SE Asia manufacturing lawyers

As buyers work to diversify their supply chains out of China, many are finding the process is not easy. Most buyers are finding they have been spoiled by China. Foreign buyers have been working in China for over thirty years and during that thirty year period, these buyers have been training Chinese suppliers on the whole range of issues required for meeting the needs of foreign buyers and their customers. It has been a very difficult process. Though Chinese suppliers are far from perfect, the fact is that after this 30 year training program Chinese companies have reached a generally high level of performance. For example, recent surveys by inspection companies show Chinese suppliers have made steady improvements in both quality control and in complying international ethical and sustainability standards.  On the other hand, factories in South/S.E. Asia are often going in the opposite direct.

In our own practice, we find many buyers expect their new suppliers from S.E. Asia and South Asia will operate at the same level as has been achieved in China. Their supply chain system usually assumes this. They are then surprised to learn that the level of performance in these new territories is more like China was in the 1990s and not at the level China has achieved. So buyers are faced with a new period of monitoring and training. Many smaller buyers are not prepared for the effort this requires. For this reason, buyers need to consider the key issues carefully before they move their manufacturing out of China.

Though there are many issues that arise in moving to S.E./South Asia, we are currently seeing problems arise in the following three critical areas:

1. Quality Control. The first thing our clients usually notice is that the defect rate in S.E. Asia and South Asia is much higher than in China. The defect rate in these regions has traditionally been higher than in China, but while the defect rate in China has fallen over the last five years, the opposite has happened in S.E./South Asia. As buyers have moved into this region, local manufacturers have struggled to keep up with the increase in orders. This has resulted in a decline in quality. During the holiday season, as factories become even busier, the defect rate historically soars, and we’ve had clients tell us they’ve seen defect rates as high as 40% at this time of year.

Buyers must therefore plan on dealing with defects from the start. Inspection is key. Inspection after your product arrives in your overseas facility is not acceptable; inspection must be done on site before product is shipped. There is a larger issue hidden here. For many buyers, discovering that the defect rate is unacceptable at the end of the production cycle means the problem will be found too late. Buyers typically rely on a full delivery. A delivery in the holiday season with a defect rate of 40% or more can be a crippling blow for a buyer. For this reason most buyers find they are required to do ongoing, continuous inspection during the entire production process so as to be able to identify defects when they occur and not when they are all piled up in a warehouse ready for shipment.

Often the only realistic strategy is to hire an agent to visit the factory on a regular basis. For large orders, this may require a factory visit almost every day. The alternative to a resident agent is to engage an international inspection company to do regular on-site inspection. Either way, this level of inspection is costly and many smaller buyers determine they cannot afford the expense. This is generally a failed analysis; the cost of inspection is part of the cost of the product. If the cost is too high, the product is simply too expensive.

2. Delivery Delay. Factories in S.E./South Asia will generally accept any order without any concern for scheduling production. This means that during “crunch” periods such as the U.S. holiday season, the factory will fall behind in production. Delivery is delayed and many deliveries are short. The factory will say: “we are only two months late, what is your problem?” But consider a delivery scheduled to arrive in October, just in time for the holiday season. If that delivery arrives in mid-December, it is just as if the delivery never arrived at all.

Due to the recent increase in orders throughout the S.E./South Asia region, the issue of late/short delivery for consumer products has become a significant issue and buyers must be realistic about the fact that just in time delivery may not be possible. This means your ordering system must take this into account and include a “cushion” for delivery dates. This requires ordering early and then dealing with the burden of warehousing for product that does arrive on time.

Buyers should assume the delivery date will be an issue. The issue must be discussed directly with the factory and a procedure must be devised to deal with it. This usually requires at least the following: First, the factory must be clear that when they contractually commit to a delivery date, that date is a hard date and not a wish or a goal. Factories will often respond by openly stating that any delivery date they agree to may be delayed by as much as six weeks before the delivery is considered to be “late.” Second, to make clear that the delivery date is a hard date, your manufacturing contract should  include an effective and enforceable contractual penalty for late delivery. This penalty must have a real impact, so it must be imposed by a reduction in the final purchase price payment. Third, given that late delivery is such a critical issue, some form of monitoring process must be imposed through factory inspection or some other process to confirm the progress of manufacture and the actual date of delivery. The buyer cannot afford to simply assume the shipment will be made on the required date.

We have found that many S.E./South Asia factories do not like to discuss the delivery date issue. They do not like being held to a hard date and they very much do not like to be penalized for late delivery. This is because the know they will be late. When a factory strongly resists all discussion of this issue, the buyer should assume the probability of late delivery is high.

As with the issue of quality control, monitoring delivery dates and conducting periodic inspections is expensive. Buyers must take this expense into account in determining the real cost of the product they purchase.

3. Protection of Product Design. When your product purchase is an off the shelf product designed by the factory, there is no issue of protection of product design; the factory owns the design and it has the right to sell their product to any buyer without any restriction. The issue on design only arises when the off the shelf product has been customized for purchase by the buyer. This customization can take many forms. It can be as simple as application of a logo or use of custom colors. Customization may move on to changes in configuration of the product such as a change in control layout or cover design. Where this type of custom product is purchased, it is critical your require your factory not make the custom product for itself or for any other customer. Since there is no formal intellectual property protection in this case, this kind of protection must be done through a written contract.

At the other extreme is the custom manufacture of an item designed by the buyer and for which the design is owned by the buyer. Where the buyer owns the entire design, a contract is required that establishes the ownership of the design and that prevents the factory from making the design for itself or sale to any of its other customers. Such a contract is particularly important in situations where the factory is a direct competitor of the buyer. Buyers that do not enter into this type of contract before they reveal their design to the factory are simply giving their design away as a gift to the factory. See How to Give Away your IP in China Without Realizing it.

For factories in S.E./South Asia, we have found that the issue of protecting product design is different than the issues we see in China. In China, the Chinese factories will aggressively infringe on product design with the goal of selling directly into the foreign market — typically the United States or Europe. S.E/South Asian factories have not generally reached this level. Factories in this region are more like Chinese factories from the 1990s.

