Just read a Bloomberg News article, “Proview Using ‘IPad’ Name is Harmful: Apple,” that quotes me on the Apple-Proview dispute, as follows:

“It’s not really trademark law, it’s about whether the trademark was legally transferred or not,” Dan Harris, a Seattle-based lawyer with Harris & Moure who handles cases on intellectual property in China, said before the hearing. “Proview Taiwan agreed to sign over the trademark, but Proview Taiwan didn’t own the trademark.”

I see the case as being about authority. Authority to sell the iPad trademark. Who had the authority to sell the iPad trademark to Apple back when Apple (acting through a third party intermediary) thought it purchased the trademark for iPad in China back in 2009?  Let me explain.

If you bought the Brooklyn Bridge from me, you would not own it. Why not? Because I cannot transfer title in the Brooklyn Bridge to anyone because I do not own it in the first place. This analysis should be the starting point for analyzing the Apple-Proview case. I say this because it appears that Apple bought the iPad China trademark from a company that did not own it. Apple (again, acting through a third party intermediary) bought the iPad China trademark from a Taiwanese company called Proview Electronics Company, Ltd. (“Proview-Taiwan”) at a time when a Shenzhen company called Proview Technology Shenzhen Co, Ltd. (“Proview-Shenzhen”) actually owned it.

So the big legal issue in China is not really a trademark issue, it is an ownership and authority issue. The ownership of the trademark when it was allegedly sold is not really in doubt; it was owned by Proview-Shenzhen. The real question is whether Proview-Shenzhen authorized Proview-Taiwan to sell the iPad trademark to Apple and that is mostly what is being argued in the Chinese courts.

To modify the Brooklyn Bridge analogy, let’s say that you bought a house from Mr. Jones and it turned out that Mr. Jones did not own the house, but rather, his wife, Mrs. Jones, owned the house. If Mr. Jones and Mrs. Jones were in the midst of a divorce and she had told him not to sell the house and had told you that she owned the house and so Mr. Jones could not sell it to you, your claim to own the house through the purchase would probably be pretty weak. But let us suppose that Mr. and Mrs. Jones were happily married and Mrs. Jones was right there during the negotiations for the sale of the house and never said a word about how she was the one who actually owned it. Well your claim to own the house would be a lot stronger.

The Apple-Proview case is dealing with similar factual issues, as can be seen in the Bloomberg article. In other words, it looks like a factual mess.

And that is not the only factual mess. Remember how I keep saying Apple used a third party intermediary to try to buy the China iPad trademark. Well, Proview-Taiwan is suing Apple in the United States about that, claiming that the way Apple sought to buy the iPad name constituted fraud and unfair competition. My initial reaction upon hearing of this lawsuit was to assume it had little validity. I assumed this because it is quite common for big companies (small ones too) to try to buy something through a third party intermediary so as to avoid revealing to the seller how much the desired item may really be worth and I had never heard of a lawsuit being brought over that.  But in reading, “How Apple snookered Proview to get the iPad trademark,” I am not prepared to just laugh off that lawsuit.

So what should your takeaway be from the Apple-Proview case? Nothing more than that you need to be sure that the company with whom you sign a contract is the right company. I know this sounds basic, but this sort of thing happens more than you can imagine in international deals.  I personally have worked on at least two joint venture deals gone bad where the American company had signed an agreement involving the wrong party. In both cases, the American company thought it had a deal to be the distributer of the Joint Venture’s products outside China, but in fact, the agreement actually said that the American company would be the distributer for its Chinese joint venture partners’ products. And since the Chinese partner did make products that the American wanted to distribute….

For more on the Apple-Proview case, check out “Apple v. Proview. China Trademarks And So Much To Learn” and if you want still more, go over to China Hearsay, where Stan Abrams has written nearly a dozen posts on this case. And for you law-geeks out there, click here for a copy of the just-filed Amended Complaint (along with some interesting exhibits) in Proview’s U.S. litigation against Apple.

Surprised and honored by a post over at the Associate’s Mind Blog (a terrific blog, BTW, written by a neophyte lawyer out of Birmingham Alabama). The Post is entitled Law Library of Congress Archiving Blawgs and it told me something I did not know: The Library of Congress maintains an archive of what it has apparently deemed to be the top legal blogs and that list includes CLB:

I went in expecting to find only things like the Harvard International Law Journal (which I did), but I was also pleasantly surprised to find regular blogs, such as China Law Blog, Simple Justice, The Trademark Blog, and others included. There are even a couple Canadian blogs included as well. It’s a nice resource when/if some legal bloggers decided to hang up their hats.

