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 what we usually do is 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. On Fridays, like today.

One of the most common questions our lawyers have been getting lately is “what should I do.” Mores specifically, we are getting this classic question from our clients that are making their products in China, either in their own facilities in China (that they own via their own China WFOE) or via third party contract manufacturers. They want to do what to do in light of the tariffs the United States is imposing on incoming China goods. More particularly, they want to know what more about non-China options.

I today read one of the best articles on what is happening out there with respect to US companies leaving China to manufacture elsewhere. The article is by CNN and its titled The trade war is pushing business out of China, but not into America and I like it so much because it 100% correlates with exactly what my law firm’s international lawyers are seeing and hearing, mostly from our own clients.

The article starts with the following:

US tariffs are prompting companies to move some production out of China, but it’s not going where President Donald Trump would prefer.

The trade war has made more than $250 billion of Chinese exports more expensive for Americans — from leather belts to refrigerators to motorcycles. The disruption to the world’s biggest trading relationship has electronics manufacturers, industrial machinery makers and fashion brands working on shifting some of their assembly lines.

“We are flooded by inquiries,” said William Ma, group managing director of Kerry Logistics, a Hong Kong-based firm that helps companies around the world manage their supply chains. “It all happens after the trade war.”

Many firms are keeping much of their operations in China, which offers a giant domestic market and advantages that businesses struggle to find elsewhere. But those that are moving aren’t flocking to the United States. Instead, they’re looking to transfer work to other Asian countries.

This is exactly what we are seeing. Many of our clients are moving their manufacturing elsewhere in Asia, many of our clients are “stuck” in China, and none of them have resourced their manufacturing to the United States, at least not yet.

The article then notes how “the tariffs have accelerated the shift of manufacturing from China to countries in Southeast Asia, where labor is cheaper.” and it uses the Steve Madden Company as an example of this:

Steve Madden (SHOO), whose handbags have been hit by a 10% tariff, says it’s moving a significant chunk of its production to Cambodia and other countries. The company currently makes about 85% of its handbags in China, a figure that could drop to 50% or 60% next year.

“The shift is almost entirely due to the US-China trade conflict,” Steve Madden CEO Ed Rosenfeld told CNN’s Alison Kosik. “We have to prepare as though tariffs will be the new normal, but we are hopeful that cooler heads will prevail.”

Again, this is exactly the sort of thing we are seeing from our clients whose products can relatively easily be made outside China; they are having some of their products made outside China. Only some because it just isn’t that easy or even possible to move all your production at once.

The article essentially says consumer tech brands are desperate to manufacture outside China and we are seeing the same thing:

Consumer tech brands are also looking to Southeast Asia. Hugh Lo, vice president of the consumer division at Taiwan’s New Kinpo Group, which makes electronics for clients such as Toshiba (TOSBF) and Samsung (SSNLF), says he has been inundated with inquiries from companies keen to transfer manufacturing out of China.

A year ago, his team got about one inquiry a week, he said. Now, it’s “maybe 30 times more.”
Lo said that TV and gaming device makers have been particularly interested in relocating. He declined to name individual companies.
Here’s the thing though; there just isn’t sufficient capacity for this outside China. Yet.
To what countries are manufacturers moving? The article nails this as well:
Nathan Resnick, whose San Diego-based startup Sourcify helps thousands of businesses place orders with manufacturers across Asia, has also noticed a clear shift away from China this year.
In January, Chinese factories supplied as much as 90% of the orders his company helped place in industries like textiles and household appliances. Now, he estimates that figure has plummeted to about 50%, with the focus moving to countries like Thailand, Vietnam and the Philippines.
“It’s really just been recently,” Resnick told CNN. “I didn’t go to any of those countries last year.”
Again, this is exactly what our international lawyers have been seeing as well. I estimate that among my law firm’s clients well over 50% of the production that is moving outside China is going to Vietnam and Thailand and the Philipines comes in third. Our clients looking to outsource their manufacturing are mostly favoring Vietnam and our clients looking to build their own manufacturing facilities are mostly favoring Thailand and the Philipines. We will see…
The article also rightly notes that leaving China is not easy and many cannot:
A lot of companies are unwilling to leave China, which has a range of advantages for manufacturing industries that are spread across Asia.
Many of the products US firms export from China have to fit exact requirements, necessitating specialized equipment and highly trained workers, according to Harley Seyedin, president of the American Chamber of Commerce in South China.
“Their supply chains cannot be adjusted in short order,” Seyedin told CNN.
China also boasts better roads, ports and power grids than most Southeast Asian countries. “China just has such a great infrastructure,” Resnick said. “You go to some of these areas in the Philippines or Vietnam, and the ground surrounding the factory is not developed whatsoever.”
Starting from scratch in another country is a major step.
Executives estimate it could take up to two years to build a new factory. Then there are the challenges of navigating the local bureaucracy and training new staff to meet the company’s standards.
One more big problem: many (most?) factories in countries like Vietnam and Thailand are bursting at the seams:  “Businesses that want to move their orders outside China face another problem: finding factories in the region that can accept them.” Our firm works extremely closely with well-qualified people in both these countries and so we know this problem is very real.
What are you seeing out there?