Once they have learned how to make a new type of product, they will add that product to their portfolio of items they seek to sell to foreign buyers. They feature the products in their showroom, in their brochures, on their website and in their tradeshow displays. Many factories do not see anything wrong with doing this. In their view, if the product is not protected by a patent or a trademark or a contract, why should they not go out and sell it? They did the hard work in learning how to make the product on a commercial basis and they should be allowed to leverage this expertise by selling the product to other customers.

The only way to prevent this kind of infringing sale to third parties is to enter into a contract that effectively addresses the issue. Conduct that is prohibited has to be described and penalties for any failure to comply must be specified. Factories will not want their own off the shelf technologies to be restricted. It is often a complex process to describe what exactly is protected and what is not. In the current conditions of South/S.E. Asia, failing to enter into an agreement on this issue is an invitation to disaster and our international manufacturing lawyers as well as our international IP lawyers have seen a massive increase in calls and emails from foreign companies seeking legal help to stop this after it has occurred.

It is simply not possible to successfully purchase product from S.E./South Asia by executing a simple purchase order and hoping for the best. The above issues must be assessed and a calculation of the real cost of the product must be made. An enforceable contract with the factory must be negotiated and executed. After the contract is signed and the order is made, continuous monitoring is required. All of this can be difficult to accept by buyers who are moving from China to another region.

Many buyers assume the conditions in S.E./South Asia will be basically the same as for the advanced contract manufacturing centers in East and South China, but these regions are in fact more like China in the 1990s and you must account for this in planning your new product purchase programs. The notion that you can operate in Vietnam, Thailand, India, Pakistan, Bangladesh, Malaysia, Myanmar, or Cambodia just as you did for China is simply false. On the other hand, experience gained in dealing with China during its rise as a supply center can be applied directly to avoid making mistakes in new regions. See also, How YOU Can Avoid Problems when Manufacturing Overseas.

Five China IP Tips

I was recently interviewed by Tyler LeMasters on The Far East Podcast on IP protection in China. We had a great chat and I encourage you to listen to it and check out some of the other content produced by this DC-based Spokanite.

My conversation with Tyler gave me a chance to share my Five Favorite IP Tips for China (and for pretty much all other countries as well). Actually time constraints limited me to only four of these on the podcast, but I’ve added the fifth one below.

1. Register Your IP—in China

This could well be the Carthago delenda est of the China Law Blog—and for good reason. First, if your trademarks and patents are not registered in China (it’s a bit different with copyrights), there may be very little, if anything, you (or we) can do to protect them against counterfeiting or other infringement. This is because trademarks and patents not registered in China are not protected under Chinese law, except in the case of a “well-known” trademark, which you almost certainly do not have.

There are other risks as well. As we put it last year in China Trademark Theft. It’s Baaaaaack in a Big Way:

There are actually a number of people in China who make a living (and a good one at that) by usurping foreign trademarks and then selling a license to that trademark to the original, foreign, license holder. Once one comes to grip with the fact that China, like most of the rest of the world is a “first to file” country, one can understand how easy this usurpation is, and also, how easy it is to prevent it.

A few years ago I represented a European company that ended up having to pay more than $200,000 to buy its “own” trademark so as not to miss out on the Chinese market entirely. But even if you don’t plan to sell your products in China, failing to register your IP can create major problems., as we explained:

The fact that you are manufacturing your product in China just for export does not in any way minimize the need for you to protect your trademark. Once someone registers “your” trademark in China, they have the power to stop your goods at the border and prevent them from leaving China. That’s right, they can stop your goods from leaving because they own the trademark, not you.

Given that the costs associated with registering trademarks and other IP in China are modest, failing to do so could well be one of the worst possible business decisions your company could make.

Oh, and don’t forget to record your IP with Customs once you register it. This is essentially your way of letting Customs know that you are facing a counterfeiting problem and asking them to keep an eye out for fakes.


2. Engage with local law enforcement

There are two aspects to working with local law enforcement. First, you should give law enforcement a helping hand by conducting your own investigations and providing them with actionable intelligence. Second, if law enforcement requests assistance, provide it.

This second point might seem an obvious one but supporting IP enforcement activity can become onerous for a company, especially if it doesn’t have dedicated brand protection staff. If the quantity of goods seized during a raid is low, it may not seem worthwhile to pursue the matter. However, if you don’t help local law enforcement officers close their cases, they will conclude that you and your brand are not worth the trouble and they will be a lot less likely to help you the next time around.


3. Sue the Infringer/Counterfeiter 

Having worked on more than my fair share of IP litigation matters in Chinese courts, I can confirm that those can be an extremely frustrating experience. In my interview with Tyler, I talked about what should have been a slam-dunk case where the judge refused to award damages out of concern for the financial situation of the pregnant defendant. This reflects the fact that in reaching their decisions, Chinese judges often consider the “legal effect, social effect and political effect.”  In this particular case, though it would have made legal sense to compel the defendant to return some of the money she had earned from . selling counterfeits, the Chinese judge decided that favoring a U.S. based multinational over a pregnant local resident would not be a good social and political look.

Thankfully, cases such as this tend to be the exception not the norm and I have handled many cases in which Chinese courts handed down decisions in favor of my foreign clients, imposing considerable damage awards. I also have had many cases where the threat of an IP lawsuit has led the Chinese counter-party to pay money in settlement to my foreign clients.  Admittedly though, China damage awards and settlements seem low to foreign companies, even when they understood the amounts are a big deal for the average Chinese citizen.

Your willingness to go to court in China is nonetheless important to show that you mean business, not just to would-be counterfeiters, but also to law enforcement. When I worked in China, I did a lot of anti-counterfeiting work for Premier League teams and after a successful warehouse or shop raid, we would usually find jerseys and other gear for teams other than our clients. Most of the time, the police would leave that other stuff behind—they knew which teams would play ball (pun intended) and which wouldn’t. Pursuing counterfeiters also sends a powerful message to your customers, showing them that you truly believe your products are valuable.


