a meeting, at which point the Chinese company (usually with local police right there) makes clear that it is not willing to compromise in any way and angerly demands that the American company pay the Chinese company every single dollar the Chinese company claims to be owed (and sometimes even more than that). The representative for the American company refuses, at which time the “quasi-kidnapping” begins.
  6. The Chinese company/local police will then seize the American’s passport, tell the American that they have already sued their American company for the alleged debt and alerted the border police not to allow them to leave China.
  7. The “partner” of the person being held hostage in China then calls us to assist, always letting us know that they wished they had read our blog posts on this subject before their partner had left for China.

So I am writing about this yet again in an effort to reach as many as possible before they go over to China.  What should you do if you have a problem with your China counterparty?  What should you not do?  How can you avoid being held hostage in China?

In How Not To Get Kidnapped In China, we set out the following three rules to follow if you or your company are alleged to owe money to a Chinese company:

  1. If you are in a debt dispute with a Chinese company, think about not going to China at all.
  2. If you must go to China, think about using a bodyguard or two and think very carefully about where you stay and where you go. Most importantly, be very careful with whom you meet.
  3. Consider preemptively suing the alleged creditor somewhere so that you can very plausibly claim that you have been seized not because you owe a debt, but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China.

We really should have added a fourth rule, which rule we discussed in “Shanghai Thugs Forcibly Remove Shanghai Residents. Why This Matters For YOUR Business”:

Though China is relatively safe, one should absolutely not write off the possibility of violence in one’s business dealings in China. My law firm has been called in at least a half dozen times where violence was either threatened or occurred. We tell our clients that if they owe money to a Chinese company or are involved in any sort of dispute with anyone in China (partner, employee, etc.), they should avoid meeting to discuss the dispute/problem anywhere other than in a neutral, very public place in the day time. A high end hotel lobby in Shanghai or Beijing is a good choice. Singapore or Tokyo or Seoul are an even better choice.

In other words, if you really think it necessary for you to go to China to try to resolve your company’s debt issues, at least seek to have the meeting in a hotel lobby in Beijing or in Shanghai, rather than in Xiamen in the conference room of the company to whom the debt is allegedly owed.

In “Bo Xilai’s Lessons For Your China Business,” we wrote of how arguing that the hostage does not personally owe the debt is usually not the fastest/best way to resolve these sorts of situations:

I say this because we have been involved in at least two cases where this was the case. U.S. company owes money to Chinese company. U.S. company ceases to do business and so its key figures assume the issue is resolved in that the company has no assets to pay any debt.  They then get on a plane to a foreign country (one was a China case, the other was a Russia case) and they both get seized and “held hostage” until we negotiate out their release. They wanted us to argue that they personally did not owe the debt; their companies did. Our response was to tell them “that would be an excellent argument if we had the luxury of filing court briefs and waiting months for a judge’s decision, but our goal here is to get you released as quickly as possible.”

We deal with this issue in its nascent stages all the time when we work with our clients to shut down their Chinese entities (which for some reason has been happening like crazy of late). We always instruct our clients never to reveal that they will be shutting down their China operations while anyone from the home office is in China. We also tell them that if they or their company ever wish to return to China, they should pay off all their debts and usually the best way to do that is to announce from outside of China the plan to gradually shut down the China office and then, using that as leverage, negotiate down all of the debts. We always stress that once a reduced debt is agreed upon, there should be a written agreement on that and there should be proof of payment on that agreement as well.

All of this is necessary if you want to formally close your China entity, which is, in turn, necessary, if you want to be able to return.

For more on hostage situations in China, check out the following:

I cannot emphasize enough how serious this is and how little the US Embassy and Consulates can do to help Americans being held.  China law actually allows for keeping people in China for the debts of their companies.  And trust me when I tell you that accomodation quality can vary.

What are you seeing out there?

Yet another story of an American businessperson being held in China for his company’s unpaid debt. Hate to say we told you so, but we told you so. And more than once (note this is Part 3!)

