China has liberalized its minimum capital requirements for a WFOE and the amounts required have been reduced in many Chinese cities/districts. But even if the Chinese government is going to let you get away with a very small amount of registered capital, you may want to pay more.

You should think about the registered capital you should be paying by considering how much money you will need to sustain your China WFOE until it can generate enough revenues from its own cash flow in China to sustain itself. If you inject less than you need in registered capital to sustain your WFOE until it generates enough in revenues to sustain itself, your WFOE will need a cash injection from somewhere. If you transfer money to your WFOE from overseas but you do not go through the correct process of re-registering your registered capital (which typically takes at least six weeks and involves having to get a new business license issued) the funds that you (or anyone else) send to your WFOE will count as income to your WFOE and will be taxed accordingly.

We often get calls from fairly new WFOEs seeking our help in figuring out how they can problem here is that quick-buck China lawyers and China consultants are interested in securing their fees to stay in business, not in your long term well-being. Getting you a WFOE as fast and as cheaply as possible in the short term is their goal because by the time you get hit with the tax bill they have already moved on to their next victim.

A while back, we did a similar post, entitled, China Company Formation Law Is Clear — WFOEs Are Easy, in which we discussed three companies my law firm’s China lawyers were in the midst of forming and noted how China’s minimum registered capital requirement was the biggest source of confusion for all three of these companies. All three companies contacted us after having become confused about registered capital after talking with various company formation consultants. We blamed the consultants for the confusion, insisting that the law itself is clear:

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.

Every company in China must have a stated registered capital. The registered capital includes all of the components of the initial investment in the company, including its start up cash, contributed property, and transferred intellectual property.

Where the registered capital is small, the entire amount must be contributed immediately upon formation of the company. If the amount is large, it may be contributed in installments. There are a number of schedules for the percentage and timing of large amounts of registered capital.

It is a crime to state a registered capital amount and then fail to contribute. It is also a crime to withdraw registered capital after it has been contributed.

The purpose of registered capital is to provide some notice to creditors of the capital adequacy of the company. Because of this, Chinese regulators take very seriously the rules regarding registered capital.

Registered capital is an initial investment that is intended to be immediately used in the operation of the company. It is not a deposit that must just sit in a bank and never be touched. It can be used to pay salaries and rent, to purchase product, or for any other normal start up operating expense. Registered capital may include contributed real and personal property used in operating the business. Many foreign investors think registered capital is some sort of security deposit that they can never utilize. This is not true.

On the other hand, some foreign enterprises believe they can simply withdraw their registered capital to their home country after the Chinese company begins normal business operations. This also is not true. The only way to get funds from the Chinese company out of China is by repatriating profits or by liquidating the Chinese company. Both of these methods will work, but they both require paying Chinese taxes and meeting other requirements under Chinese law.

Investors should also note that the RMB is not a freely convertible currency. For companies that will earn RMB income, the issue of conversion to U.S. dollars or other foreign currency should be carefully considered.

Chinese law is quite clear regarding minimum capital requirements for a WFOE but the statute’s prescriptions on this are essentially meaningless in actual practice. Under Chinese Company Law, the minimum capital requirement is either 30,000 RMB (less than $4,000 US) or 100,000 RMB (a bit over $12,000 US) depending on whether it is a multiple or single shareholder company. However, these numbers have no real meaning for forming a WFOE in China.

The real question is what the Chinese authorities will consider as adequate capitalization for the specific project and that always depends on the type of business and its location. For example, it is very expensive to operate a business in Shanghai. On the other hand, it can be very inexpensive to operate the same business in a rural part of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business. Finally, some Chinese cities just seem to want WFOEs more than others.

The Chinese regulators usually consider all of these issues. To complicate matters, each local regulator has its own basic standards on what constitutes adequate capital for certain types of business activities. These numbers are not published, but when asked they will almost always be provided. They can only be determined through direct contact with the regulator but only after providing a clear explanation of the project.

The local regulator virtually never considers the statutory minimum in making a determination regarding adequacy of capital. Rather, the local regulator will determine what it believes is an adequate amount of capital based on all the circumstances. Once the investor has a clear idea of the outlines of a project, it is usually a good idea to engage a China attorney to contact the local regulator to see what their response will be to the proposed amount of investment. This initial screening can save a lot of time if the investor’s idea of the proper amount of capitalization is dramatically different from that of the local regulator.