4. Protect your house

What this means is that you should do all you can to identify and thwart internal threats from within your own organization and from your own suppliers and distributers. As I mentioned in How to Move Your Manufacturing from China AND Protect Your IP:

[I]n the face of a reduced ability to rely on the legal system for protection, savvy businesses need to do all they can to protect themselves—and protection starts at home. Through preventive efforts at their manufacturing facilities, businesses can go a long way towards minimizing IP and related risks. What sort of prevention are we talking about? Obviously, you want to guard against unauthorized (i.e., third shift) production by your suppliers. You will also want to prevent sensitive prototypes from being photographed or extracted, as well as digital files with design specs from being leaked. You will also want to exercise strict controls over any materials that could help criminals improve the quality of their counterfeits, such as genuine accessories.

Clear, comprehensive guidelines are a cornerstone of product security in China and everywhere else. If you have experienced professionals on your payroll, they can draft those guidelines, but you should not wing it…

Having established guidelines, the next step is to ensure staff actually comply with them. Though some factories do a pretty job monitoring themselves, most don’t. This is why you need specialized compliance audits, by professionals who understand the underlying risks…

And oftentimes most importantly, your contractual framework with your supplier must include product-security considerations, such as your right to audit facilities and provide remedies for IP-related breaches. You almost certainly will also need country-specific NNN Agreements and Manufacturing Contracts for each new country in which you are having your products made. See China NNN ≠ Foreign NDA and Overseas Manufacturing Contracts (OEM, CM and ODM). You may also need a Product Development Agreement, Product Ownership Agreement, and a contract protecting your molds and tooling. With all the tariffs and duties coming (and even occasionally going), it also makes sense to have your manufacturing contract delineate who will ultimately be responsible for paying what.

5. Educate the consumer

The final tip is the one companies typically find to be the most gratifying. Tell your story to your customers. Tell them why they should be getting the genuine article and not some cheap knockoff. Be creative in this regard. Take some of those seized samples you get from your raids and put them on display at your store. Let customers see, touch, and smell the low-grade pirated crap that’s out there. If you’re selling makeup, show them a video of the clandestine labs where they make counterfeit lipstick and mascara—and contrast it with your own, clean facilities. Talk about the risks.

One of our China lawyers loves to tell the following story, which graphically illustrates why buying the real thing matters:

This lawyer was in Shanghai and his favorite uncle was also in Shanghai and he met his uncle and a couple of his friends at a restaurant there. One of the friends talked about having bought a set of “Ping” golf clubs for only $350. The lawyer told this person that there was no way the clubs were real Pings. The friend responded by saying that “even if they are not, I still got a fine set of clubs for only $350.” Two weeks later the uncle called our lawyer to tell him that he’d been golfing with his friend and on the second hole, the friend hit a ball off the tee using his fake Ping driver and the driver head flew off in his backswing and just missed hitting someone in the head who was walking behind the tee at the time. The friend right then and there walked to the clubhouse, tossed his entire set of fake Pings in the garbage and bought a real set of Pings right then and there. 

It also usually makes sense for you to provide information to allow the public to identify fakes through the use of security features and/or by pointing out common flaws found on counterfeits.

China employment lawyers

A China employment contract must specify the employee’s working hours and the working hours system under which the employee will work. The employee contract for an employee working under the standard hours system must state the employee will have “standard” working hours (this generally means 8 hours a day and 40 hours a week) and if an employee is working under the flexible hours system, the contract must specify that as well.

As the name of the flexible hours system indicates an employee can be designated to work flexible hours and not adhere to the standard 8 hours a day/40 hours a week. One of the most appealing features of China’s flexible hours system is that allows employers to avoid having to pay for most overtime. However, as with pretty much everything else having to do with China’s employment laws, this sounds way better and simpler than it actually is.

It should go without saying that this system is not designed to allow employers to abuse their employees’ working hours. For example, if your flexible hours employee works long hours every workday and/or during the weekends, even with proper government paperwork, an arbitral body/court will likely “pierce the veil” of the working hours arrangement and rule that the employee is really under the standard hours system and rule that the employer owes the employee unpaid overtime and additional penalties. Numerous cases confirm that “gaming” China’s flexible hours system can lead to massive problems for employers that do this.

As part of their efforts to prevent employer abuses, the Chinese authorities require prior government approval and periodic renewals for an employee to come within and remain within the flexible working hours system. Despite what you may have been told otherwise (and that includes being advised by your own employees), an employee’s signed consent to work under the flexible hours arrangement is NOT sufficient. This is so important I will say it again. For the flexible hours working system to work you need prior government approval and an employee’s agreement to work under this system is not enough. I repeated this because huge numbers of foreign employers believe otherwise.

Also, and despite what you may have been told otherwise, not all employees are eligible to work flexible hours. Whether an employee is eligible to work flexible hours differs by locale, but in most places, employee eligibility largely depends on the employee’s job title, and job duties, though some cities take the employee’s salary into account as well. What our China employment lawyers have been seeing these days is that the labor authorities across the country are getting much tougher with their flexible hours reviews. Therefore, when a foreign company employer comes to us for help in getting all of its China positions classified as flexible, we usually suggest that we first figure out whether the employer can achieve that and if not, we suggest prioritizing the need for flexible hours position by position. Then one of our China employment attorneys will gather up all relevant information regarding the employer and each employee and then we have initial conversations with the local employment authorities to get an idea of who may be eligible to work flexible hours. Our clients often will ask us to give them a list of who is and who is not qualified to work flexible hours. Our usual response is that we cannot provide such a list because (like so much else in China) such a listing can vary from district to district within the same city and even within a district, it can constantly change. We then offer to send them a list that can give them a basic idea of who can work flexible hours, while in the meantime we contact the authorities in their specific district regarding the exact requirements.

Up until about a year ago (yes, about the start of the US-China Trade War), we were often able to get verbal telephonic confirmations of eligibility from the authorities simply by providing some basic information. Without revealing the employer’s identity, we would tell the employment authorities about the employer’s situation and why it needed its employees to be able to work flexible hours and the authorities would then usually provide us guidance on the sorts of things their specific office wanted to see on the flexible hours application documents.

By way of a bit of background, Chinese government authorities have traditionally been great at helping foreign companies navigate Chinese laws and applications, not just in the employment arena. A large part of our job as China lawyers has always been to call up local Chinese government authorities, tell them generally about what our client will be seeking to do (without revealing any client names) and asking how that is being done these days in that particular district. Up to a year ago, Chinese government authorities were invariably exceedingly helpful. The reason for doing things this way is because the last thing you want to do is just go off and file something with the government and get it rejected because after that one rejection you become suspect and getting acceptance becomes ten times more difficult. It can be even worse to get Chinese government acceptance for something that does not 100% correspond with what you actually end up doing.