China manufacturing lawyers

This worry is leading many Chinese manufacturers to view their foreign buyers as likely to eventually leave them and that makes them less interested in doing what it takes to maintain a good long term relationship. For purposes of this post, it also makes Chinese manufacturers a lot more likely now than even a year ago to as quickly as possible purloin whatever they can from their Western buyer so as to be able to as quickly as possible compete with the Western buyer with the Western buyer’s own product.

The China lawyers at my firm have a front row seat to all this because we get emails from many Western companies whose products are being copied weeks after they first meet with a Chinese manufacturer. In the old days (of about a year ago), it usually took years and a deteriorating relationship between buyer and manufacturer before the manufacturer would start directly competing. In other words, Chines manufacturers used to wait until they believed they could make more money selling YOUR product than they could making your product for you before they would compete. Today, many Chinese companies have made the calculation that they can make more money selling your product starting on day one.

What’s all this got to do with mold ownership agreements? A lot.

One of the best ways to stop or slow your Chinese manufacturer from competing with you is by legally blocking it from using your molds for anything other than making products for you. There are a lot of ways to accomplish this, but oftentimes the best way is with a relatively simple mold ownership agreement that makes clear the molds belong to you, your manufacturer cannot use them for anything other than making product for you, and your manufacturer cannot hold on to them once you seek their return. For more on the benefits of protecting your molds (and tooling as well) from China, check out the following:

There are a whole host of other things you can and in many cases should be doing to protect against your own China manufacturer, but a mold agreement is oftentimes a good and relatively cheap start. See Protecting Your Product From China: The 101. 

What are you seeing out there?

 

China non-compete lawyers

It has become increasingly common for both foreign and Chinese companies to require their expat employees sign a non-compete agreement as part of their employment contract package. The below are some of the more common issues that arise with most expat non-compete agreements.

Non-compete timing. When it comes to China employment contracts, our China employment lawyers represent both foreign companies and expats. One of the things we have been noticing lately when retained to review expat employment documents is what we have taken to calling a “future” non-compete agreement. We mostly see this where a high level expat is negotiating employment with a Chinese company and the Chinese company’s employment contract will explicitly mention a non-compete agreement and explicitly state that the expat will sign a non-compete agreement, but the Chinese company will not provide the expat with a non-compete agreement for signing. To make matters worse, this mention of a non-compete is a lot clearer in the Chinese language portion of the employment contract than in the English portion and always to the expat’s detriment. This really matters because unless specifically specified otherwise in the Chinese language portion of the agreement, the Chinese portion of any China employment contract is all that legally matters in a Chinese court or arbitration. See Dual Language China Contracts: Don’t Get Fooled! This means an expat who is negotiating with its putative Chinese employer without the assistance of an experienced China employment lawyer will be signing on to sign on to a (very likely onerous) non-compete agreement without ever having seen it.

Non-compete compensation. Will the expat receive fair compensation for performing her or his non-compete obligations? According to China’s Supreme People’s Court, if the employee and the employer agree on the employee’s non-compete obligations but the employment agreement is silent on the post-employment compensation for the non-compete, the employer must pay the employee 30% of the employee’s average monthly salary in the twelve months before termination or the local minimum wage where the employment contract was performed, whichever is greater. This generally means the post-employment non-compete compensation agreed to in the employment contract or in the non-compete agreement will prevail because the parties are free to agree on this amount by a mutual agreement. There are though some China courts and judges and arbitrators who will disregard the parties’ own agreement and apply the 30% standard if the parties’ agreement calls for a lower than 30% payout. No matter what, it is generally a good idea for both the employer and the employee to agree in writing to a clear and specific compensation amount for the employee’s agreement not to compete with the employer.

Geographic scope. Far too often the agreement that sets forth the non-compete obligation fails to clearly address exactly what this obligation will be. We most commonly see this in its failure even to address the geographic scope of the non-compete. In other words, will the expat be forbidden to compete with her employer in Shenzhen? In China? In China and Hong Kong? In China, Vietnam and Thailand? In all of Asia (and how is that defined?)? In the entire world? Uncertainty on geographic scope usually works against the expat down the road because it can limit the expat’s ability to get hired. Sure, you can as an expat argue that your non-compete does not extend beyond China, but will potential employers in Hong Kong or Vietnam be willing to hire you and take on the risk that it extends beyond that?  On the employer side, one of the more common mistakes we see is a non-compete that extends so far that few courts anywhere would ever enforce it. It behooves both the employer and the employee to have a non-compete that reasonably coincides with the employee’s position/company role and the employer’s business, size, and industry. A multinational with offices in 85 countries will be given more geographic leeway than a company that sells tortillas in just Qingdao.