My firm’s China attorneys always go to the local regulators to get this amount before we get very far along in the application process. Almost without exception, our experience has been that after we explain the nature of our client’s business to the regulator, the regulator’s decision on the minimum capital required has been a very workable one for our clients.

In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that all rents are paid in advance, that payment for products for sale are usually paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up cost is going to be higher than for a comparable company in the United States, where credit and time payments are much more common. Chinese regulators will not approve a project that looks risky or under-funded.

For more on forming WFOEs in China and the minimum capital required to do so, check out Chinese Company Formation, Part II — WFOE Minimum Capital Requirements and Chinese Company Formation — Forming a Wholly Foreign Owned Entity (WFOE) in China.

As China inexorably continues increasing its restrictions on hiring personnel via third party employment agencies (sometimes referred to as FESCO companies or as staffing agencies), our China lawyers are more and more often being tasked with helping our clients move their personnel from the third party hiring company to a newly formed (0r even existing) WFOE.

The usual procedure for moving an “employee” from a third party hiring company to a WFOE is as follows:

  1. Terminate the contracts with the hiring agency. Terminate the contract between your company and the hiring agency and terminate the contract between the hiring agency and your “employee.”
  2. Upon resignation, the employee is IMMEDIATELY hired by the WFOE pursuant to the standard employment agreements. There is NO time gap.
  3. Normally, the third party hiring agency is williing to allow you to terminate your contract with them, so long as the employee voluntarily resigns, so long as you pay any fees owed to the employee and to the third party agency, and so long as you sign an agreement freeing the third party hiring agency of any liability surrounding the employee. In many cases, you will want to continue using the third party hiring agency as your outsourced payroll department  to take care of the administrative side of salary payment and payment of employer/employee taxes and benefits. If you keep the third party agency on in this capacity, it will usually be delighted to terminate the employment agent relationship to move into a standard benefits processing arrangement.
The employee usually also prefers moving from being the employee of a third party hiring agency to becoming the employee of a WFOE, but the following two issues typically arise with the employee, assuming he or she has been employed for some time:
  • The employee will not want to lose the employee’s seniority in the employment relationship.
  • The employee will not want to be placed in a setting where they are in a probation period.
Normally, the second issue is always resolved in favor of the employee as it makes little sense to put a good long-time worker under probation. The issue regarding seniority is less clear and typically is subject to negotiation. It makes sense to resolve both of these issues before starting the changeover process.

This post is by Grace Yang, one of our China lawyers resident in Beijing. Grace has her B.A. from Beijing University and her J.D. (law degree) from the University of Washington. Grace is licensed to practice law in Washington and New York States and she will be sitting for the China bar exam this fall. The below post stems from a recent project/memo Grace did for one of our American clients doing business in China.

 

We are often asked whether it is legal to pay a non-Chinese employee from both the China WFOE and from a company outside China (usually the US parent company).  The answer to that question is an easy yes, but the tax issues that arise from that are where things get difficult.

It is perfectly legal for an American company to pay its American employees from both China and the United States. However if your American employees are resident in China for more than 183 days in any calendar year, you must pay taxes in China on the combined U.S.-China salary of your employees. This obligation to report and pay taxes is stipulated in the Circular of the State Administration of Taxation on Income Tax Paid by the Enterprises with Foreign Investment and Foreign Enterprises for Their Employees on Behalf of Their Enterprises Abroad (Guoshuifa [1999] No. 241).

The Circular on Questions Concerning Tax Payments for Wage and Salary Income Gained by Individuals without Residence within the Territory of China (Guoshuifa [1994] No. 148), mandates that if your employee works in China for less than 183 days in a calendar year, he or she is obligated to pay taxes only on that portion of salary received from the China WFOE when he or she was in China.

But if your employee works in China for more than 183 days but less than 365 days and so long as your employee did not live in China for a full year prior to this year, your employee must pay China taxes on the salary paid by the China WFOE and on the salary paid by your US entity during the period he or she is in China. In other words, your employee must pay taxes on whatever salary was earned in China, no matter who pays it.

If your employee works in China for over one year, but less than five years, your employee must pay China income taxes on the salary received from the China WFOE as well as on the salary received from your US entity during the time your employee is in China.

Don’t let the above throw you off, it is actually quite simple: if your employee works in China for 183 or more days in any calendar year, both you and your employee must pay tax on the combined U.S.-Chinese salary. There is no way around this obligation. We advise our clients to take this seriously, because failure to comply with this rule can result in penalties for both the WFOE and for the employee.