Recently, however, things have been different. The “new normal” is that Chinese government authorities are a lot less interested in helping foreign companies than they were and Chinese employment authorities are generally now refusing to verbally confirm an employee’s eligibility over the phone or in person. Their response these days is usually to say that flexible hours eligibility will depend on a number of things, with the nature of the employee’s work and job responsibilities being most important. They will also usually explicitly say they will not render any opinion (even verbally) until they have fully reviewed all of the application documents. They are also fairly consistently making things more difficult for foreign employers by imposing new requirements without notice. So now, in addition to our China employment lawyers having to draft the essential working hours-related employment documents for our clients, we also have to provide considerably more legal counsel on this issue, including working with the employer to make sure its application documents meet the government’s exact requirements.

Bottom line: With Chinese authorities cracking down hard on foreigner employers for not being in full compliance with China’s employment laws and with Chinese employee lawsuits against their foreign employers rapidly increasing, prudence and preparation are required when arranging your China employees’ working hours. See Want to Keep Your Business in China? Do These Things NOW.

international law

This is the seventeenth episode in our ongoing Saturday series on eight+ things to read about China and a lot more. We constantly get emails from readers asking what to read on China and all sorts of things related and even barely related to China and this series is intended to constantly and consistently answer these questions.

As we said in our initial post on this, our plan is to list out eight (or so) articles we benefitted from reading and think you our readers would also benefit from reading, along with a very brief explanation as to why the particular article was included. More specifically:

The articles will likely include many on China and on Asia and a few on international trade, international politics, Spain and Latin America, economics and really just anything else we believe might benefit our readers or even that we just want people to read. We do not plan to choose articles that push our or any other political agenda or any other agenda for that matter, but having said that, we are not objective and our views may creep through. Our goal though is to focus on articles that are important or helpful or — most importantly — that make you think. Our posting of an article will NOT mean we agree with all of it or even any of it. Most of the articles will be from the week preceding the post but we will also sometimes throw in older articles (classics if you will) as well.

Please do not hesitate to comment at the end of this or any other post. We cannot tell you how much we appreciate your comments, good, bad and indifferent.

Here we go, in absolutely no particular order.

1.  China Lost the United States First. Foreign Policy. Because Beijing’s hostilities did start before the trade war and because it certainly does seem like 90+ percent of people who have dealt with China for the last decade are tired of making excuses for it.

2.  As trade war deepens, a state-owned insurer in China helps soften the blow. Reuters. Because hardly anyone knows what Sinosure is until it comes for their first born child. Because Sinosure’s collection tactics are one of the few things I would describe as pure evil. See China Sinosure: What You NEED to Know.

3.  When the Culture War Comes for the KidsAtlantic. Because this is a very thoughtful and well-written piece. Because I love, love, love, this statement from it: “Our goal shouldn’t be to tell children what to think. The point is to teach them how to think so they can grow up to find their own answers.” I’ve always wanted my kids to be capable of thinking for themselves.

4.  La fábrica de Europa: Turquía, Italia y Rumanía copan el 66% del empleo en confecciónModeas. Because it shows that European countries like Romania, Bulgaria, Poland, Turkey, Italy, Portugal, Spain, France and even Germany, have robust clothing manufacturing industries. Because as our law firm’s clients continue moving their manufacturing out of China, our international manufacturing lawyers are excited to rediscover that there is a big and fascinating world out there and there is a lot more manufacturing going on outside China than many people realize. See How to Stop Manufacturing in China: Try Harder.  See also Doing Business Outside China: It’s Thailand’s Time and The China-US Trade War and the Winner is….MEXICO.

5.  Can We Survive Extreme Heat? Rolling Stone. Because global warming is real and because I am obsessed with figuring out how it will change things.

6. “He is Trying to Play a Very Difficult Game”: The Once and Future Imran KhanVanity Fair. Because Pakistan is on the precipice of entering the 21st century and falling into an endless pit of extremism. Because Pakistan matters.

7.   Cathay Pacific swings axe in response to sharp drop in passenger numbers. South China Morning Post. Because the fact that hardly anyone is traveling to Hong Kong these days is just additional cold hard evidence that Hong Kong is sinking into irrelevance as an international financial and legal center. See Hong Kong for International Business: Stick a Fork in It.

8.  China’s Economy Will Shrink. Trade War Has No End In SightForbes. Because it’s true.

9.   It now costs $350,000 a year to live a middle-class lifestyle in a big city—here’s a sad breakdown of why. CNBC. Because it highlights the growing urban-rural divide. Because my late night flight earlier this week from San Francisco was cancelled and I had to scramble for a hotel room and I ended up choosing a Residence Inn 6.5 miles from the airport because it was a deal at $465 a night. For a Residence Inn!

10.  Sushi Dictionary. TripSavvy. Because if you know these terms you can eat at any sushi restaurant in the world without knowing even one word of the local language. Because there are very few things better in the world than sushi.

11.  Are Chinese companies using Cambodia to evade US tariffs? South China Morning Post. Because of course they are. Because many of our clients are concerned about moving their manufacturing to places like Cambodia for fear that the large amounts of illegal transhipping will soon cause President Trump to slap China-like tariffs on those places. Because our international manufacturing lawyers typically tell them that Cambodia and Vietnam are the two countries at highest risk for this. See US-China Tariff Updates: What You Can (and Should NOT) do NOW and How To Get Rich From Your Competitor’s Illegal Transshipping: Moiety and the False Claims Act.

12.  The World Expected a Chinese Tech Takeover. Alibaba Can’t Even Conquer Vietnam. Wall Street Journal. Because the prowess of China tech companies has been greatly exaggerated. Because the typical Chinese company is unbelievably ham-fisted when it comes to doing business outside China, but a select few of them are slowly but surely improving at this. See Chinese Companies Are Getting More Internationally Sophisticated. No, Really.

Please do give us your feedback on  the above, good, bad or indifferent.