The full archive is here. In addition to our blog, Stan Abrams’ China Hearsay also made the cut and so too will live forever. Near as I can tell from my quick review, the list of the 100 or blawgs that are being saved for archiving are all worth a read so if you are searching for a new law blog or two to follow, do check out the archive.

On November 4, CLB’s own Steve Dickinson participated in an Internet discussion regarding Variable Interest Entities (VIEs) in China. The discussion was entitled, “Foreign Ownership in China: Still VIEable?” and the other participants were China Hearsay’s Stan Abrams (an attorney), China Accounting Blog’s Paul Gillis (an accountant), and China Finance Blog’s Fredrik Öqvist (a financial analyst).  A full transcript of the proceedings can be found here. If you have any interest in VIEs or investing in the companies that have VIEs, I strongly urge you to read the transcript. I also urge you to check out this post on VIEs, which has a long list of good readings on VIEs.

What I found most interesting about the discussion is that everyone seemed to agree that Chinese courts will not enforce the contracts on which VIE structures are based. In light of this, what exactly do U.S. listed companies with VIE structures really have in China?

For the last couple of years, there has been massive discussion regarding Variable Interest Entities (VIEs) in China. We at China Law Blog have taken a strong stand on them and our position has always been that we will not do them because we do do not think they hold up to legal scrutiny. Or to put it another way, our law firm is too small to withstand the onslaught of malpractice litigation we forsee when these VIEs start to unravel.

Under a VIE structure, a Chinese Internet provider is effectively owned by a foreign entity through a complex set of contractual arrangements, rather than through ownership of stock.  The control by the foreign entity is so total and complete that the arrangement is considered the equivalent of ownership under U.S. accounting rules. However, by there being no actual foreign ownership of stock, these VIE structures have managed to operate in China, evading the clear rules restricting foreign ownership.

Our concern has always been that the Chinese side in these deals will be able to jettison the foreign company because the foreign company will not be well positioned to fight back because its connection with China is not legal. We are hearing that none of the Big Four accounting firms will have anything more to do with VIE deals so it appears that our stand on this issue has now become the new reality.

Others do not see things the same as us and think that we are being too cautious and that VIEs are too important to China and so will always be protected.

This Tuesday, November 1, there is going to be a web discussion/debate/cage fight involving some very outspoken people on VIE structures. The event is going to consist of CLB’s own Steve Dickinson (an attorney), China Hearsay’s Stan Abrams (an attorney), China Accounting Blog’s Paul Gillis (an accountant), and China Finance Blog’s Fredrik Öqvist (a financial analyst).

There will also be a VIE-related Q&A through the G+ site during the course of the week. Anyone with an interest in VIEs should tune in. Go here to find out more. The main event will take place this Tuesday, November 1, from 10 am until 11 am EST.

For background on VIEs, I suggest you read the following China Law Blog posts:

And the following China Hearsay posts:

And the following China Accounting posts:

And the following China Finance posts:

If you read all of the above, you will probably know more about VIEs than anyone else alive. If you are going to read just one post, make it “Explaining VIE structures.” Oh, and just to give you more to read, I also recommend you read the Silicon Hutong post, “VIEs, The Long Resolution.” In that post, David Wolf talks of how the Chinese government likes to “boil its frogs slowly, not all at once,” and he then talks of how VIEs are on the wrong side of where China wants to be going. I could not agree more. I do not see VIEs disappearing overnight; instead, I see foreign companies involved with VIEs suffering a very long and very gradual squeeze out.

What do you think?

Yesterday, co-blogger Steve Dickinson wrote a post essentially excoriating VIEs. That post went live early this morning. A few hours before our post went live, Bill Bishop (who knows as much about China’s tech industry as any human being alive) wrote a post essentially saying that those who are trashing VIEs are engaging in scare tactics and that there is little cause for worry.

Bishop makes his very powerful counter-argument on his Digi-Cha blog, in a post entitled, “Bloomberg Keeps VIE Fears Alive: China Companies Evading Rule With U.S. Listings Stump Regulators” [link no longer exists]. Bishop contends that “so many powerful interests have financial stakes in VIEs that it would be career suicide or worse for a Chinese bureaucrat to destroy this structure on a wholesale basis.” We do not disagree with this statement, but we do not think it deals with the two main issues. One, the government has come out with regulations making very clear that such structures are illegal. On top of that, and as we have said all along, these regulations probably should not have even been necessary because VIEs were almost certainly already illegal under a proper reading of the various applicable laws. Having said this, however, we fully recognize that the Chinese government has in the past come out and said something was illegal and then done nothing about it. See, for instance, “China Rules Skype Illegal. Tell Me Something New,” where we predicted that the government’s making Skype “illegal” would have no real impact.