The problem is that foreign companies have customarily ignored this rule and while Chinese tax authorities have recently become much more aggressive in enforcing it. The issue normally arises when the employee applies to renew his or her visa. If the employee has resided in China for more than 183 days, the local tax authority will request a copy of the employee’s US tax return. If the employee fails to provide the US return, that employee’s visa gets denied. If the employee does provide the U.S. tax return, the tax authorities assess the tax, along with interest and penalties.

Our China attorneys are aware of several cases where foreign employees were denied entry into China after 183 days of residence for failing to report their combined salaries. We also are aware of multiple cases where the Chinese tax authorities took very aggressive penalty actions against WFOEs for failing to report and pay taxes on the combined salary of their high level China company managers. The risk of noncompliance is therefore significant.

So what should your WFOE do? Report the combined salary and pay the full tax, or ensure your employee resides in China no more than 182 days in any calendar year. In part II (coming tomorrow), we explain why you really do have no choice in this.

Just sent an email to an American company setting out the basics of what it should be looking for in the initial stages of determining whether it wants to invest in another American company that has a WFOE in China. The list included that the American company make sure that the China WFOE is properly registered and structured. But in that same paragraph, I added the following, which I probably would not have done even six months ago:

You should determine whether its [the WFOE’s] employees are all signed to proper contracts and whether the WFOE has paid ALL employer/employee taxes to the government and that it is not at risk for a large number of employee lawsuits. We have in the last few months been contacted by a slew of foreign companies that are trying to decide whether to stay in China after having learned that they owe large amounts in employer taxes or large amounts to their employees that they “didn’t realize” they had failed to pay.

In one instance, the American company said that its WFOE manager never told the home office that the WFOE had not been paying employer taxes for the last few years and now the Chinese tax authorities were demanding that [very large] payment. In another instance, the American company doing business in China via its wholly owned WFOE had just learned that one of its employees had been badly injured and had sued the WFOE and won and now the WFOE owed this employee a lot of money and it did not help that it did not have written contracts with any of its employees and now it was having to deal with that as well. Both of these were in the last week!

One of our China lawyers also got an email from another American company who was being “confronted” by its lead employee because it was doing business in China with “employees” but without ever having registered an entity that would allow it to do so legally. My response to that company was as follows:

You may be in the worst situation possible. You are operating completely illegally in China at a time when the Chinese government has stepped up its searching for companies just like yours and shutting them down and issuing massive fines and worse. So on the one hand, you have absolutely no choice but to get legal fast or you might find your entire China program shut down and nobody from the US able to go there again.

But on the other hand, you have a Chinese “employee” who on one level “completely owns” you because if you do something that he doesn’t like he and all of your other “employees” can sue you for back wages/back taxes because you had no written contract and because you failed to pay their benefits and because your relationship with them was/is illegal. And if you do all of a sudden choose to go legal, your overall employee costs will increase by about 60%. Right now, you are, let’s say, paying an employee $1000. If you go legal, you will need to pay around 40% in employer taxes, which will get you to $1400. But even that won’t work. Because if you go legal, your employees are going to have to start paying their own income taxes of about 25% and that will mean that they will almost certainly demand a raise to cover that. So you give them a raise to $1300 and then your 40% will be on that amount, which will then raise the monthly salary+benefits to around $1820 a month. And this completely ignores the corporate taxes and other fees and costs that your China entity will need to pay.

So essentially you either pay a lot of money to get legal or you should just start acting as though your China operations are almost certainly going to get shut down within the next 1-12 months. One thing you do not want to do in this situation is to go to China or to send anyone from your company to China to “try to work things out.” For why this is the case, check out The Single Best Way To Avoid Being Taken Hostage In China.

Your best course of action might just be to start all over in Vietnam.

Bottom Line:  There has never been a better time than now to make sure that you know what is going on with your China WFOE and that your China operations are fully legal.

 

Just got back from speaking at a truly excellent doing business in China seminar at the University of Toronto. I was on a panel where the question was asked whether the rising tensions (real or perceived) between foreign companies and China were due in large part to the changing nature of their relationship with China. The question posited that in the “old days” the typical relationship was that of an American company sending money to China to buy a product, but today, the typical relationship is far more complicated and these increased complications are increasing “tensions.”