Non-compete period. China’s legal maximum is two years after the employment contract is terminated or ends so the first thing our employment attorneys do is make sure the non-compete agreement complies with this. We then focus on making sure the non-compete period makes sense for our client. What this usually means is that when we represent the expat we seek a non-compete duration of less than two years. Because so much of our expat representation is for high level management and physicians, both of whom are in high demand by China employers, we have a very good track record of being able to narrow the scope of the employer’s proposed non-compete, both in duration and in geographic scope.

Termination rights. What are the termination rights (if any) for either party? Is the employer allowed to terminate the non-compete agreement at any time without making any additional payment? Can the employee terminate the non-compete agreement and, if so, how? Keep in mind once a non-compete agreement is signed it is usually difficult for either party to get out of it.

Contract damages. Is there anything in writing specifying the damages the employee will need to pay for breaching the non-compete agreement? If yes, what does it say? When dealing with Chinese employers we often see the damages provision be a lot clearer in the Chinese portion of the contract than in the English portion and always to the expat’s detriment. Since the Chinese portion of any China employment contract is all that legally matters in a Chinese court or arbitration (unless clearly specified otherwise in the Chinese language portion), this really matters. At minimum, the damages you as the expat must pay should be proportional to the non-compete compensation you will receive. Note also that it typically makes sense to impose specific breach of contract damages against the employer as well.

The non-compete agreements my firm’s China employment lawyers review for expats always favor the employer; this makes sense because the employer prepares this agreement. Non-compete agreements are not “just a formality” and it is critical you as the expat fully understand what you are being asked to sign and that you make a concerted effort to negotiate for better terms and protection. The fact that the Chinese language portion of the agreement is nearly always the only portion that legally matters further tilts the playing field against you. Having an experienced Chinese employment lawyer who is completely fluent in Mandarin review your non-compete agreement is usually your only real protection.

 

 

 

China lawyers

Our China lawyers get a steady stream of emails from companies seeking our help in recovering money lost in China scams or just telling us about the scams and asking us to report the scammers to “the police, the government, the State Department, the Embassy, and/or the consulate. Many of these emails also request that we write about the particular scammer on our blog or on our China Law Blog Facebook page.

Less than one percent of the time we probe a little further to see if there is any chance at all of a financial recovery, and we do so only in those matters where the losses are in the six figures or higher. We never report anyone to anyone and we never name names here on the blog.

Why not?

We don’t report anyone to anyone because if we did so we would be spending hours a day doing so and all without pay. We cannot just take what someone tells us and go to anyone with it as their lawyers. Our job as lawyers is to do our best to determine what is true and what isn’t and to dig into the facts to come up with as much as possible that might be helpful to government and law enforcement authorities in finding the culprits. Equally important, I have serious doubts that any government body in any country does much with these scams. So instead we tell the writers that they should do these things on their own.

Why though do we not name names here on the blog? Why don’t we have a list of scammers on here? For the following two reasons.

In many cases of alleged fraud, it is not clear at all that there has been a fraud. Here is one recent example. A Mexican company bought $60,000 in t-shirts from a Chinese clothing company. The Chinese clothing company sent the requisite quantity of t-shirts and the Mexican company alleges that they were of such poor quality as to be a scam. Was it a scam? I have no idea. Did the Mexican company have a written contract with the Chinese company specifying the quality of t-shirts it would be buying? I have no idea. Did the Mexican company spend $10 per t-shirt or $1 per t-shirt? I have no idea.

In many (most?) cases of alleged fraud, the name of the company is NOT the company that committed the fraud. Fraudsters often claim to be with a particular legitimate Chinese company but they really are not and a quick check of their email address reveals this. Guess what, people. It is extremely unlikely that a legitimate Alibaba employee will be emailing you from a qq email account. Many times the person behind the fraud is not Chinese and is not based in China; they are simply claiming to be with a Chinese company to pull off the fraud. We are not going to list company names when we have zero clue whether the names of the companies listed had anything at all to do with the alleged fraud.

I do note though that there are many sites that do name names and it does make sense to do an internet search before you send it money. Indeed, in most cases, additional due diligence is warranted.  See China Business Due Diligence.

Your thoughts?

China laws and business are very different from the West, of this there should be no dispute. China lawyers

And yet, our China lawyers oftentimes get emails from potential clients telling us that they have drafted a contract for China and asking us whether we would revise that contract to “make it work for China.” Our initial response to this is to say yes but to warn them that our fees for doing so will almost always be the same as our fees for our drafting the contract from scratch. The reason for this is because, with very few exceptions, the contract we are given is so different than what is required for China that its only benefit is that we can pull some (never all) of the terms we need for drafting the contract.