China lawyers
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments or phone calls as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So we usually provide a quick general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well, which we generally do on Fridays, like today.

In the last week or so the most common question we have been getting is whether we think an end to the trade war is in sight. The answer is no.

But what about all the goodwill gestures we have been seeing from both sides of late? Those are pretty meaningless because the “goodwill gestures” by the United States (delaying the tariff increase by a few weeks) are aimed at helping the U.S. economy, not at helping China. And China’s goodwill gestures of rolling back tariffs on certain agricultural goods are aimed to trying to keep in check massive inflation that has been hitting portions of China’s food chain and not exactly making its citizens happy. So no, we do not see self-serving efforts by both sides as a kumbaya moment.

And if you want further proof of that, the second most commonly asked question we’ve been getting in the last few weeks is coming from people we know who work in China or do China supply chain work and those email chains usually go somewhat like this:

FRIEND:  If you run across a company looking for assistance with their supply chain in Asia or in professional services management/BD, I am open to new opportunities.

ME: I will absolutely do so. Are you hoping to stay in China?

FRIEND:  No. I’m looking to get out of here as fast as I possibly can. I want to go somewhere else in Asia or back to the States. I’ve been spending quite a bit of time in Vietnam setting up suppliers as you might expect given what is happening in China. Does this make sense to you?

ME:  Yes. There are tons of people with China expertise but far fewer with knowledge of places like Vietnam, Thailand, Indonesia, Taiwan, Cambodia or Malysia (or anywhere else for that matter). When the trade war started, so many companies told us that they wanted to move their manufacturing out of China but they didn’t know how to do that we brought in-house three people we’d worked with for years on Thailand, Malaysia and Vietnam. So yeah, there is definitely a need for these sort of people right now. Thailand, Malaysia, Vietnam and Taiwan are where we are seeing the most action these days. I am a huge fan of Latin America and we are definitely seeing growth there, especially with clothing. That is where I’d like to see the most movement, but that region is truly terra incognita for just about everyone (except our clients from Spain). There are some incredible things happening on the tech front in places like Colombia (where I just spent ten days) and Chile and Mexico and Mexico’s jean manufacturing is soaring. And yet nobody is talking about this. Argentina is having massive economic problems, but it too can be a great place for tech.

FRIEND: Thailand is penciled in for November so if you know of anyone you believe I should speak to while I’m in Bangkok, let me know – it would be greatly appreciated. You are right, I know nothing about Latin America — never been South of Texas.

ME: Keep me posted and let me know if I can help. As far as returning to the U.S. keep me posted on that too. Where would you go:

FRIEND: I’ve always loved Seattle.

ME: Seattle is super expensive. I always say that China’s expats used to go to San Francisco but that got too expensive so then it was Seattle. But that got too expensive so then it was Nashville. But that got too expensive and so now it’s Raleigh-Durham but I am getting the sense that is getting too expensive and people are now talking about Salt Lake City and Grand Rapids, Michigan. Both Salt Lake City and GR are way more international than you would ever think. Grand Rapids has Amway and its furniture and auto part companies and Salt Lake City has just a huge number of people who return from their missions with international experience. You would be shocked at how many of our clients are based in SLC.

FRIEND: Good to know. I didn’t know any of that and I guess that’s because until recently I hadn’t even though of leaving. But things have really changed here.

ME: I get it. Keep us posted and don’t hesitate to let us know if and how we can help.

What are you seeing out there?

China full service outsourcing PEO

Somewhat paradoxically, increasing tension and tariffs between the United States and China seem only to drove more companies to want “to go into China.” See Why NOW Is a Good Time to Double Down on Doing Business in China. Most of these companies looking to go into China are companies that sell something to China — either goods or services — and are looking to go into China to “solidify” their relationship with their Chinese customers.

There are obviously risks to going into China these days, chief among them that you will essentially be putting your company in harm’s way if relations between the West and China deteriorate even further. And yet, if past performance is any guide to future performance (and we all know it is), companies in China have for the most part been exempted from these sorts of problems. By exempted, I mean that we are simply not hearing of China going after foreign companies in China that are in full compliance with China’s laws. For the increasing need to be sure you are in full compliance with China’s laws, check out the following (now!):

Generally, “going into China” means setting up a company in China, be it a WFOE, a Joint Venture, or a Representative Office. It is also possible to go into China using a hiring agency, such as FESCO.  Sometimes referred to as third party hiring agencies, these companies will hire employees in China for your company and thereby (in some circumstances) allow your company to delay having to set up its own full-fledged entity in China. There are benefits to be realized from third party hiring agencies, but also considerable risks. This means that this sort of arrangement — if done properly, which they often are not — can make good sense for some companies and terrible sense for others.
There is also another kind of arrangment known as “full outsourcing,” (sometimes referred to as PEO) whereby a company in China essentially “becomes” the foreign company in China and does everything or almost everything in China for the foreign company. I am writing about this sort of arrangement for the first time because our China company lawyers are seeing a big uptick in companies asking us about these. And by big uptick I mean that over the last ten years we typically would get maybe one or two questions about this model per year and we are now getting maybe one a month.
To very quickly tell you how I feel about full outsourcing in China I show you the below email exchange (very much shortened).
Foreign Company: Is the full outsourcing model a bad idea for China or is it just something your firm does not do?
Me: Both.
Our China lawyers do not help foreign companies enter into full outsourcing arrangements in China because we deem them too risky and too expensive and, more importantly, because we do not believe they are legal.
In addition to their highly questionable legality, we have the following issues with them:

1. The main reason companies seek to go into China via full outsourcing is to save money. I get that, but to ameliorate the risks of such an arrangement, you need a really good contract and due to the complex nature of these arrangements, the cost of that contract could very well end up costing as much or even more than other (clearly legal) alternatives. So there goes what is usually the sole basis for such an arrangement. Think IP, taxes, office and employment issues, at a minimum.
2. Many companies choose full outsourcing as a way of “putting their toes into the China waters.” In other words, they view full outsourcing as a cheap and fast and easy way to “test” out China, all the while planning to go into China full-bore if the test succeeds. But what seems to never occur to these companies is how difficult and costly it will be to switch from full outsourcing to a WFOE or Joint Venture model. Think about it. With full outsourcing you have essentially turned over your IP (and you had better do this correctly or you could literally lose it) and your employees and your office and whatever else you are doing in China. Now tell me how smooth it will be when you tell your Chinese full service hosting company that you are done with them and you want them to “give” you all this back. And imagine having to now hire “your” employees and deal with their seniority issues.
3. These full service outsourcing companies nearly always have multiple clients and this usually means that “your” resources and even your employees may not be lent out to other companies.
4. What happens if you get all set up with your full service outsourcer and you end up not liking them at all? You will probably end up needing to negotiate a termination or having to sue on your contract, both of which can be time consuming and costly. And what do you do for China in the meantime?
5. How good can a full service outsourcing company be in conveying the full essence of your company?
Bottom LIne. When it comes to full service outsourcing for China as an option for going into China, there is pretty much always a better way.