My answer was that I had never thought about it in that light, but that it was probably true. I then went on to talk about how the nature of my law firm’s China business has so drastically changed over the years. Whereas five years ago, probably 75% of our business was for companies looking to manufacture products in China, with 25% focusing on businesses that wanted to sell products or services to China, that ratio has pretty much exactly flipped.

When I got back to my computer, I had an email from a retailer asking whether it was really true that it would need to open up a branch office in every city in which it wanted to locate a store.  Our short answer was generally yes.

The big issue today is not so much how to make product in China, but how to sell product and services to China, be that within China or from outside China. Needless to say, the “within China” part is where the complicated legal regulations and hence the tensions can arise.

Twice in the week before I left for Toronto I was interviewed about this “sea change.” Once by a friend writing a book and the other by a reporter. Both of them wanted examples of American companies profiting or seeking to profit from selling their goods or services to China, and I talked a bit about the following, in an effort to show the incredible diversity of ways American companies are “going to China” these days:

  • US company that provides high end remote medical testing. It sells its testing system to hospitals and then does the diagnostics from the United States. It is not forming a company in China; it does this from the United States.
  • US company that provides movie services to China’s leading movie companies. It is not forming a company in China; it does this from the United States.
  • US and Canadian and European companies  that provide online learning to Chinese companies. These companies, pretty much by necessity, are having to work with Chinese domestic companies that possess an ICP license or have the ability to get one. Some of these companies are not forming companies in China, but selling from the United States or Canada or Europe.  Some of these companies are forming companies in China to assist in the selling or to provide support services there.
  • US and Canadian and European companies that sell enterprise level software to Chinese companies.  Some of these companies are forming companies in China and some are not.

I could go on and on with examples of how foreign companies are seeking to profit from China’s rising wealth. The point though is that the legal and business issues foreign companies face in trying to profit from China are usually very different and oftentimes more complicated than those faced by foreign companies that have their products made in China.

If you are sitting in the United States and just buying product from China, your legal issues are going to be both very different and less complicated than someone selling enterprise software to China’s hospitals. The company buying product needs to have a good contract that makes sure its IP is protected and that its widgets are of good quality and arrive on time, but the software company is going to need to deal with pretty much the full panoply of China’s laws. The software company will almost certainly need to form its own Chinese entity (almost certainly a WFOE) for China and then it will need to make sure that it complies with China’s employment laws, antitrust laws, and anti-corruption laws, just to name a few.

Inquiries to my law firm regarding how to deal with both American and Chinese anti-corruption laws have probably quintupled in the last five years and they have probably tripled in just the last eight months — thanks mostly to the Chinese government’s treatment of GSK executives. For more on how foreign companies are needing to step up their FCPA and other anti-corruption compliance programs check out China Bribery. A Few Facts And A Few Tips.  and Rule One For Doing Business In China. No Bribery. Rule Two, Make Sure Of It. and China and the Foreign Corrupt Practices Act.

The legal work that we do to decrease the chances of our clients going to jail in either China or the United States is more important and more pressing and more complicated and drawn out than the work we do to make sure a $300,000 shipment gets to Peoria on time. I say this not to in any way denigrate manufacturers, but to highlight how different (and yes more tense) it is for those on the ground in China as opposed to those able to sit at home and watch the Seahawks crush the Broncos in the Super Bowl. Needless to say the odds of going to a Chinese jail while ordering product from the United States are considerably lower than if you live in China. The same holds true on getting your business shut down by the Chinese Government.

I just read a Forbes article written by Michael Zakkour (or at least by the time I started writing this post).  The article is entitled, The China Luxury Downturn Is Real – Global Luxury Brands Must Adjust and it focuses on what foreign luxury brands are facing in China these days, and what they should/can do about it. Zakkour’s article nicely highlights from a business perspective the huge difference in issues faced by sellers to China as opposed to buyer’s from China. There too the complications and risks are generally with the sellers.

The article talks of how the “premium luxury market slowed” in China in 2013 and of how that trend will likely continue in 2014, especially for those companies that “depend on gifting.” But even that market, according to Zakkour is “still pointing up.”

Zakkour starts out listing a number of factors that have driven growth in the premium luxury segment down to about 2% and he leads it off (rightly I think) by citing to President Xi Jingping’s intent to make “a huge dent in the endemic corruption in Chinese politics and business.”