But guess what, that benefit almost never outweighs the harm. Let me explain.

Much of the time when we are given a draft contract that contract is a result of weeks of negotiations between the Western company and the Chinese company. If our China attorneys then substantially revise the contract and our Western company client then sends the substantially revised contract to the Chinese company, the Chinese company is rightly irritated because it believed it had a deal or was on the verge of a deal with the Western company, even though it really wasn’t.

But most of the time, the draft contract we are given is so far afield from what is needed that instead of our China lawyers being able to draft a new contract, our China lawyers instead have to tell our client that it really needs to start back at square one. Most of the time the draft contract we are given is so internally contradictory and so rife with provisions that literally do not work at all under China’s laws, that the first thing we need to do with our client is figure out exactly what it is trying to accomplish with the deal.

And then, once we have that figured out, the next step is usually to draft (in English and in Chinese) a term sheet to send to the Chinese company to determine whether drafting a contract will ever be warranted. Oftentimes, there is a critical provision that the Western company and the Chinese company never previously discussed and on which they are at clear loggerheads. The term sheet quickly reveals this and the parties then choose to go their separate ways. Oftentimes, there is a critical provision that simply cannot legally work and without that provision one or both sides do not want to go forward with the transaction and the parties then choose to go their separate ways.

We see these sorts of looming problems so often with draft agreements that I have drafted the following “template” explanation, which I then modify to fit the particular situation:

We reviewed the draft contract you sent us and we think it premature to begin drafting a contract based on it. Some of it is contradictory, some does not make sense, and some is almost unworkable or illegal. It also fails to address critical deal terms.
What we need to do here is to work with you to figure out what exactly you are seeking to do and then use that to determine whether the Chinese side will be on board with that or not. Once we are clear on what you are seeking to do here, we then draft a term sheet in English and in Chinese and use that to see whether a deal is possible. If a deal is possible, we then move forward on drafting the contract. If it is clear that no deal is possible on your terms, you then determine whether you want to compromise or walk away.
We will charge considerably less to develop the term sheet than we would charge to draft a full-fledged contract. This means that If it turns out no contract is warranted, you will have saved quite a lot of money. If it turns out a contract is warranted, much of what we will have done to develop the term sheet will apply to what we will need to do to draft the subsequent contract.
The above is our advice, but obviously what you do is up to you in the end.
Please let us know.

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 what we usually do is 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. On Fridays, like today.

One of the questions both our China lawyers and our IP lawyers have been getting frequently of late — especially from the media — is whether it is possible too protect your IP from China.

To which I always start out with a lawyer answer: yes, maybe and no.

Yes, if you are making a product that the Chinese government does not care about, such as toys, furniture, clothing, most electronics, etc. But if you are making something the Chinese government really does care about, like high speed rail, or cutting edge semiconductors or cutting edge energy technology, the answer is maybe/no. Let’s just say that our China IP lawyers generally drafting contracts and doing China IP registrations for an IoT company than for a semiconductor company simply because we have a lot more confidence in the results we can achieve for the IoT company than for the semiconductor company and we tell our clients that. Nonetheless, even the semiconductor companies must do what they can (both legally and via their own protective systems) to protect against IP theft, otherwise, if that theft happens, they will have no legal arguments against it. See How to Protect Your IP from China.

 

China lawyers
Image by Florian64190

The trade and investment relationship between the U.S. and China is going through permanent change, with the current round of tariffs just the start. As the tariffs fail to bring a resolution, we should expect the United States to implement other restrictive measures, including, some combination of the following:

  • Prohibiting the selling or licensing of technology to China.
  • Prohibiting Chinese companies from purchasing all or part of U.S. technology companies;.
  • Prohibiting Chinese students from attending U.S. schools and universities
  • Prohibiting the hiring of Chinese nationals by U.S. business
  • Ending cooperative research programs with Chinese scholars and researchers.

This will be the “new normal” in China/U.S. business relations and U.S. companies that do business in or with China should start now to prepare for this new reality. Many companies are waiting to react because they believe this conflict is a temporary political problem and will soon blow over. This view is a mistake.

The tariff measures are the first step in a much more general conflict over the entire Chinese system. The U.S. objects to virtually every aspect of China’s economic/trade/investment system. Rather than take on the entire Chinese system as a first step, the current tariff dispute with China has been narrowly defined.

The USTR 301 Report bases the US tariffs on two concrete issues: China’s well-documented propensity to engage in forced technology transfer and IP theft. When confronted regarding these two issues, the Chinese government response has been to simply deny every claim. In its White Paper responding to the 301 Report, the Chinese government flatly denied every claim in the report. On forced technology transfer: it does not happen and U.S. companies that transfer their technology to China do so voluntarily based on their own business calculations. On IP theft: it does not happen and accusations of trade secret theft and cyber-hacking are simply lies.