But with VIEs it is different and Bishop does not address our main point (note again that his post came before ours).

Whether or not existing VIEs are shut down (and at this stage we tend to agree with Bishop that they generally very likely will not be), the reality is that they have now been deemed illegal and that cannot help but have a major and game-changing impact on them. As mentioned above, VIEs are a structure that allows foreign companies to control the Chinese entity via various contracts. Now that those various contracts have been declared illegal, it will be difficult/impossible to enforce those contracts in Chinese courts. In this VIE structures, many of the contracts involve foreign countries and foreign country enforcement so their illegality in China may be minimized to that extent. However, even outside China, the party seeking to avoid enforcement of a contract will, in many cases, still be able to argue against enforcement based on China’s having made the structure illegal.

In many ways, what is happening to VIEs is no different from what we have called “fake Joint Ventures” and on which we wrote in the post, “Fake China Joint Ventures: Why You Calling Me, I’m Not The Guy:

In that post, I very loosely transcribed into one conversation a number of conversations I had been having with people wanting to set up contractual arrangements to avoid China’s expensive and difficult joint venture laws:

Caller: I’ve got this great website and it is exactly what China wants/needs. And I’ve been working on developing it with some Chinese tech friends of mine and we want to take it legal so we can start getting VC (venture capital) funding for it. Here’s our plan. Now I know that the old/truly legal/expected/usual way to do this is for me to form my own company and then form a joint venture with my Chinese partners, but I also know that will cost a lot of money. So our plan is for the Chinese company to own the website and then we will have an oral agreement (or a written agreement) that I really own half of it.

Me: Listen, my firm has been contacted at least twenty times after these situations have gone bad and I am aware of at least another twenty times where the same thing has happened, and let me tell you, these arrangements (it is NOT proper to call these joint ventures) virtually always end the same way. They end with the Chinese company booting you out completely and leaving you with no recourse. Protecting foreign companies in legitimate joint ventures is difficult enough, but it is pretty much impossible under the scenario you are describing. We had a guy who paid us a lot of money once for us to do everything we could to try to get “his” multi-million dollar business back. Guess what, we could not even come close to getting it back. Every Chinese lawyer we talked to about suing to get it back told us we had no chance of winning at all. I mean, just listen to the argument we would need to make to the judge:

Your honor, my client knew that China’s laws are very clear on what foreign companies must do to operate legally in China, but he thought these very clear laws should not apply to him because, well because he is an American tech company and he was just too smart/too poor to bother to comply with the very clear laws. So instead, he had this great method for completely circumventing China’s very clear laws. His idea was to not form a company, but rather, have his Chinese friends form the company and he would have a little side deal with that company. Well, that side deal has now gone bad and my client wants you to go against China’s very clear public policy on how foreign business is to be done in China and enforce this unwritten side deal.

What do you think of that argument?

Caller: (long pause) I understand things could go wrong with that kind of arrangement, but would you be willing to draft the contract between me and the Chinese company?

Me: No. I can’t do that. I can’t draft a contract that I know will never work. I just can’t. Give me a call if you ever want to do this legally, in a way where you actually have a chance of profiting from your work down the road.

For more on this, check out “China SMEs, Own If You Want To Own.” To get a feel for how difficult it can be even with a fully legal joint venture, check out this article by Steve Dickinson in China Brief, entitled, “Avoiding Mistakes in Chinese Joint Ventures.” and this Wall Street Journal article I wrote, entitled, “Joint Venture Jeopardy.

Update: In, “Private Equity, Venture Capital and ‘Fake’ China Joint Ventures,” China Hearsay very nicely maps out the way these deals are typically done (using an offshore holding company) and notes that you might have legal recourse in the rare instances where your Chinese partner has “huge assets offshore” in a country in which you can sue and win:

You can tie up the Chinese founders in 100 different contractual knots, but unless those founders have huge assets offshore (real assets, not equity in the holding company) that you can go after in a dispute, they can always tell you to piss off and kick your ass out of the business.

All I can say is that I have never and I will never invest in a company based on so thin a reed.

FULL DISCLOSURE: Our firm long ago made the decision to work with those companies and individuals with claims based on the arrangements set forth above, as opposed to representing those wanting to enter into such arrangments.