The article then lists the following reasons why luxury brands should “continue investing in China as a long-term growth market”:

  • After 30 years of exponential  economic growth and development, China’s economy is slowing, but this is relative, from 10% to 6%-7%, which is still robust — luxury purchases will continue to grow with the economy in general.
  • Urbanization and an ever enlarging middle and upper class are fueling further growth for the best things in life – While 1st Tier cities and regions have been saturated, the new growth will come from Tier 2, 3, 4 and 5 cities, representing another potential 300 million new luxury buyers.
  • Current events and government policy are always fluid in China.  When the differences between legitimate and illegitimate purchases are sorted out “this too shall pass.”
  • The accessible luxury market will continue to grow and prosper.

I agree.  The opportunities for making money in China are considerably greater today than they were five years ago and will almost certainly be considerably greater in five years time than now. But selling into China — especially selling from within China — is not the same thing as sending out a purchase order.

Chinese and American businesses are working together (or not) in a different way than they did even five years ago. Their business relationships are getting more complicated and the competition between them is increasing.

A couple days ago, we ran a guest post on Expat Stress in China and we received an unusually large number of fairly strident comments and emails from that post, most of which highlight increased tensions.

Is the business relationship between China and America fraying? And, if so, why? Is the switch from foreign companies manufacturing to selling products and services into China driving this?  Or was the relationship never really all that good in the first place?

What do you think?

Got an email the other day (probably the tenth such email I have received) from someone about to sign a contract with a Chinese employee dispatch company.

The email asked that one of our China lawyers review the contract within the next two days to make sure there were no “hidden issues”.  I promptly wrote back to decline the assignment, explaining that there were far too many questions/hidden issues to accomplish much of anything within two days.

Foreign companies sometimes use Chinese employee dispatch companies to hire employees in China on behalf of the foreign company. The advantages of this can be many, the chief one being that the foreign company need not worry (at least so much) about China’s various and complicated employment laws.  Some (though fewer and fewer) employee dispatch companies will even hire someone on behalf of a foreign company that does not have a China entity (such as a WFOE).  This is a legal (as opposed to illegal) way for a foreign company to have someone in China essentially operating as their employee.

But the laws/regulations on employee dispatch in China are constantly changing and so using one of these companies can be a legal minefield.  And the thing to remember is that the China employee dispatch company does not care much about you (the foreign company) beyond your ability to keep paying them.

Anyway, I very quickly (as you will see below) reviewed the documents provided to me and just as quickly fired off a return email warning of countless “hidden issues” that were immediately apparent to me at first glance.  My email (modified slightly) is below.  I am posting it here because the issues (hidden or otherwise) it discusses are relevant to virtually all relationships with these third party dispatch companies, and because it highlights the dangers of just signing the dispatch contract put in front of you.

Here’s my email:

Based only on the documents you have provided me and on the very limited facts I was able to glean from a two minute review of the emails that were included with yours, I see all sorts of potential hidden issues here and there is absolutely no way we can do anything on this in two days.  We have dealt with ________ [the dispatch company] many times and so I am not terribly surprised by what you have here, but based on my five minute review of just the English language documents (as opposed to the email) here are my initial thoughts:

1.  It is not clear to me that you can legally do what you are doing.  I do not have enough information to know one way or the other.  Company D [this will be what I call the Chinese dispatch company] does not really care about the legality of what you are ding because it will get paid anyway, even if someone from your company finds him or herself in jail the next time they go to China.  The legality of this whole arrangement is the first issue that should be determined.

2.  I saw only a contract between you and Company D, nothing between Company D and the putative employee of Company D. What this means is that the employee of Company D can do whatever he or she wants and probably can never be fired.  Reveal your company secrets. Check.  Steal from you.  Check.  All without your having any recourse.

3.  Oh, and if the putative employee steals from you or reveals your company secrets, it appears that nobody can fire this employee under Chinese law, but on top of that, you couldn’t do it anyway because there is no mechanism in your contract with Company D that would require Company D to fire the employee.  But hey, you are still required to pay Company D for this employee for two years and then if Company D deliberately or accidentally signs the employee (or even with your begging Company D not to do so) for another two years, you have to pay for that too.  And if you somehow manage to fire this employee for stealing from you and this employee sues Company D for that (but remember, it is very unlikely that Company D would ever fire this employee so this is not really a likely scenario, but I am running with this just to highlight how much is missing here) Company D will no doubt just pay this employee whatever it wants because you are the one who will be on the hook for that payment anyway.  Why should Company D pay lawyers to defend claims that you are required to cover in any event?