China’s consistent and complete denial of every statement in the 301 Report has been maintained by every layer of the Chinese government. There has been no movement at all. For example, in the forced transfer area, the Chinese government has refused to even consider opening the network, e-commerce and cloud computing markets in China to foreign based businesses. In the IP theft area, the Chinese government has refused to cooperate in investigating and extraditing those sought under recent U.S. indictments in several high profile cases.

There is a reason for China’s hardline position. Its forced transfer and IP “assimilation” regimes are at the core of China’s economic system. The current leaders of China understand this and that is why they cannot even suggest a compromise on these critical issues.

With China standing resolute and with there being no hint or likelihood of this changing quick resolution of the US-China trade war will require the U.S. trade team to capitulate. U.S. businesses have waited twenty years to see real improvement in the Chinese system only to see things grow steadily worse. China has lost nearly all of its former supporters in the U.S. business community. Since China has lost its main body of support in the U.S., there is very little pressure on the U.S. trade team to back down. It is therefore unlikely it will.

The situation is critical and nearly all foreign companies that operate in China should be analyzing how they can best deal with the trade situation. These companies need to make concrete plans for dealing with the impact the US-China trade war is having and will have on their business operations. Many companies believe they must either abandon China or pretend nothing is happening and go on with business as usual. For nearly all companies neither of these approaches make sense.

Some companies will continue to work with China based the same way they have for the past decade. For these companies, their major adjustment should be that they quit dreaming anything will change. For other companies, developing supply relations outside of China will become critical. For some of these companies a move out of China will be required. Others will be best off splitting their production between China and other countries.

What is consistent for pretty much every company that operates in China is the need for it to evaluate its operations in China under the New Normal of increasingly restrictive trade and investment measures. In assisting our own clients with this sort of evaluation we’ve been targeting the following:

1. How will current and future tariffs impact the business. For some of our clients, the tariffs are largely irrelevant. For others, the impact is so severe that failing to move quickly could lead to their demise.

2. What can be done about the tariffs? Is an exclusion from the tariffs possible? Will the Chinese factory agree to a price adjustment? Should the supply chain be moved to another country? Should the company shift the sales of its products to countries (other than the U.S.) where tariffs are not being imposed?

3. If the supply chain needs to be moved to another country, a careful analysis is required. Will you need to build a factory in that other country or can you purchase your products from an existing supplier or contract manufacturer? Is the infrastructure and legal system in the target country adequate for your needs? How long will it take to move and what will be the cost? As high as the costs are going to get to manufacture in China, this analysis often reveals China is still many companies’ cheapest and best choice.

4. China currently requires many technology companies to license their technology into China. For example, such licensing is essentially required in the network, cloud, SaaS sector, e-commerce and fin-tech sectors. The Chinese government has made clear this policy will not change. Companies in these sectors that have held off on “going into” China in the hopes of a change in policy should now either accept the licensing requirement or just abandon China as a market.

5. Many U.S. companies engage in co-development of technology and products in China, working with many types of Chinese entities. Over the past 15 years, the Chinese court system has been largely receptive to protecting the contractual rights of foreign entities, provided that the contracts are properly drafted. See China Contracts: Make Them Enforceable Or Don’t Bother. Will Chinese courts continue to enforce these manufacturing contracts, especially on behalf of American companies? Or will U.S. companies need to look to different ways to protect their innovations that do not rely on the Chinese legal system? Fortunately, all signs still point to continued contract enforcement.

6. Will new rules (either from the U.S. or from China) make it difficult or impossible for U.S. companies to sell or license their technology to Chinese companies? For U.S. companies that want to bring in Chinese investment, what will be the impact of restrictions that are currently being proposed? For U.S. companies that rely on hiring large numbers of Chinese professionals, what will be the restrictions? For U.S. education and research institutions that want to work with Chinese researchers, will that be possible? What about Chinese scholars who have become naturalized citizens of other countries? Will they also be banned?

Every party from the U.S. that works with China in any way should be asking themselves at least some of the questions above. Foreign companies that sell their Made in China products to the United States should be doing the same. China will not be completely and permanently cut off from business relations with the United States, but the nature of the US-China relationship has changed and it is not going to return to the way it was for a long long time.

The US-China business relationship is fluid and its final configuration has not yet been settled. Nonetheless, businesses that wait for a final resolution will be left behind. Now is the time to evaluate and take action.

What is your company doing to get ready?