THIS JUST IN: Stan Abrams over at China Hearsay is out with a post, entitled, “A Post-Holiday Update on VIE Chatter,” that essentially says what this post says, which is that the dividing line between Bishop and us is that Bishop is analyzing what the government is likely to do with existing VIES while we are analyzing the risks involved in having a corporate structure based on unenforceable contracts. Stan completely nails it when he says he thinks the differences between us and Bishop stem largely from the angle from which we are looking at the VIE issues:

Anyway, I have nothing new to say, but I did want to point out a couple of new things for you VIE groupies to read. First is a lengthy Bloomberg overview of the issue. It’s generic, and therefore a decent place to start if you’re looking for a jumping-off point to the topic. Second and third are two opinion pieces, by Bill Bishop (DigiCha) and Steve Dickinson (China Law Blog), who sort of set themselves up on opposing sides of the issue.

It was interesting reading these two blog posts, since both authors are wicked smart, experts in their respective fields, and very opinionated (not that there’s anything wrong with that).

Stan then describes Bishop’s post as putting forth “The sky is not falling” position and Steve’s post as “VIEs are complete rubbish and should be avoided like the plague.” Stan then notes how the positions appear very different, but maybe not so:

So, at first glance, two very different views, and I bet they would get into a serious argument if the opportunity arose. But I actually think that their fundamental conclusions are both right but are merely coming at the issue from two very different perspectives. Bill is a Internet and finance guy, and is looking at the market, firms’ access to capital, and what the government is likely to do.

Steve, on the other hand, is a corporate lawyer. He is looking at potential risk, at what might go wrong, and what is/is not a technical violation of the law.

When Bill says that we shouldn’t worry about the government going after Chinese listed firms in the U.S. that use the VIE structure, I think he’s right. All the inside chatter on that issue seems to indicate that the government will grandfather in those companies even if it adopts a new enforcement strategy.

And when Steve says that VIEs are rubbish, he’s of course right. These things are illegal in that their purpose is to deliberately skirt foreign investment restrictions. I don’t actually agree with him on what the M&A rules mean (I think it’s too early to tell), but I definitely agree with his overall legal opinion.

Stan then goes on to say essentially what I say above, which is that the story is not the shutting down of VIEs, it is the inherent risks they present by being based on illegal contracts:

All this being said, if I have one bone to pick with recent commentary on this subject it’s that it emphasizes the latest regulatory goings-on without paying attention to the real risk story with respect to VIEs. The most likely source of problems with these companies has nothing to do with the government, but rather with unenforceable contracts and unstable shareholding structures. Perhaps this is one of those things to which Bill was referring when he said that there are other reasons to be cautious about investing in China. (I should also point out that Steve regularly writes about these sorts of legal issues as well.)

I completely agree.

UPDATE: Fredrik Öqvist over at the China Finance Blog did an excellent post today, entitled, Consolidating Recent Opinions on VIEs, in which he seeks to synthesize all the posts that have been written on VIEs in the last few days by me, by Steve Dickinson, by Stan Abrams, and by Bill Bishop. Fredrik concludes his post with his own take on VIEs:

Here’s where I think the real issue lies, but I don’t think it’s entirely confined to future deals and PE/VC investors. This could for all intents and purposes have a deeply negative impact for listed companies as well.

In order to consolidate VIEs one has to show that the listed company not only receives the economic benefits and takes the economic risks of the venture, a second condition is to show that the VIE is in fact controlled by the listed company. If the contracts, which are put in place to establish this control, are indeed deemed illegal and unenforceable, fulfilling the second part of the consolidation requirement becomes decidedly more difficult.

I agree.

Growing up, I used to occasionally play basketball with a guy by the name of Eddie Stokes. Eddie was a few inches shorter than me, but a heck of a lot stronger and quicker and he used to give me fits. What particularly irritated me about him was that every single time he would score against me (or anyone else), he would point at me and say “money….so money”  Though Eddie was a nice guy, every time he did that, I wanted to punch him.  But seeing as how he was a golden gloves boxer (and apparently 1-0 as a professional), I was smart enough never to do that.

I thought of Eddie for some strange reason today when viewing the “China Money Podcast” site for the first time. I was directed to this site by a China Hearsay link-over to a podcast by China Hearsay’s Stan Abrams on Variable Interest Entities. The podcast is called “Variable Interest Equity is a Very Risky Structure” and it is excellent.