4.  Like I said, the above is based on the English version only.  The English is actually completely irrelevant since the Chinese controls.  My guess is that the Chinese version is considerably worse (to the extent that is even possible) for you.

What we typically tell our clients (and let me stress that you are not our client and that the above is based on only a 7 minute total review — five for the contract and two for the emails — and therefore you should not consider it to be legal advice and you should recognize that it is based on what might be inaccurate facts and incomplete documents and that we never even looked at the Chinese language document(s) and therefore you should NOT rely on it in making your decision and you should seek out your own independent legal counsel to assist), in these situations is that we need a sufficient and realistic amount of time to review the documents, to revise the documents, and to work with both the client and with the Chinese employee dispatch company to craft some documents that will protect the American company from its employee and from the Chinese employee dispatch company.  This sort of thing takes more like two weeks, not two days.

I truly wish you the best of luck on this and I am sorry that we could not help you.

What do you think?

I am going to be speaking at USC this weekend and in poring over old PowerPoints (to create a new PowerPoint for my talk), I came across one with a fairly extensive China law bibliography of some of our most helpful posts.  This bibliography is definitely slanted towards the legal issues that confront foreign companies doing business in China.

Here it is:

CHINA CONTRACTS

CHINA LICENSING AGREEMENTS/CHINA DISTRIBUTOR AGREEMENTS/CUSTOMS

CHINA COMPANY FORMATION/CHINA WFOE FORMATION/CHINA JOINT VENTURES

NEGOTIATING WITH CHINA

CHINA —INTELLECTUAL PROPERTY

The Compliance in China blog has a really interesting and informative post, entitled An Incriminating Board Decision of D&B in Violation of Chinese Privacy Law.  The post is on a recent China criminal case against Dun & Bradstreet China subsidiary (presumably a WFOE) Shanghai Roadway D&B Marketing Services and key personnel with that company.  The post is interesting because it highlights how risky it can be to operate illegally in China and because it nicely sets out what it takes to criminally prosecute corporate officials in China.

Most importantly, it teaches some key lessons about doing business in China.

As a bit of a sidelight, I also have to admit that I like the post because a few years ago when a US company came to us with plans to run a “D&B type credit reporting agency in China” my law firm was adamant about how we doing so would violate China’s laws and that we would have no part in it.  To our client’s credit (pun intended) it decided against doing business in China.

The Compliance in China blog relayed the following regarding the Shanghai Roadway D&B Marketing Case :

  • Shanghai’s prosecutor charged Shanghai Roadway D&B Marketing Services Co., Ltd. with illegally obtaining private information on Chinese citizens.  The Chinese press reported that the private information included personal data (income, job titles and addresses) of 150 million Chinese citizens.
  • The Shanghai Zhabei District Court found Roadway guilty of illegally purchasing personal information of Chinese citizens and it fined Roadway around USD $160,500.
  • Because this crime was allegedly committed by an entity and not an individual, Chinese law imposes responsibility for the entity’s crime on “the  responsible persons who are directly in charge” and on “the other persons who are directly responsible”.
  • Because intent is an element of the crime of illegally obtaining private information of Chinese citizens, the prosecutor could not obtain convictions against individual Roadway employees without proving that they committed the crime intentionally.
  • Four Roadway employees allegedly involved with the buying of information were convicted and they were sentenced to up to two years in jail.

Here’s the kicker:  Two of the four eventually convicted Roadway employees heard about a Beijing criminal case involving the purchasing of private information and they mentioned that case to the two other Roadway employees and they also consulted with Roadway’s lawyer about whether those purchases were legal or not.  The lawyer did not tell them “yes or no” regarding legality.  He instead proposed that Roadway change the title of their purchase contracts from “Contract for Purchasing Information and Data” to “Contract on the Advice and Consultation for Commercial Data,” as though that would in some way help. In light of the lawyer’s advice, Roadway continued purchasing the private data and that decision became “perfect incriminating evidence to prove that Roadway and the other four accused individuals intentionally committed the crime of breaching privacy.”

There are countless takeaways from this, including the following:

  1. First is that calling your table a chair not only does not make it a chair, it also will make anyone who sees the document in which you called the table a chair very suspicious that you were trying to hide the fact that you had a table.  We always tell our clients that if what they are doing is legal, they should have no trouble being upfront about it and if they do have trouble being upfront about it, then they really need to decide whether they really should be doing it.
  2. Second is that you want a lawyer who is going to tell you what the law is and not just what he or she thinks you want to hear.
  3. Third is that operating illegally in China is a very bad idea.  Like jail time bad.