China Belt and Road

I like to keep company with savvy international people with expertise that complements mine. My longtime friend, David Baxter, is one of those people. He is a South African who now lives in the Washington, D.C. area but routinely travels all over the world to advise governments and companies as an international development consultant. I call him “Mr. PPP” (Public Private Partnerships) because one glance at his LinkedIn profile makes that clear. As Mr. PPP, David specializes in public development projects in Africa, the Middle East, Asia, and everywhere else, which gives him insight into how governments are fostering international business, which governments are serious about international development, and which ones are smart about it. When speaking with David recently, we concocted a series of blog posts about the impact of China’s Belt and Road Initiative from David’s boots-on-the-ground perspective.

Many of these BRI countries will need increased economic activities to pay back their Chinese debt and will welcome U.S. and foreign companies that want to use their new infrastructure in both import and export ventures.

The goal of this and the future connected blog posts is to help U.S. and international companies understand what China is doing in target international markets so that they can benefit from utilizing Chinese-funded or Chinese-built infrastructure. As David put it, “Increased traffic using those facilities is in the national government’s interest, and those facilities are ready doors to enter into many regions. Why aren’t companies looking at opportunities where they’re using Chinese infrastructure in these foreign markets?”

Since 2013, China has been busy making friends through its Belt and Road Initiative (“BRI”). China aims to encircle countries in the historical overland Silk Road and new maritime Silk Road in interconnected infrastructure to bring them closer into China’s realm of influence and provide a host of mutual benefits to China and the involved countries. China provides long-term, low-interest loans to governments and often provides the lowest priced skilled labor required for those projects.

As of May 2019, over 60 countries have agreed to or expressed interest in BRI projects, and those countries encompass about 2/3 of the world’s population, representing both potential markets for Chinese goods and potential labor pools for lower-cost labor. They represent a large portion of the world’s natural resources, which can provide raw materials to feed China’s manufacturing complex. These countries include Pakistan, India, Sri Lanka, Malaysia, Philippines, Thailand, Cambodia, Vietnam, Myanmar, Laos, New Zealand, Iran, United Arab Emirates, Saudi Arabia, Qatar, Turkey, Egypt, Ethiopia, South Africa, Russia, Poland, Ukraine, and many more (see CFR’s Belt and Road Tracker for the full map, and CSIS’ interactive map is also excellent). These countries include many of the global energy producers (Middle East and Russia) and energy consumers (developing nations). Because China is an export-focused economy, it cannot let up its current pace of development. It needs to keep its SOEs and workers busy, either on domestic or international projects, or both.

But like all friendships that come with strings attached, many countries have started to feel uneasy about chummying up too close with their lender. In China’s BRI, in which China shows up with a checkbook, an open handshake, and a Xi Jinping-worthy smile (especially when that relationship sometimes mandates Chinese firms be included in the bidding process) those strings can feel more like chains. Debt trap diplomacy is a term that has been used to describe China’s BRI projects because China has been willing to extend loans on outwardly favorable terms with plenty of recourse for China if the borrowing nation defaults.

Due in part to this type of heavy-handed diplomacy, U.S. and foreign companies have opportunities to make inroads into these countries and markets. The Chinese are building ports, roads, rails, and power plants, along with cables and pipelines, but they do not control who uses the infrastructure. And because China’s BRI investments often bring additional cultural and political baggage, some target countries are loathe to fully engage with China. China’s “big brother” oversight through both technology and individuals on the ground and Chinese information (and disinformation) networks disguised as cultural enrichment programs, together with the prospect of Chinese colonization by leaving its workers in-country are just some of the concerns of BRI partner countries. Many of these BRI countries will need increased economic activities to pay back their Chinese debt and will welcome U.S. and foreign companies that want to use their new infrastructure in both import and export ventures. Those countries with ports, energy infrastructure, and a willing (trained or trainable) labor force will be most attractive to companies in maritime countries like the U.S. who know that maritime transport is a fraction of the cost of overland transport.

In sum, China is looking at the long game, and so should your company. (For instance, China’s state-owned Chinese Overseas Ports Holding Company has a long-term lease on Pakistan’s Gwadar Port through 2059, but in Chinese consciousness, anything less than 1,000 years is short-term planning.) If your company does not have a 40- or 50-year plan, it should start to think in those terms. China’s long-term BRI infrastructure development is a boon to companies who are looking to engage with new international markets for raw materials, a deeper labor pool, and potential consumers. In our future posts, we’ll do our best to help you recognize and utilize the most promising BRI markets, including identifying the best enabling environments and potential legal issues.

China Risks

Should I stay in China or should I leave?  Should I enter the China market or is it too risky?  The answer to these questions is simple:  it depends.  The secret is understanding what those dependencies are and how your company strategically fits within them.

What follows is an oversimplified view of the playing field in China whose main purpose is to provide a high-level framework to think about where your company fits into the overall China market from a risk perspective.

The first step is understanding the context in which you will do business in China.  You need to accept the following as absolutes that will not change:

  • China will not change its position on protecting intellectual property, if anything, it will further institutionalize and your risks of losing your IP will increase.
  • China will not change its position on subsidizing and protecting state owned enterprises (SOE).
  • China will not lessen its control of the Internet and the technology supporting it.

For many years the conventional wisdom was that China would soften on the above positions as it became more integrated into the global marketplace. That turns out to have been wishful thinking and now it is essential to face that reality.