Stan knows VIEs and, even more importantly, he and I see pretty much eye to eye on them. To grossly summarize our positions, we are both wary of VIEs and particularly of the idea that they are risk-free. If you want to listen to Stan discuss VIEs and the risks (and rewards) inherent in them, I urge you to check out his podcast here, or go here for the iTunes version.

Stan has written extensively and well on VIEs, including the following:

For even more on VIEs, check out the following CLB posts:

How do you feel about VIEs?

For years I have been fighting against those who claim Chinese laws are gray. China’s business laws are generally as well written or as clear as any other country’s. My contention has always been that those who claim China’s laws are grey are usually just saying that to excuse their own failure to abide by them.

I wrote on this way back in 2007, in the post, “China Company Formation Law Is Clear — WFOEs Are Easy,” where I talked of how the so-called lack of clarity in China’s laws on forming companies arises from those who have not actually read them or from those who benefit from propagating this idea:

We recently took on three new WFOE formation matters for U.S. lawyers. Two of these matters are for lawyers working on behalf of their clients and one is for a lawyer who owns the (non-law related) business. All three of these lawyers told me they had spoken with company formation firms and had grown frustrated with the information they were being given. They relayed that these firms were not giving clear answers to many of their questions, but were instead responding by saying China’s WFOE laws were “vague” and/or “ever changing.”

What these company formation firms are saying is just not true.

Chinese law on WFOE formations is actually quite clear and I suspect these company formation firms were claiming otherwise only because the laws are vague to them. Near as I can tell, these company formation firms typically consist of a foreign voice or two (oftentimes in Hong Kong) who takes in the work and then farms it out to a Chinese lawyer in a low cost city to do the work. The people on the phone or at the other end of the e-mail at these firms have never read China’s laws on WFOE formation and so, not unexpectedly, those laws are vague to them.

As for “ever changing,” on January 1, 2006, there was a sea change in China company formation laws for foreign companies, but they have remained static since then.

By far the biggest source of confusion/frustration for these lawyers seeking information on forming a China WFOE is the minimum registered capital requirement.

The law on minimum registered capital is clear, but the amount of capital that will be required does vary, depending mostly on the nature of the business of the company to be formed and on the city in which it is going to be registered.

I wrote on this again in 2009, in a post entitled, “China’s Business Laws. Ignore Them At Your Peril.” In that post, I reiterated that China’s business laws are just fine:

But what about the grey areas in China’s laws? China’s laws are simply not that grey. They were grey five years ago, but their business laws are now, for the most part, pretty clear, particularly as they apply to issues important to foreigners.

I really do not see much more gray in China’s business laws than in those in the US.

In the post, “Rationalizing Risk: Phantom Gray Areas in Chinese Law,” China lawyer Stan Abrams seems to concur. Stan’s post is on VIEs and he gets all nicely worked up by those who attribute the problems that arise from them to gray areas in China’s laws. Stan starts out by talking of how the media (and others) have been chalking up Yahoo’s problems with Alibaba to “gray areas in Chinese law” and Stan ain’t buying it:

It sounds comforting, but I think it’s a rationalization employed by those responsible for making risky moves in the first place. When the Board of Directors is staring you down and asking “How the f#@% did this happen?” you tend to shift the blame elsewhere.

Bloomberg ran an article on the Yahoo/Alibaba case, written by Debra Mao in Hong Kong, in which the dispute was explained away, for the most part, as the result of uncertainty due to legal gray areas. (The title of the piece was “Yahoo’s Alibaba Spinoff Losses Show Dangers of China’s Legal Gray Areas.”)

For my take on Yahoo/Alibaba/Alipay, check out “Yahoo/Alibaba/Alipay/Jack Ma/Carol Bratz: What Really Happened And What It All Means.

Stan goes on to extoll a quote from Pillsbury Winthrop’s Tom Shoesmith:

Western businesses come into China and they want to know what the rules are, Shoesmith said. There’s the technically correct answer, there’s the practical answer, and then the third one is, “Who cares anyway?” Sometimes the answer is “Who cares anyway?” until you get busted.

Stan sees Shoesmith as saying “that his clients sometimes flaunt risk entirely, hoping that they won’t get caught. This isn’t about whether the system here is transparent, or unclear, or if gray areas exist. This is about understanding risk and plowing ahead anyway.”

I 100% agree. Just as my firm always makes very clear in writing the fact that VIE structures are inherently risky and are of questionable legality in China, I am quite certain that every other legitimate law firm does the exact same thing. That being the case, no company can claim that it had no idea of the potential problems with VIEs and no company that does a VIE structure in China can claim a “gray area” excuse. Or as Stan puts it, gray areas in Chinese law “does not explain Yahoo/Alibaba, and it doesn’t mesh with what Shoesmith was saying.”