This latest debt-hostage story was brought to my attention by Jeremiah Jenne of rectified.name (a terrific new China blog, but one that really ought to allow comments) and Jottings from the Granite Studio fame (a terrific old China blog that does allow comments).  Jeremiah asked me about it via Facebook by sending the following:

Sure to be more to this story than just ‘bad China.’ Rep sounds clueless at best, downright dumb at worst. US company boss also seems quite shady, firing the poor schmuck but still unable to remove him as ‘legal representative.’

Need help making sense of this. Sending bat signal to Dan Harris.

Not sure there really is all that much unusual to the story as it reads like a typical debt-hostage story, with the following standard elements:

  • For whatever reason, American company owes China company money (or even just China company claims American company owes it money).
  • For whatever reason, company doesn’t pay China company.
  • For whatever reason, important American guy (I’ve heard of this happening at least a dozen times and my firm has been actively involved in these at least twice and every single time it’s been a guy) goes to China to try to resolve the debt either by trying to convince China company to accept less than the full amount owed.
  • For obvious reasons, important American guy gets his passport taken and is blocked from leaving China until the matter is resolved.
  • For whatever reason, important American guy thinks that whining to the U.S. Embassy and the press is going to help him.

Anyway, here is this latest story, courtesy of the Washington Post, and titled, “Missouri businessman in limbo in China in dispute over debt, unsure when he’ll get back to US”:

The Chinese government forced Steve Fleischli of Labadie, Mo., to surrender his passport in a dispute over his company’s unpaid debt to Chinese firms. Complicating matters is that he has lost his job since going to China on business in January.

Many of the details of the case, including exactly why Fleischli was fired from his job, are unclear. But his story offers insight into the perils of a western businessman doing business in China, especially when commercial disputes are involved.

The State Department declined comment on his case, but its website says there is little it can do to intervene on behalf of Americans in situations like Fleischli’s, which can take years to resolve.

Let’s break down this intro a bit.  First off, it says the “Chinese government” forced this American to surrender his passport. What is meant by “Chinese government”?  Local police or President Hu Jintao?  I’m betting it’s local.

Second, it says that “Many of the details of the case….are unclear.”  Yup.  No surprise. Reading between the lines, this probably (note I said probably because I do not know and I am just guessing here) means that the company does owe the debt, the American hostage is responsible for the debt under Chinese law, and the company that fired the American was less than happy with him.

More of the story:

“I think he’s more frightened about the comment that sometimes these things go on for years, rather than about his personal safety,” Fleischli’s attorney, Mitch Margo, said.

Fleischli, 37, began his career at Washington, Mo.-based NorthPole Ltd. 11 years ago and rose to CEO. The company is a leading maker of outdoor gear including tents, foldable camping chairs. Warburg Pincus, a global equity firm, is NorthPole’s majority owner.

Times got tough for NorthPole in recent years as prices for materials increased and retail orders slowed. The company owed money to suppliers in China. Margo said Fleischli even loaned NorthPole $200,000 of his own money last year. The company declined to discuss details of the loan, but it was an issue in Fleischli’s firing.

Let’s look at the above.  The American guy is “more frightened about the comment that sometimes these things go on for years, rather than about his personal safety.” That makes sense.  In my law firm’s experience, these things only end by an agreement by the Chinese company to accept a certain payment and then that payment being made. Maybe these things can end some other way, but I am not aware of that ever having occurred. The Chinese company typically wants its money, not to physically harm anyone.  I do hope Mitch Margo is working with other lawyers experienced in negotiating with Chinese companies.  “The company owed money to suppliers in China.” Presumably, the American company owes money to the Chinese company that saw to the taking of Mr. Fleischli’s passport. Why does a company fire someone for loaning the company money? This does not make much sense and there has to be more to it than this.