It almost goes without saying that, even with the above realities, Western companies still want to do business in China.  See China Unfair, But We Don’t Really Care. It is also important to recognize that China actually does want Western companies to do business there as long as those companies play by China’s rules. See China’s New Company Tracking System: Comply, Comply, Comply.  So, the question becomes what types of companies can do business in China successfully with manageable risk and what sorts of companies are in the high-risk category.

On the lower end of the risk scale are marketing-driven and consumer-oriented companies in which intellectual property resides more in their marketing and product plans than in their technology. This type of intellectual property generally of less interest to the Chinese government and therefore considerably easier to protect. Also, on the lower end of the risk scale are many professional services consulting companies whose IP is largely in the brains and capabilities of the employees themselves.

The fact that there is lower risk doesn’t mean these types of companies will necessarily be successful, it just means the playing field for these sorts of companies will be more level and their risks more manageable. With its size, growth, and opportunity, the China market should deservedly be high on the strategic priority list for companies in the lower to medium risk categories.

Markets that have inherently greater risks are those that compete in industries where SOEs exist and in high technology markets with sophisticated hardware and/or software. Markets that are considered by the Chinese government to be strategically critical from an infrastructure or a technology standpoint will get the most scrutiny and carry the greatest risks.

SOEs are government owned and subsidized companies that are largely concentrated in key infrastructure related industries (steel, coal, utilities, energy, communications, mining, etc.) as well as financial services. If you are in a market that competes directly or indirectly with an SOE you will most definitely be on an uneven playing field and you will be swimming upstream to compete, if you are allowed to compete at all.

High technology companies risk the greatest damage from IP loss, but not all high-tech companies are created equal from a China risk profile. Of course, the China market isn’t even open to some technology companies, particularly those related to the internet or social media. Even within the high-tech sector there are areas of greater strategic interest to the government (like 5G and cutting edge semi-conductors) and those are of greatest risk.

It is the nature of most technology driven companies to think they are leading edge, but in reality, most are not. Most compete with me-too technology and differentiate themselves through marketing and product plans like CPG companies. These companies bear moderate risk, but their best ally is to out-execute the competition.

For those truly leading edge technology innovators the risk of doing business in China, or even with China, is enormous. This is especially true for those whose technology is a strategic focus for the China government. There are a number of strategies to potentially mitigate some of the risk for these companies (such as only manufacturing and selling older technology in China), but it is essential that these companies have no illusions about protecting the IP for products they sell in China.

The intent here was not to cover all the potential risks or market nuances, but to provide a general framework for thinking about risk in the context of your specific market. Too many discussions about China lump everyone together and don’t distinguish between the risk profiles (and associated opportunities) of vastly different markets companies may encounter.

Finally, there is no such thing as no risk in China. Even if you do everything right you may end up being investigated by the government because of a disaffected employee or you might find out your general manager is running a competing business on the side. Situations like this are common in China. However, having a balanced view of China’s overall cost/benefit/risk equation will help facilitate better decisions.

Note that this post primarily addresses commercial risks associated with selling in China.  Manufacturing and supply chain risks, though sometimes related, have quite different dynamics and warrant their own post, which will follow in a week or so.

The above is a guest post by Patrick O’Hara, an international business consultant with 25 years of high-level China business experience, with big public companies and private equity funded tech companies. I asked Patrick to write this post because our law firm’s China lawyers have worked with Patrick on many China matters and we view him him as one of the smartest and best prepared and easiest to work with clients ever. Our China WFOE lawyers worked with Patrick on setting up a WFOE in China and getting that WFOE operational and that WFOE set-up was easily one of the two or three smoothest, best run, and fastest WFOE formations we’ve ever done, and I attribute that largely to Patrick. He had lined up and prepared the right people to help every single step of the way in forming the WFOE and getting it operational. Our China WFOE lawyers are always asked: how long does it take to form a WFOE? Our answer invariably includes stating that the biggest factor in how long it takes to set-up a WFOE is you, the client, not us the WFOE lawyers, nor the Chinese government. A prepared client able to make quick decisions is key. I asked Patrick to write the above because I figured our readers could learn a lot from Patrick about how to leave China as well. For previous posts by Patrick on how to enter into China, check out Five Ways to Accelerate Your China Market Entry and for how to leave China, check out Five Ways to Facilitate Leaving China. 



China employee termination lawyers

Just about every week, one of our China employment lawyers will get an urgent email from a non-client that goes something like this

We terminated an employee yesterday because of X, Y and Z and we just need one of your China lawyers to quickly review our situation to make sure we handled the termination properly under Chinese law. We figured it should only take you a couple of hours. Can you help?

We usually respond by saying that before we can give any legal advice, we must first run a conflicts check to make sure there is no conflict with any of our existing clients and then we need to onboard you as a client. We then usually explain how China employee terminations are pretty much always complicated and seldom if ever can we get a good handle on one in just a couple of hours. This is because China employee terminations nearly always require we review the employment contract, the employer’s rules and regulations, and the termination document and any other documents (including emails and WeChat, etc.) that might be relevant to the employee’s termination. This includes any communications regarding the employee’s performance, promises made along the way to the employee, and — of course — anything that discussed the employee’s possible or actual termination. And then we have to talk with our client to gather up all of the facts.

After we have all the facts, we usually then must conduct at least some quick research before we can advise on the legal issues involved. China’s employment laws are national, provincial and, most particularly local.  See China Employment Law: Local and Not So Simple.

Only after we have done the above are we ready to start figuring out what our employer client should do to reduce the likelihood of being sued by its terminated employee. Most of the time, that will involve our drafting a bilingual Chinese-English (with Chinese as the official language) employee termination agreement.

Sometimes, the terminated employee is not contesting the termination and just wants money and to move on with his or her life. In those cases, the termination agreement usually gets signed with little to no fuss. Until about a year ago, this sort of smooth termination was more the norm than the exception, but that has drastically changed. When China’s economy was booming, the typical terminated employee wanted just money and to move on, confident they could get at least as good a job within a few weeks. But as China’s economy has slowed, our China employment attorneys are having to deal with a very different sort of terminated employee. We are now seeing a constant stream of angry and scared terminated employees, who are rightfully worried about the long term. This has been especially true in the last 3-6 months where scared employees want big termination packages and are more than willing to fight and sue until they get one.