And lest anyone out there think that the VIE structures are gray, Stan emphatically tells us that they are not; at minimum, they clearly go against the spirit of Chinese law:

Remember the fundamental problem with the so-called “Sina Structure” or “VIE” that I’ve talked so much about recently? If you recall, the government restricts foreign companies from investing in certain industries, yet some of those sectors are so attractive that foreign investors will pretty much do anything to get in anyway.

So what happens? An elaborate structure is cobbled together that includes offshore holding companies, onshore subsidiaries, and a series of exclusive commercial agreements. This is done to approximate, as much as possible, a direct investment.

Here’s the crux of the matter. Is this kind of structure an example of a legal gray area under Chinese law? News Flash: this isn’t a gray area at all; it’s obviously improper, designed to circumvent Chinese foreign investment law.

Yeah, I really said that. It’s rather obvious. All those folks out there, including many of the top Internet firms in China that received foreign money, who set things up to skirt legal restrictions, are violating the spirit of the law.

Stan then points out that the real issue with VIEs is not their legality, it is simply whether the Chinese government will continue to look the other way and allow them to continue:

To be clear, I’m not suggesting that legal uncertainty doesn’t exist. Indeed, when I counsel these guys, the discussion is not “Hey, you know you’re violating the spirit of the law?” They already know that. What they really want to know is the likelihood that: a) their structures will be enforceable, and b) will the government swoop down on them at some point and force them to restructure (e.g. Yahoo/Alibaba).

So yes, there is uncertainty here with respect to enforcement of these structures and their related commercial agreements. Moreover, the authorities here are aware of these “spirit of the law” violations and generally allow them to exist (at least until they decide otherwise).

That’s a far cry, however, from suggesting that the structures themselves occupy a gray area under Chinese law. They don’t. That’s wishful thinking and a rationalization.

But I understand what’s going on here, at least psychologically. If there is a gray area, then the investor and his lawyer are off the hook, at least to a certain extent. Instead of telling the Board of Directors “I knew it was illegal, but since everyone is doing it, we decided to go for it and hope for the best,” a more respectable “The legality of the structure is unclear, so we moved forward as carefully as possible” can be used instead.

So true.

In fact, I am going to go a step further and say that the Chinese government generally does not crack down on foreign companies unless their violations of Chinese law are clear. So the next time a foreign company claims its Chinese legal problems were due to “gray areas” at least make them explain the law being discussed.

I also like Law Professor Donald Clarke’s post, “Phantom gray areas in Chinese law.” Professor Clarke also notes how “gray areas” are used as an excuse for contravening what was actually quite clear:

I want to recommend this post from China Hearsay on what the author (Stan Abrams) calls “phantom gray areas” in Chinese law. These are areas where the law really isn’t uncertain at all, but people for various reasons like to pretend it is. Sometimes it’s just because they don’t like the rule; sometimes it’s so that they can blame unpredictable government policy instead of themselves when things go wrong. Stan’s example is that of the use of contractually-based Variable Interest Entities to attempt to get around Chinese restrictions on foreign ownership in various industries.

One favorite area of mine is the uncertainty I often heard alleged about what would happen to long-term land-use rights under the Urban Real Estate Administration Law when their term expired. (This is before the Property Law injected real uncertainty into the process.) Well, the answer was always quite clear: everything goes back to the state, including all buildings on the land, without any further compensation. But holders of LURs didn’t like this result – they would conjure up pictures of granny being thrown out onto the street as year 70 expired. (As if the LUR holder hadn’t had a full 70 years’ advance notice that this was going to happen!)

Where’s the gray?

What do you think?

Last week, China came out with some guidance as to how it is going to determine whether foriegn company acquisitions (M&A) endanger China’s national security and there have already been all sorts of articles speculating that this is going to mean a real crackdown on foreign acquisitions. I was going to wait a few weeks to write on this, but since Stan Abrams over at China Hearsay just did such a nice job covering it, I am going to write on it now.

I like Stan’s view of it because it comports with mine. In his post, entitled, “Reciprocity and Slippery Slopes: China’s New M&A Review System,” Stan tells everyone to relax. I could not agree more.

Stan bases his advice on the following:

1. China’s laws often start out with little detail and then it “sometimes it takes years before additional guidance (e.g. from the Supreme Court) or simply a track record of judicial action lets us know how a new law is going to be enforced. In other words, let’s not get too excited about the broad language in the scope of this review body just yet.”   