Fleischli, who has a 3-year-old daughter and wife back home in Missouri, decided to fly to China to address concerns of suppliers in person. He left in January in anticipation of a meeting with suppliers at a factory in Xiamen, China, in March. The meeting was a disaster as angry suppliers rioted. After more than a day, police were able to help Fleischli get out of the factory.

In How Not To Get Kidnapped In China, we set out three rules to follow if you or your company are alleged to owe money to a Chinese company:

So what are the lessons from all this?

  1. If you are in a debt dispute with a Chinese company, think about not going to China at all.
  2. If you must go to China, think about using a bodyguard or two and think very carefully about where you stay and where you go. Most importantly, be very careful with whom you meet.
  3. Consider preemptively suing the alleged creditor somewhere so that you can very plausibly claim that you have been seized not because you owe a debt, but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China.

We really should have added a fourth rule, which rule we discussed in “Shanghai Thugs Forcibly Remove Shanghai Residents. Why This Matters For YOUR Business”:

Though China is relatively safe, one should absolutely not write off the possibility of violence in one’s business dealings in China. My law firm has been called in at least a half dozen times where violence was either threatened or occurred. We tell our clients that if they owe money to a Chinese company or are involved in any sort of dispute with anyone in China (partner, employee, etc.), they should avoid meeting to discuss the dispute/problem anywhere other than in a neutral, very public place in the day time. A high end hotel lobby in Shanghai or Beijing is a good choice.

In other words, if you really think it necessary for you to go to China to try to resolve your company’s debt issues, at least seek to have the meeting in a hotel lobby in Beijing or in Shanghai, rather than in Xiamen in the conference room of the company to whom the debt is allegedly owed.

The article goes on to say that Fleischli is being held because he was/is NorthPole’s “legal representative in China” and that a court in Xiamen actually ordered Fleischli to be held.  I am pretty certain that in every case like this on which my law firm has worked, there was no court order.  Instead, the company and the police had merely acted together to block any exit by our client.

In “Bo Xilai’s Lessons For Your China Business,” we wrote of how arguing that the hostage does not personally owe the debt is usually not the fastest/best way to resolve these sorts of situations:

I say this because we have been involved in at least two cases where this was the case. U.S. company owes money to Chinese company. U.S. company ceases to do business and so its key figures assume the issue is resolved in that the company has no assets to pay any debt.  They then get on a plane to a foreign country (one was a China case, the other was a Russia case) and they both get seized and “held hostage” until we negotiate out their release. They wanted us to argue that they personally did not owe the debt; their companies did. Our response was to tell them “that would be an excellent argument if we had the luxury of filing court briefs and waiting months for a judge’s decision, but our goal here is to get you released as quickly as possible.”

We deal with this issue in its nascent stages all the time when we work with our clients to shut down their Chinese entities (which for some reason has been happening like crazy of late). We always instruct our clients never to reveal that they will be shutting down their China operations while anyone from the home office is in China. We also tell them that if they or their company ever wish to return to China, they should pay off all their debts and usually the best way to do that is to announce from outside of China the plan to gradually shut down the China office and then, using that as leverage, negotiate down all of the debts. We always stress that once a reduced debt is agreed upon, there should be a written agreement on that and there should be proof of payment on that agreement as well.

All of this is necessary if you want to formally close your China entity, which is, in turn, necessary, if you want to be able to return.

Fleischli appears to be in an even worse situation in that a court has already found him personally liable for the debt as NorthPole’s legal representative in China.  Fleischli pleads ignorance: “I had no clue,” Fleischli told the Post-Dispatch. “I’m an American guy over here in China. I can’t read Chinese. I had no idea what a legal rep even was.” To which we can only say that ignorance of the law is no excuse in China just as in the United States.

Now here’s where the story gets weird.

Then in May, Warburg Pincus fired Fleischli for “gross misconduct.” The company declined to comment further on the firing, but Margo said it meant Fleischli also lost access to the company’s lawyers in China.