We always used to tell our foreign clients that terminated Chinese employees virtually always win in lawsuits against their foreign employers, but now we are saying that they will win and they will win big. Chinese government officials and judges and arbitrators view it as essentially a public service to transfer money from foreign companies to terminated Chinese employees. This is the reality with which we as employment lawyers are having to deal and we have modified just about everything we do to meet it.

The mere fact an employer first comes to us after a termination is a tell that it will not be a straightforward matter. I say this because the best way to handle a China employee termination is to have worked with your China lawyer long before the termination. Companies with well-honed HR machines have been using China employment lawyers all along and they have well-crafted documents in place to protect against future terminations and they go to their China employment lawyer weeks before any termination so as to plot out exactly how that termination should go down. It should go without saying that employers have more power the day before a termination than the day after. So if a company comes to us for the first time and in a rush after a termination, we know that does not bode well for the sort of documents they have or for their HR system.

It also does not bode well for the procedures they employed in the termination itself, which, standing alone, can be disastrous for employers. I say this because Chinese arbitrators and judges do not hesitate to find an employee termination unlawful based solely on procedural problems with the termination itself. In other words, these arbitrators and judges may very well agree that the employee’s misconduct warranted dismissal but the employer’s failure to consult with the employee’s union before the termination made the entire termination unlawful.  Perhaps most commonly, the arbitrator or judge will find the termination wrongful simply because the employer failed to provide adequate termination notice — which can include the employer simply having said the wrong thing in the termination notice or not having said something in the notice that should have been said. This is why we always stress the need to take great care in drafting all termination-related documents. Companies that contact a lawyer for the first time after a termination almost invariably have done something wrong in the termination itself and our spending “a couple of hours” is not going to remedy that.  Sorry.

The good news though is that no matter how messed up your employee termination situation, until a judge or arbitrator actually rules against you, there will always be things that can be done to ameliorate your situation. Even if the terminated employee brings a labor arbitration claim, the labor authorities will almost always push the parties to mediate before the formal labor arbitration. This means that even far along in the process, it is still possible to settle with your terminated employee and get him or her to sign a China-specific settlement agreement that will avoid or terminate labor arbitration/litigation altogether.

international law

This is the sixteenth episode in our ongoing Saturday series on eight+ things to read about China and a lot more. We constantly get emails from readers asking what to read on China and all sorts of things related and even barely related to China and this series is intended to constantly and consistently answer these questions.

As we said in our initial post on this, our plan is to list out eight (or so) articles we benefitted from reading and think you our readers would also benefit from reading, along with a very brief explanation as to why the particular article was included. More specifically:

The articles will likely include many on China and on Asia and a few on international trade, international politics, Spain and Latin America, economics and really just anything else we believe might benefit our readers or even that we just want people to read. We do not plan to choose articles that push our or any other political agenda or any other agenda for that matter, but having said that, we are not objective and our views may creep through. Our goal though is to focus on articles that are important or helpful or — most importantly — that make you think. Our posting of an article will NOT mean we agree with all of it or even any of it. Most of the articles will be from the week preceding the post but we will also sometimes throw in older articles (classics if you will) as well.

Please do not hesitate to comment at the end of this or any other post. We cannot tell you how much we appreciate your comments, good, bad and indifferent.

Here we go, in absolutely no particular order.

1. Are We Creating “Big Marijuana”? YouTube (Ted Talk). Because cannabis is legalizing around the world and the United States and because its not yet clear what that will mean. Because this is an amazing talk that has garnered more than 88,000 views for a reason. Because this talk is by one of my law partners, Hilary Bricken, who has to be one of the most dynamic/charismatic lawyers on the planet and because I cannot even tell you how many times I’ve heard people marvel at her speaking abilities. Because the dude does abide and because you will greatly enjoy this video, I promise!

2. The Two Most Mysterious Words in Modern ShoppingAtlantic. Because sales of private label goods are growing in the United States and because in Spain (where ), more than half of all product sales are private label. Because this trend is having a huge impact worldwide.

3. Merkel Has Made a U-Turn on China But It May Be Too Late. Bloomberg. Because China’s unfair treatment of foreign companies is resented by more than just the United States. Because every time I talk about the growing fissure/decoupling between China and the West, someone will insist that it is just the United States. Because so many of our firm’s European clients have made a point of letting us know that they hope the United States “wins” the trade war against China because its doing so might open up China’s economy for European companies as well.

4.  Discovery of Long-Lost Silent Film With All-Indian Cast Has Historians Reeling. Indian Country Today. Because this is just so flat out amazingly cool.

5. Tariffs are no longer China’s biggest problem in the trade war.CNBC. Because this article posits that China is eagerly returning to the trade negotiating table with the United States because it fears decoupling from the West way more than it fears U.S. tariffs. Because I do not think China fears decoupling but I do agree that decoupling is what we are seeing and will continue to see over the next decade. See Does China WANT a Second Decoupling? The Chinese Texts Say That it Does and The US-China Cold War Starts Now: What You Must do to Prepare.

6. Covert Wars, to What End? Texas National Security Review. Because there have been so many covert wars and yet they have a “sorry track record.”

7. America’s Orthodox Jews Are Selling A Ton Of The Products You Buy On Amazon. BuzzFeed. Because who knew? Because our International manufacturing lawyers and our international IP lawyers knew because many of them are our clients!

8. Popeyes customer pulls a gun after being told there were no more chicken sandwiches. CNN. Because this person was hungry and because these sandwiches have been so over-hyped (spoken by someone who has never had one).

9 Investors have set their eyes on Thailand as the trade war deepens. CNBC. Because our law firm has been super bullish on Thailand as a China alternative for manufacturing, pretty much since the trade war started. See Doing Business Outside China: It’s Thailand’s Time.

10. Hong Kong Good Citizen Applications Jump as People Eye Exit. Bloomberg. Because Hong Kong as an international business and financial center is over and the sooner people realize this and act accordingly, the better off they will be. See also Hong Kong protests fuel buyer interest in Australia, New Zealand luxury homes. Not surprisingly, our immigration law team has seen an uptick in Hong Kongers looking to flee HK for the United States.