2. “Beijing has always been big on reciprocity. If a foreign government does something to China, or Chinese companies, there is a good chance that Beijing will strike back in some way. We’ve seen this with trade and investment matters, visa procedures, etc. To some extent, this national security review is a reaction to similar bodies abroad that have hindered efforts of Chinese companies to engage in offshore acquisitions.” China is likely to treat companies from other countries similarly to how those countries treat companies from China. 

3. China already has plenty of ways it can block deals so there is no reason to think it has added this national security review simply to do so.  

Agreed.

By the way, if you are not reading China Hearsay, you should be. There used to be a number of excellent China law blogs out there, but with the exception of China Hearsay, few if any of those post wtih any real regularity. It really is pretty much just us two now and so if you read us, I urge you to read China Hearsay as well. Stan’s blog is generally more analytical and less nuts and bolts than this one, which is all the more reason to read us both.   

Stan Abrams over at China Hearsay has an excellent China post, entitled, “A Never-ending Supply of China Business Advice.” The post starts out with Stan talking of how there has been so much written on how to do business in China and some of it is less than top-notch:

At the same time, a lot of this material is repetitive, obvious, and not at all China specific. Most of the low-quality drek is written by consultants looking for clients, writers looking to sell books, or bloggers looking for more eyeballs. I’m in that last category of course, so you should always take what I say about business with a grain of salt. Damn it, Jim, I’m a lawyer, not a business expert!

Stan then notes how there is no quick “no quick list of ‘Ways to Spot a China Biz Poseur.’ Well, no comprehensive list anyway. The post then starts talking about a brief interview Stan read over “at Gizmodo [entiled, “What It’s Like To Manufacture Technology in China“] of an Australian electronics guy and his experience with Chinese factories in Guangdong. The article is the usual blend of useful suggestions, cultural stereotypes, and universal advice masquerading as China-specific insider tips.” 

Stan then proceeds to very effectively deconstruct much of the “electronics guy’s” advice. Stan does this by focusing on the following three points made by electronics guy: 

1. Adding value to a relationship. Electronics guy says one needs to add value to a relationship. Before I talk about Stan’s views on this comment, let the record reflect that I have never (as in not even one time) mentioned adding value to a relationship on this blog.    

Anyway, electronics guy says that his first China order was rejected as too small, but then he came up with a way to add value to his deal with the Chinese manufacturer:

and what I did was stayed up one night and redid all their marketing material. And when I was done I emailed it to them and told them ‘The value in dealing with me isn’t the profit you make from one container, I can add value in other areas and I really want to work with you.

“They replied nearly immediately saying thank you and accepted the order. Then about a week later they emailed me and said that because of what I helped them with, they won a massive customer in America.

Stan’s interpretation of this is as follows:

Advice: blah blah think outside the box blah blah add value blah. Or something to that effect.

I’m not trying to be a jerk here, and his experience is worth noting. But let’s face it, this is not really a China biz anecdote. If you are trying to make a deal with someone and the numbers don’t add up, you either walk away or change the parameters of the discussion. In this case, the foreign dude found that he had something else of value to trade on.

Why I found this interesting: file this under the category of “relationships,” but not in the usual hyper-inflated sense of importance that many people still place on business relationships in China. What I refer to is that when you deal with a factory, or any other business partner, you are dealing with other people/firms that also have needs and goals, which may go beyond cash and profit margins. If the deal was only about finding an appropriate price and quantity, we could probably just write an app for that instead of keeping human beings in the loop.

Anytime human beings are involved, so are relationships and the possibility for creativity. Is this really “thinking outside the box” or an exercise in common sense?

First off, I completely agree with Stan. This isn’t really much for business advice. But (and maybe I am trying to be a jerk here), this particular advice is probably pretty crappy as I do not think it is repeatable. Chinese factories generally hate small orders and they also tend not to value English language marketing all that highly. I am just guessing here, but my would think that nine out of ten Chinese factories would rather have one of their own employees who allegedly speaks English do their marketing as part of their very low salary (by Western standards) and not fill the tiny order, than have a Westerner do their marketing and fill it.  

2. Language vs. cultural barriers.  Electronics guy says it is important to communicate effectively. I love Stan’s comment regarding this advice: “OK, chief, duly noted.” Seriously, how many of you did not already know this?  