China Law Professor Donald Clarke sent me a great article this week from New York Magazine, entitled, How China Drove Out Mister Softee. Professor Clarke’s email with the link said the following:

Thought you might like this. Interestingly, it is NOT a story of “guy skirts rules, naively trusts Chinese partner, gets screwed.” It’s “guy does everything absolutely by the book, has reliable Chinese partner who does not screw him, and still gets screwed by changing political atmosphere.” For him to get competition eventually is quite normal, and the competition wasn’t using a trade name similar to his. But the rules were not evenly enforced.

This is the sort of story I both love and hate. I love this sort of story because it is interesting and important but I hate it because I constantly and aggressively stress to my clients the need to follow China’s laws to the letter and with that I ought to be able to tell them that by doing so they will have no problems. I also hate this sort of story because it reveals the cynical truth that the reality is really more the opposite: if you do not follow China’s laws you will have a problem. If you do follow Chinese laws the odds of your having a problem will go way down, but hey, it is no guarantee. Truth is that as a foreign company doing business in China you will be a target and this means you must follow the laws to avoid being an easy and legal target but even if you do follow the rules you are still a target.

Quick aside. Why the Jim Carey clip about “messing with the doo?” Two reasons. One, It’s just a great clip. And two, I love soft-serve ice cream and I have fond memories of eating Mr. Softee ice cream when visiting my grandmother in New Jersey. So I see China’s messing with Mister Softee as the equivalent of “messing with the doo.” But I digress.

So if you read the New York Magazine article, you will learn that Turner Sparks brought New York’s iconic Mister Softee trucks for the first time to China” back in 2007 and eventually built his ice cream empire to ten trucks and 25 employees in Suzhou. You will also learn the following:

Mr. Sparks did local TV and newspaper interviews and was a fixture at school and corporate events, where he and his team doled out waffle-cone soft-serve to thousands. During one corporate party at Bosch, an international electronics company, he sold $9,000 worth of $1 cones in just two hours.

Competition was scarce, because he essentially invented the Suzhou ice-cream-truck market. “All these trucks were just going nuts, doing really well. Huge lines all the time,” he told me. “Everyone knew Mister Softee.”

He planned an ambitious expansion, and lined up investors to back it: He wanted to quintuple his fleet to 50 trucks, add more storefronts, and move into new territory.

More importantly, you will learn how tough it can be to do business in China, because you will learn that instead of expanding his business in China, Mr. Sparks ended up leaving China “with just enough money to reinvent his life as a New York stand-up comic.” and that “what happened to Sparks is an illustration of how the landscape has shifted for foreign businesses in China since current premier Xi Jinping has taken over the country, and the climate has become considerably less hospitable for foreign business — small ones, in particular.”

The article talks about how things began to change for foreign companies in China starting in 1978 and how Sparks was able to build up his ice cream empire:

They created a local supply chain from scratch, finding vendors for cones, straws and soft-serve mix at a Shanghai food-and-drink expo. Using secret blueprints from Mister Softee, the truck was built in Nanjing by a company that makes telecommunications trucks, armored vehicles, and ambulances. Workers were hired from a job fair, with many long-distance drivers jumping on the opportunity to work locally and try something different. To give the soft-serve the same taste as back home, they shipped the milk in from the U.S.

Suzhou officials worked with Sparks to create a new kind of business permit for their ice-cream trucks, called a Qualified Mobile Vendor License. It let them operate the trucks, but only as “delivery vehicles” for two stores. The license also required they have a staffed office and were restricted to operate at certain spots around the city. The solicitousness of Suzhou officials wasn’t unique. All around China, local governments were inviting in foreign businesses, easing the cost of doing business with tax breaks, and giving them friendly government liaisons to help them navigate the labyrinthine bureaucracy.

Then you will learn how the ice cream empire fell apart, for reasons that will likely not be unfamiliar to most foreign companies that operate in China — taxes and thieving employees who then go out and illegally and even violently compete:

The first inclination Sparks got that things were changing was around 2012, when a local official called him into his office and accused Sparks of not paying enough in taxes.

“Immediately, I knew it was a shakedown,” he said. “This guy was an idiot. He was like, ‘There’s money, I need some.’”

Sparks declined the man’s offer and left, but says that meeting was his first experience with the corruption he’d often heard about in China. Soon after, two new drivers alerted Sparks to a longtime scam by his eight other drivers. They were quietly making extra soft-serve sales and pocketing the money for themselves. Because Mister Softee was a cash business, office workers would count drivers’ ice-cream cones at the start and end of their shifts to make sure they weren’t stealing. To circumvent that control, drivers bought their own cones. When Sparks started measuring the ice-cream mix instead, the drivers would buy extra cones and mix, too.

Eventually, he instituted random checks on drivers and fired several on the spot when they were caught with more mix in their trucks than they had at the start of the day. Soon after, his tires outside his apartment were slashed. Then a fired driver showed up at Mister Softee’s office and threatened to kill the workers there.