It’s not clear to Margo or Fleischli why the firing didn’t absolve Fleischli of his duties as NorthPole’s legal representative. Fleischli has sued NorthPole and Warburg Pincus seeking severance and damages and asking to be removed from that role. Margo believes that would help him get out of China.

But Warburg Pincus says it can’t remove Fleischli from that role.

“Warburg Pincus has had no involvement with any travel restrictions Mr. Fleischli may have in China. The firm does not control Mr. Fleischli’s status as legal representative of NorthPole in China, and does not control any travel restrictions that local authorities in China have placed on him,” the company said in a statement.

Fleischli was fired in May. Why didn’t anyone pay the company debt before that?  Presumably it is because the company lacked the funds to do so. Why didn’t Warburg Pincus pay the debt then? Presumably because even though it has power to fire the company CEO it is not on the hook for company debt. I guess that can make sense.  But what about removing Fleischli from his role as NorthPole’s legal representative?  I do not see why NorthPole and Fleischli cannot agree to make that happen, unless, of course, Chinese law forbids changing legal representatives in a situation where the company has debt.  But I also do not see how Fleischli’s removal as legal representative will help him at all with his present situation.  I truly hope Fleischli has good legal counsel in Xiamen where he is being held.

The story concludes by pointing out how the U.S. State Department’s website makes clear that when it comes to commercial disputes, the Chinese “may prohibit you from leaving China until the matter is resolved under Chinese law. There are cases of U.S. citizens being prevented from leaving China for months and even years while their civil cases are pending.” And how the U.S. Embassy and consulates general “have no law enforcement authority in China and cannot recommend a specific course of action, give legal advice, or lobby the Chinese government regarding a private citizen’s commercial dispute.”  All true.

For more on hostage situations in China, check out the following:

And just to scare you a little bit more, I have a friend who works for a high end China risk consultancy and he tells me that they started seeing a massive increase in these cases this year.

What are you seeing out there?

Every few months we get a call from someone wanting to shut down their China WOFE (Wholly Owned Foreign Entity a/k/a WFOE or Wholly Foreign Owned Enterprise). Interestingly, these calls usually come from companies who have been in China for a long time (average time, maybe ten years). Their reasons for seeking to leave China are all over the map but usually involve a decision relating to their China operations lack of profitability or lack of cost-effectiveness. Surprisingly often, they say that they might return to China in three to five years. And that is the problem.

If both you (and I will define that later in this post) and your company will never ever again be returning to China AND if both you and every other foreigner in your company will never again be returning to China, closing down is easy. Essentially, just close down.

A friend of mine who does business in China found himself not being allowed to go out of the country because of a lawsuit filed against him by a Chinese company. They are saying that he owes them money while all the while they have been cheating him (cutting corners on products, using low quality materials instead of the good quality materials agreed upon, late shipments which causes cancellation of orders). He was not notified beforehand of this lawsuit against him before he came and only found out about it when he
was about to return home and was stopped at the border crossing. Is there a way he can be allowed to leave China while the case is pending?

We have written about this same thing numerous other times:

If you have any foreigners in China and you want to shut down your business, either get all of those foreigners out and have them never again return, or shut down your business correctly.

How then does one shut down a Chinese business correctly?

There are essentially three ways.

1.  Formally dissolving the company.  This is done by paying all existing debts, including especially all debts to employees and to the government. Doing this correctly (and complying with China’s myriad labor laws) involves going through a long drawn out government audit and typically takes at least a year and is far more complicated and time consuming than you would think. The advantage to shutting down this way, however, is that in the end you satisfy the government and both your company and its employees could return to China the next day (or whenever) and legally open a new business. Without a formal dissolution, there is a good chance that neither your company, nor any of its employees of whom the Chinese government is aware, will be able to return to China problem-free.