Electronics guy then talks of how after talking with the Chinese factory on the telephone, he follows it up with an email using Google Translate. Stan finds this silly, as do I: 

First, language barriers can be huge, and while judicious use of Google Translate or similar tools can save a lot of money, you better not rely on them too much. I’ve always found that the best use of translation tools is when they are used by management, who already have bilingual staff handling day-to-day matters, as a way to keep up to date on current issues, the status of a deal, etc.

For example, you better not rely on a machine translation of a Term Sheet if you’re negotiating a deal, but if you are supervising a bilingual lead negotiator, checking out translated emails once in a while to check up on status can be helpful.

Second, the bit about having conference calls with folks whose English sucks and then following up with emails sounds dangerous. Better than no emails at all I suppose (documenting everything is undeniably one of the best things you can do), but if the foreigners have little experience in this market, then there is a good chance that the details “agreed” between the parties over email may not really represent a meeting of the minds.

Why? Because these days, language barriers are much less important than cultural ones. You can’t swing a dead cat in Beijing these days without finding someone who’s bilingual, but 90% of them have no useful bilateral business experience. The negotiating parties may end up apparently agreeing on some terms, but there might be some fundamental disagreements lurking just under the surface of the relationship that won’t come up until later, usually at an inconvenient time. Language comprehension does not automatically equate to substantive comprehension.

This advice borders on bizarre. My law firm has a Spain and Germany licensed attorney and so we have a number of clients who correspond with us in Spanish and in German and I am often cc’ed on those emails and, occassionally even sent some of those directly. My Spanish is weak and my German is non-existent and so I will sometimes use Google Translate to try to guage the urgency of the email so I know how quickly I need to bring in one of our native speakers of those languages. Google Translate is great for things like this, but I would say that it typically captures only around 80-90% of these emails. If it is getting only 80-90% of Spanish and German emails, with languages very close to English, it has to be getting way less than that when the emails are in Chinese. That sort of accuracy might be good enough if you are making rubber duckies, but I do not think it cuts it if you are making brake parts.  

3. When in doubt, go for a cultural mainstay.

Electronics guy tells us how to take advantage of the fact that “one of the things they all [i.e. all 1.3 billion Chinese] care about and never want to do is ‘lose face’:”

That makes doing business with them very easy because if you document everything and then ask ‘do we have an understanding on this?’ and then later down the track something doesn’t go as planned, you can confront them with the emails and they’re always very quick to act on it. They’re very honest and they don’t want to lose face, so they will do their absolute best to keep everyone happy and to keep the relationship up.

Stan notes no objection with electronics guy calling for documenting everything but he (rightfully) resents the cultural stereotyping:

Why I find this interesting: the quote has little to do with documentation and a lot more to do with lazy cultural stereotypes.

First, one should never use “they” when talking about people in another country like this. I’m not sure why, but “they don’t want to lose face” sounds vaguely racist to me.

Second, watch the stereotypes and generalizations, even nice ones like “they’re very honest,” which is downright silly. Also, “they” might in fact not want to “keep the relationship up.” Maybe the factory, after a few years, hates your guts and wants out. These generalizations about honesty and assuming that everything is happy happy with the relationship is just asking for trouble.

Stan then points out that backing down when confronted by a written document may have absolutely nothing to do with face:

[S]ometimes there is no need to bring in these culturally-specific concepts, particularly when general human psychology and common sense will suffice. Take the above quote as an example. Let’s say one company documents a relationship, perhaps by holding onto an email thread. Five years later, there is a dispute, and one of the parties digs out the email and says, “See here, we discussed this and you agreed to do X.”

If the other party backs down, is it because he wishes to avoid losing face? Maybe. Another explanation is that the other party made a simple mistake, you noticed the error, and the mistake will be corrected in good faith. Still another explanation is that the other guy tried to screw you over, you caught him, and it’s easier for him to admit defeat that fight a losing battle. No mystery, no cultural stereotypes, just human beings interacting with each other.

Very true. I will also note that it has been my experience that an email to a Chinese factory is not nearly as valuable as electronics guy makes it out to be. I will admit that as a lawyer I am going to be called in when things have gone bad, but I have to say that I get calls from Western companies all the time who say that their Chinese factories have failed to abide by their email agreements. Having an email that says exactly what your Chinese factory is going to do is indisputably better than having nothing at all, but having a clearly written and signed contract in Chinese is going to be far better than a few emails, but even that is not a guarantee.  

There are plenty of excellent China business and sourcing consultants out there with whom I (and I am sure Stan as well) have had the pleasure of working. If you are confused about how to do China sourcing, I suggest you contact one of them.