Things got more bizarre. In early 2013, just a few weeks after they were fired, Sparks’s former drivers resurfaced with their own unlicensed ice-cream trucks, with knockoff names including Baby Bear, Snow Princess, and Mr. Big. These drivers would park along Mister Softee trucks’ routes to poach customers. Plus, they didn’t have the special city license, which allowed them to operate without having to open storefronts or an office, and they could sell wherever they wanted.

Conway was too far away to help out as problems started cascading. Cai, meanwhile, had moved to the suburbs about an hour away and was starting another printed circuit board business, so had no time to lend a hand.

*   *   *   *

Perhaps the slashed tires and death threats were unique to Mister Softee, but local officials’ deciding to yank support was downright typical of the changing times.

For the record, nothing that happened to Mister Softee in Suzhou is “unique.”

The article then goes on to rightly note that foreign companies that bring technology or know-how that China hasn’t developed on its own are still very much welcome in China, but the others not so much. “One in four foreign businesses are scaling back in China or say they plan to, and most say they feel increasingly unwelcome, according to a 2018 survey from the American Chamber of Commerce in China.”

The article extensively quotes Anil Gupta, professor of University of Maryland’s Smith School of Business, “who’s been researching and writing about China for 25 years” and who has this to say:

Gupta added that blatant knockoff enterprises are so common in China that it’s almost a wonder Mister Softee’s easily replicated business wasn’t copied sooner. Plus, local officials and courts are more likely to back the local knockoffs to support Chinese businesses — to hell with the permits.

“With 99 percent confidence, I would say this was destined to happen,” Gupta said of Mister Softee’s fate. “I would say that God couldn’t even save this business.”

What or who exactly killed Mister Softee. China:

After receiving one-year permits for his trucks without fail from 2007 through 2012, Mister Softee’s permits were withheld without explanation and Sparks couldn’t reach government officials for months to clear up the issue. When Sparks finally heard back from government officials in mid-2013, they told him they would figure out a way to regulate the new trucks. Nearly a year later, with Sparks still operating without a new permit, officials proposed holding a lottery to dole out Suzhou permits to Sparks and the knockoff trucks. Around that time, police started ticketing Mister Softee trucks for parking illegally in spots they’d been working for years.

By 2015, it became clear the lottery would never take place and Sparks’s new round of investment crumbled.

“Part of it was a relief, to know it was over,” Sparks told me. “You feel, obviously, helpless.”

Over the next year, he wound down the business, paid his remaining staff and sold off the trucks so some others could spread the gospel of neighborhood soft-serve to nearby cities.

In early 2016 on a Friday, Mister Softee’s tumultuous foray into China quietly ended with Sparks, his lawyer, and accountant filing liquidation papers and figuring out who they still owed money to. Sparks had already sold off the office furniture to his ice-cream cone supplier.

Ignoring for a minute whether any deity could have saved Mister Softee, was there anything it could have done to survive China? Maybe. Were a company like Mister Softee come to me today, I would likely recommend that instead of going into business in China, it seek our a licensee in China for its name and its ice-cream know how and its trucks look and feel. Indeed, my law firm a few years ago did a licensing deal on behalf of a regional American ice cream that has worked out very well for the American company. I constantly find myself trying to steer clients away from what I call “theoretical massive profits” that can allegedly be realized by going into China as a WFOE or a Joint Venture in favor of a licensing or distributing deal. See Forming a China WFOE: Needed or Not. See also my Forbes Magazine on this: Want Your Product In China? Try Using A Local Distributor.

Welcome to China 2018 people.

What are you seeing out there?

UPDATE: Literally minutes after I wrote this I received an email from a China lawyer friend who said I should have talked about how Mister Softee could have prevented “at least some of its problems” by having made its employees sign non-compete agreements. I don’t think those would have worked because China’s courts generally will not enforce those against any but high level employees and I do not think ice cream truck operators would qualify as high level employees. See

China cryptocurrency

The Shenzhen Court of International Arbitration (SCIA) of China recently published a case analysis (link in Chinese) on contract disputes between parties to a share transfer agreement involving cryptocurrencies.

In this case, an unnamed applicant engaged the respondent to manage and invest in a pool of cryptocurrencies (Bitcoin, Bitcoin Cash and Bitcoin Diamond) on behalf of the applicant. In another transaction where the respondent was purchasing company stock from a third party, the applicant agreed to pay part of the purchase price on behalf of the respondent, so long as the respondent returned the cryptocurrencies to the applicant. The terms of this deal were recorded in a written contract between the applicant, the respondent and the third-party seller of the company stock. The respondent failed to return the cryptocurrencies and the applicant and third-party seller demanded arbitration.