 

Many years ago, I had a long-time client call me to ask for my assistance on an Iraq deal he would be doing. This was not long after the fall of Saddam. I told him I wanted no part of it and that I thought he was crazy to be planning to go there. I strongly suggested he would be better off staying alive for his children than making a few more million dollars. He was initially irritated with me but called me back a couple of weeks later to tell me I had been right and he was done with Iraq. I swear it was only days later that I learned of American businessperson Jeffrey Ake (who I had heard speak in Seattle only weeks earlier) go missing in Iraq. Mr. Ake remains missing. Mr. Ake has four children.

The greater the risk, the greater the money. But the greater the risk, the greater the risk.

I thought of my client and of Mr. Ake this morning when I read a bunch of articles that readers have sent me regarding Glaxo’s recent troubles regarding bribery accusations in China.  Most (all?) of the readers sent me the articles along with a comment along the lines of how China is cracking down on bribery by foreign companies in the pharmaceutical industry even though “everyone knows” bribery is rampant throughout that industry in China. The general theme being that China is focusing on foreign bribery and ignoring domestic bribery so as to tilt the playing field more towards China’s own pharmaceutical companies.

Yeah so.

I say “yeah so” because I do not care why China is right now doing what they are doing with respect to pharmaceutical bribery.  My reasons for not caring are two-fold.  One, I have no idea whether tilting the playing field is the reason or not. As I have been pointing out pretty much since we started this blog, going after foreign companies in China is simply good politics. It always has been and it always will be. Read Machiavelli.  Read Sun Tzu.  Read Animal Farm.  Read 1984. Look at what pretty much every country in the world does.

And two, going after foreigners virtually always picks up during economic slowdowns, for what I generally believe are political reasons.

About a year ago, I wrote a piece for the Wall Street Journal discussing the impact China’s slowing economy is having on American businesses that do business with China and how they should respond to that.  The article is entitled, “China’s Slowdown and American Business” in the US Edition and “China’s Slowdown and You” in the Asian edition, and if you want to read the whole article, you should Google either title and “Dan Harris” and then click the leading link and the full article will appear.

In the article, I asserted, among other things, the following on doing business in China during a slowdown:

  • The Chinese government “is much more concerned with social harmony than with economic numbers” and that is why it is continuing to encourage wage growth even though higher wages make China’s factories less competitive.
  • China’s prioritization of its citizens’ contentment means that China is going to get tougher on foreigners, just as it (and nearly every other country) has always done when times are tough. Everything foreign businesses do will be under heightened scrutiny.
  • The key to weathering China’s slowdown will be for foreign companies to go back to basics: think afresh about what a company contributes to China’s economy and how that is likely to shape policy makers’ opinions; focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level.

Way back in 2006, in a post entitled, URGENT ALERT: Register Your Company In China NOW, we issued our first “urgent alert,” noting a crackdown on unregistered companies doing business in China and stressing how foreign companies are never going to be treated like domestic companies:

Long ago, when I was a young lawyer, I wrote an article entitled, “Four Essential Principles of Emerging Market Success,” positing that a failure to abide by the law in the country in which you do business is the surest way to lose your business without any basis for complaint:

In many emerging market countries, local businesses take advantage of corruption to avoid complying with laws. This may work for the locals, but it won’t work for you. The easiest way for a local rival to drive you out is for you to do something illegal. Neither you nor your government will have good grounds to complain if your rival gets your business closed down due to your illegal activity. It might even be your own partner who reports you so he can assume full ownership and control of your business.

The strength of my views on this has only increased as my firm has been contacted far too many times by companies driven out of countries for having engaged in illegal conduct no different from thousands of other foreign companies in the same country.  These companies assume they have legal redress, but in reality they almost never do. So long as the law of the country in which the company was operating allows for closures and/or penalties (and in every such situation my firm has encountered, it has), the company is essentially out of luck.

There was a time where most foreign business was illegal in China, particularly as a Wholly Foreign Owned Enterprise (WFOE).  Those days are pretty much over now and the Chinese government knows it.  If you came into China as a representative office (rep office) back when that was the only way, and your “registered office” is engaged in business activities that are improper for such an office, the time is now to get that right also.