2.  Filing for bankruptcy liquidation. if your company does not have the funds/assets to pay its debts, it may liquidate under China’s bankruptcy laws. We have many times looked at this option for our clients and many times we have been of the view that this option would have been a legally viable one. However, none of our clients have yet to pursue this option because in every instance it was determined that it would be cheaper and easier to go through a formal dissolution per the above. I am not even aware of a foreign owned Chinese company that has pursued bankruptcy in China. Are you?  

3.  An informal petering out.  Due to the time and costs involved in the two scenarios mapped out above, we have “created” a third option for our clients. This option makes the most sense for those companies that really do think they will be back in China within the next few years. This option involves the compamy doing the following, at minimum:

  1. Terminating all Chinese employees with an agreed upon severance package and a signed release of any and all claims they might have against the company. It is critical that this be done pursuant to China’s labor laws.
  2. Either buying out any lease(s) or letting any existing lease(s) expire. We have generally found that Chinese landlords are not terribly willing to give decent discounts for one time lease termination payments. 
  3. Paying all government taxes, pensions, etc. and remaining current on the same.

After completing the above, the WOFE still exists, but is essentially dormant. At this point, it must still pay its taxes (which should be minimal) and still comply with any and all government reporting requirements.This is at best a temporary solution because doing this does not stop the cost meter from running entirely and there will almost certainly come a point where the government will either start imputing higher taxes or demand a formal shutdown. The biggest benefit of this method is that it is fairly cheap and if you really are uncertain as to whether to stay or go, it will buy you time while at the same time, clearing off your books so that any subsequent formal shutdown ought to go just a bit quicker and easier. The beauty of this option is that if you do eventually decide to revive your China operations, there is already an existing company in place by which to do so.

What do you think?

The other day, in a post entitled, “China Hostage Situation. Now IS A Good Time To Pay Your Debts,” I wrote about some U.S. executives who were being held hostage in China over nonpayment of a business debt. Their US based company had gone bankrupt and when they went over to China to explain all this to their Chinese suppliers, they were taken hostage. I have since learned that they were eventually released, though I do not know whether a payment precipitated that release or not.

Forbes Magazine just came out with an article, entitled, “How To Avoid Getting Kidnapped In China,” the thesis of which is that if you are going to do business with another company in China, you should find an “uncle” first who will be able to mediate any disputes that might arise between the two of you:

Before entering a partnership with a Chinese company, you should find an “uncle”–a person both parties trust who will be able to mediate differences. This assures each side that issues will be resolved fairly. I have seen too many American businessmen drag out an inch-thick contract with some clause that they think lets them out of a deal. To their Chinese counterparts, it is clear the Americans are cheating. Use relationships rather than legalese whenever possible to solve problems.

The article  even posits that this US company whose executives were held hostage could have avoided their fate had they had such an uncle: “The case written up by China Law Blog should have been handled that way. Had the foreign company turned to an uncle to smooth relations before declaring it would not pay, the dispute would never have gotten to hostage-taking.”

Well maybe. But I still think the safer tact would have been to get all of your people out of China and then negotiate a payment plan from afar.

The article then talks about the need to “build guanxi:”

Many Americans have heard of guanxi, but it’s often translated wrongly to mean relationships with powerful people. Guanxi means something very different from the American concept of connections. It means being in a social circle where you can let your guard down a little, because there is deep trust, perhaps from generations of coexistence, living in the same neighborhoods or even with interwoven family relations. In the case I was involved in, the CEO didn’t want to hurt his relationship with the uncle, and once he knew I, too, was in the uncle’s circle, he wanted to create a friendship with me.

Many consultants like to tout that they have good guanxi and can arrange meetings with powerful officials to grease the wheels of commerce. They may be able to get the meetings, but those powerful people don’t usually really trust them–especially if the consultants are former officials of foreign governments, as they often are. Building long-term trust is very difficult, especially for those who once sat across negotiating tables representing other countries. Acceptance into a guanxi circle can take years.