One of the key issues in this case was the validity of the company stock transfer agreement. Citing the Announcement on Preventing the Financing Risks of Initial Coin Offerings made by China’s central bank and several other government agencies in 2017 (often referred to as China’s “ICO Ban”), the respondent argued the company stock transfer agreement was invalid and unenforceable because exchanging and delivery of cryptocurrency is illegal.

The arbitral tribunal disagreed holding that though the ICO Ban prohibits using cryptocurrency as a financing tool and prohibits financial institutions and non-bank payment processors from providing services related to cryptocurrency financing, no Chinese law prohibits private parties possessing Bitcoin or even engaging in transactions involving Bitcoin. Since the respondent’s obligation under the company stock transfer agreement was simply to return the cryptocurrencies to the applicant, the ICO Ban does not apply. Because the agreement was properly executed and did not violate any statutes on the validity of a contract, the agreement is valid and enforceable.

The arbitration tribunal further explained that though cryptocurrency is not fiat money (inconvertible paper money made legal tender by a government decree) and should not be exchanged and treated as fiat, this does not prevent bitcoin from being protected as property that can be owned and controlled and that has economic value.

The SCIA is not first Chinese tribunal to rule that cryptocurrencies should be protected as property. Earlier this year, a Shanghai court reached the same conclusion regarding Ethereum. In the Shanghai case (link in Chinese), the defendant received Ethereum from the plaintiff by mistake and refused to return it. The Court held that Ethereum should be treated as property and the defendant’s keeping other people’s property constitutes unjust enrichment.

Although China’s General Provisions of Civil Law (民法总则) provide that “any laws on the protection of data or network virtual properties shall be followed,” there is so far no law in China that defines or sets forth the rules for protecting network virtual property. However, as long as cryptocurrency continues to exist, it will in China no doubt continue to be heavily regulated.

Bottom Line: China is generally very suspicious of cryptocurrency, largely because it can make for such an easy tax dodge. However, recent cases do show that cryptocurrencies are not completely illegal and the property rights inherent in them will, at least sometimes, be protected.

China employment lawyers

As promised in my post from last week, China Employment Contract FAQs, I am back to write about some of the most commonly asked questions we get about China employer rules and regulations with short answers to each of them. The below are the questions that we field most often when doing our China employer audits.

Question 1: I have several separate company policies that deal with different topics such as overtime, employee leaves and discipline. Do they need to be in one document called employer rules and regulations?

Yes. You need a comprehensive employer rules and regulations document that includes all your employer policies/rules. First, this is what Chinese authorities like to see. Second, the fewer documents you have, the easier it will be for your management to enforce your company polices and for your employees to learn about and follow them. Third, by including all the policies in the same document, it will be easier to search out and eliminate any potential inconsistencies. Fourth, this makes it easier for you to be sure to keep everything updated. Lastly, having all employer policies and rules in one document and then getting each of your employees to sign a receipt proving they received it will give you added protection.

Question 2: I have more than one office in China. Do I need a different set of employer rules and regulations for each of my offices?

Yes. China’s employment laws are highly localized and this means employment rules/practices can and usually do differ by city and even by district within the same city. The differences between your various rules and regulations will depend on where your offices and your employees are based. For example, if you have an office in Beijing and an office in Shanghai, you will likely have a very different set of rules and regulations for these two cities. On the other hand, if all your offices are located in Guangdong Province, you likely will have quite similar employer rules and regulations among your offices.

Question 3: I have been operating in China for a long time and I’ve never had a set of rules and regulations. Is it too late to start doing it now?

Absolutely not. Having a well-drafted set of employer rules and regulations will not solve past problems but it will certainly go a long way towards preventing future problems.

Question 4: The rules and regulations seem negative in tone. Will my employees accept them?

Your rules and regulations need to be reasonable to be enforceable in China. But so long as they are reasonable and enforceable, and you implement them according to Chinese law, your employees need to abide by them. One thing you as employer need to do is to get an acknowledgement of receipt signed by your employees proving they received a copy of your rules and regulations. Their signing that acknowledgment also means they have agreed to follow your rules and regulations. It is true that a big part of the standard China employer rules and regulations relates to employee discipline and terminations, but a well-drafted set of these rules and regulations should also provide detailed explanations regarding employee rights and benefits, which will give your employees clarity and protections. Well-written employer rules and regulations are good for both employers and employees and most China employees recognize this and they virtually always are willing to sign off. See China Employee Rules and Regulations: Use Them as a Talent Magnet.

Question 5: Can I just use a template set of rules and regulations from the Internet? 

Only if you do not care at all about preventing all sorts of future employee problems and setting yourself up for difficult and costly employee litigation. Your rules and regulations should match your specific situation, your industry, your locale, and, most importantly, your specific issues, goals, and concerns. Every employer client for whom we have drafted rules and regulations has had their own unique programs/policies/rules and the job of our China employment lawyers is to work with our clients to determine whether what they want is workable and legal for their specific situation and locale.