If your local people in China are telling you this is not how Chinese business is conducted, you need to remind them you are not Chinese and the government will treat you differently.  Also remember that your employee’s knowledge that you operating illegally in China gives them tremendous leverage.

Then in 2007, I wrote of this same disparate treatment issue back in the context of China’s environmental laws, in a post entitled, “China Warns Foreign Companies On Pollution“:

China has always and will always (at least for the foreseeable future) enforce its laws more strictly against foreign companies than against domestic companies. I am constantly writing about this not to complain about it, but simply to point out the reality. Just because your Chinese domestic competitors are getting away with something does not in any way mean you will be allowed to do so.

Beijing is also now at the stage where it is pretty much neutral about all but the largest foreign companies remaining in China. I am not saying it is neutral about foreign direct investment (FDI) in general, but I am saying that it really could not care less about whether your individual business stays in China or goes. And if your business is a polluter, it actually would probably rather see you leave.

Lastly, going after foreign companies is politically popular.

I ended that post with the following:

Bottom Line: Obey the law, particularly the environmental laws. It is good business.

Similarly, in China Fines Unilever For Mentioning Price Increase. What That Means For YOU, we noted how foreign companies doing business in China cannot expect to be treated like Chinese domestic companies:

As long time readers of this blog know, one of our consistent themes has always been that foreign companies in China should not expect to be treated the same as Chinese domestic companies, no matter what the laws may say. The reality (not just in China) is that it is usually good politics to go after foreign companies and it is usually bad politics to go after domestic companies. The reality also is that when a large number of citizens have a particular problem, it is very good politics for the government to show that it is trying to solve it.

So I assume that you are by now wondering how going or not going to Iraq is linked to Glaxo’s bribery problems and to China’s unequal treatment of foreigners.  Here goes.

Many of us (I intentionally say us because I myself clearly fit into this category) are competitive and goal oriented. We love winning and we hate losing.  And we pursue winning with intensity, sometimes to the point of blindness. My client who ended up not going to Iraq?  This is a guy who has made tens of millions of dollars around the world in businesses so diverse as to be almost laughable. This is also a guy who works 16 hours a day and who discusses business  99% of the time during lunch.  This is a guy who was so focused on the new big deal in a new and unchartered place that it had simply never even occurred to him that he would be risking his life and that maybe doing so would just not be worth it. Only after I pointed this out to him did such thinking even enter his head.

I bring all of this up because at least a few times a year I have to tell someone that what they are doing in China is illegal as in go to jail illegal.  Much of the time what we are discussing is a plan to hire someone in China who is “really connected” and paying that person enough for them to exert their influence.  Sometimes, it is even more simple.  The company wants to pay someone a lump sum to assure business.  I always instruct them not to do what they are proposing and I emphasize that people go to jail for such things.  I then ask them if it is really worth the risk of five years in a Chinese jail for the potential of making x dollars — usually not all that high a number.  About 80% of the time, the person on the other end of the phone pauses and then says that they hadn’t looked at it like this and, no, it’s not worth it.  About 20% of the time I am given the brushoff or flat out told that I do not understand their market.

Bribery in China?  Is it worth it?  Am I the only one who would like to ask this question five years from now of the Glaxo people currently facing bribery charges in China?

Those of us who constantly deal with China have a tendency to complain about what it takes to get things done there.  We do that because in our minds, everything should happen pretty much instantaneously.  Certainly my law firm’s clients would prefer that and therefore so would I.

But I read a Wall Street Journal article today that did a great job of putting the difficulties of doing business in China in somewhat stark perspective.  The article is entitled, “Andy Puzder: Of Burgers, Bikinis and ObamaCare” and it is an interview with Andy Puzder of fast-food chain, Carl’s Jr., who explains why Carl’s Jr. will not be expanding in California.  As part of his explanation, he compared the time it takes to open a venue in various places, including Shanghai:

Consider how long it takes for one of his restaurants to get a building permit after signing a lease. It takes 60 days in Texas, 63 in Shanghai, and 125 in Novosibirsk, Russia. In Los Angeles, it’s 285. “I can open up a restaurant faster on Karl Marx Prospect in Siberia than on Carl Karcher Boulevard in California,” he says.

Shanghai isn’t bad.  Not bad at all.

Of course, this 63 day time frame has to be after the foreign company (in this case, Carl’s Jr.) has already established its WFOE in China.

What do you think?