Long-term perspective is very important in China. A defaulting borrower should avoid saying he won’t pay and instead pay a little right away and explain that he is hurting but will make good in the future. You cannot rely on bankruptcy to absolve debts.

Bottom Line: We definitely agree on the need to build long term relationships in China and having an “uncle” is certainly not a bad idea. The real key is to build up your relationships before you need them. And if you owe money to someone in China, the wise thing to do is to not go to China until your debt issue is resolved.

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Just got an email from a regular and very much trusted reader. The email (with all identifiers removed) is as follows:

Consumer product company had a rep office – staffed with people with US passports. Company had financial problems and needed to file for bankruptcy. The company sent one of their executives to China to advise their suppliers that they were declaring bankruptcy and would be unable at this point to pay their outstanding balances.

As you can imagine, the Chinese suppliers did not take this well, and they stormed the rep office and are now holding the US citizens hostage – literally. Its been days now –and neither the police nor the embassy will help to extract the people.

The whole thing was obviously not handled properly from the start – but this has turned ugly pretty quickly. Each factory is mainland owned.

I’ll let you know how this turns out – I’m not involved – just hearing most of this second-hand.

I hope to write a happy ending to this story when/if it resolves itself in a safe way that protects both the US people as well as the suppliers – but I am not so sure it will be.

Have you encountered similar experiences?

Oh yes we have. Many times. But if we had been retained, our advise would have been so different that I would like to think things would have never reached this point. We would have told this company to get ALL of its personnel out of the country before letting suppliers know (from far far away) that you had just filed for bankruptcy and that payment would be slow, at best.

We did have a client quite recently in a similar situation, which we wrote about in our post, “China, We Have A Problem. A Mostly True Story. The key takeaway from that post is that the very first thing we emphasized was the need to get everyone out of town.

Many years ago, I had a similar situation where our client was alleged to owe money to a Vietnamese company. The Vietnamese company had shipped product to our client which we contended was defective and for which my client refused to pay. My client absolutely had to go to Vietnam to meet with other clients and he and I were both very concerned about what might happen to him there. My advice was that he not go, but he insisted that he had too. That being the case, we decided the best approach would be for my client to sue the Vietnamese company in a US court, alleging the Vietnamese company owed my client money for defective product. Our thinking was this might help insulate the client from problems in Vietnam. If the Vietnamese company tried to have my client imprisoned for his company’s alleged debt, we would at least be able to point out that there was an ongoing dispute between the two companies and that the Vietnamese company was seeking to act against my client in Vietnam not to collect on an unpaid debt, but in retaliation for my client having sued. My client went to Vietnam without incident and a few months later we were able to settle all claims. We heard through the grapevine that the Vietnamese company had actually been intimidated into inaction by our lawsuit.

About a week ago, I wrote a post, with the somewhat tongue in cheek title, “Owe Money To A Chinese Company? No Need To Pay. It was on how foreign companies need not worry much about Chinese companies pursuing them overseas for unpaid debt. The gist of the post was that if you need to prioritize who to pay, you should put your Chinese creditors last. Even so, I stressed that this equation applies only if you do not have a “real presence” in China:

This is not to say, however, that foreign companies that do not pay may not face repercussions other than a law suit. For example, if you are a foreign company with a real presence in China, not paying a Chinese company might end up causing you real problems in China and you must consider this before choosing not to pay. Just by way of example, we represent a large Chinese manufacturer in an industry where there are only around five companies capable of manufacturing this particular product. Our Chinese client is owed millions by a US company and that US company figured it would not need to pay. What this US company did not figure was that our client would alert the other manufacturers of the non-payment and now none of those manufacturers will make product for this US company either. Once the US company started running out of product, it started paying our client again. On the other hand, if you have but a small presence in China and you can switch your manufacturing over to some other country….

So what should this company do now? I guess my advice would be to negotiate to get these people out of there as quickly and as cheaply as possible.

What do you think?