China import duties
                          Kanye has it right

If you are importing product originally from China covered by or even maybe covered by an antidumping or countervailing duty order, you must be very careful, no matter the country from you are directly importing the product. Two recent U.S. Commerce Department decisions to expand antidumping (“AD”) and countervailing duty (“CVD”) orders on hardwood plywood to cover ready to assemble cabinets highlight this problem.

Earlier this month the U.S. Commerce Department issued a final scope ruling on Ready To Assemble (“RTA”) Cabinets in the Hardwood Plywood AD and CVD case, finding no exclusion for RTA cabinets. Commerce held that this exclusion from AD and CVD duties applies only to cabinets sold to an ultimate end user (the consumer) and not to RTA cabinets sold to contractors that then install them. With this ruling Commerce effectively expanded the AD and CVD orders to cover RTA cabinets sold to the construction industry, which many (most? importers previously believed were excluded by language in the AD and CVD orders.

The RTA kitchen cabinet exclusion does not expressly address the manner in which RTA kitchen cabinets must be packaged to be suitable for purchase nor does it expressly define the term “end-user.” Nevertheless, the exclusion’s requirements require RTA kitchen cabinets be “packaged for sale for ultimate purchase by an end-user” and be packaged with “instructions providing guidance on the assembly of a finished unit of cabinetry.”

This decision exposes US importers of RTA cabinets to millions of dollars in retroactive liability for AD and CVD duties. U.S. cabinet importers that stuck their head in the sand while this AD/CVD exclusion case was pending will likely soon be hit with an enormous bill from the US government.

Years ago, my firm’s international trade lawyers handled a review investigation involving high tech products from China covered by an AD and CVD Order for a Chinese exporter/producer company. Much to the Chinese company’s surprise, the Commerce Department had determined that this small Chinese company was a mandatory respondent and that meant it would need to respond to the entire Commerce questionnaire and be subject to verification.

The Chinese company explained that it had never exported these high tech products to the United States because but it admitted to having sold its products to a Canadian customer. It had no knowledge of what this Canadian customer did with its products and it did not know whether the Canadian company exported the products to the US from Canada.

Under United States AD and CVD law, sales made by a Chinese company and imported into the United states are generally considered to be U.S. sales by the Chinese company if the Chinese company knew when it made the sales that its products were destined for the U.S.  In other cases, Chinese companies have been found to be respondents in AD and CVD cases if their packaging revealed that their products were ultimately destined for the U.S.

The problem for the Canadian companies and the U.S. importers in these situations is that the Chinese company that has made these Canada sales of products that go to the United States will usually just give up and not participate in the AD and CVD review investigation.  But the US importer of the products from Canada (which often has some affiliation with the Canadian company) will find itself owing substantial AD and CVD duties to the US government. I can remember a Canadian company that had to shut down its entire U.S. operations because it had exported chemical products from Canada to the United States that were covered by U.S. AD and CVD orders.  All of a sudden, the U.S. subsidiary was hit with millions of dollars in retroactive liability because of an AD and CVD case.

US importers that import products from Canada or anywhere else in the world that are originally from China need to be careful right now because their products may be covered by United States AD and CVD orders. These companies could wake up one morning and find themselves liable for millions in dollars in retroactive AD and CVD duties. This is truly the sort of situation where an ounce of prevention is worth a pound of cure. Now is the time to review your supply chain for its China vulnerabilities, whether you import directly from China or not.

China entertainment lawyer

On September 26, China media and entertainment lawyer Mathew Alderson will be discussing how movie and TV producers can “make the most of the opportunities China offers” as part of a FREE webinar. Go here to register.

PACT, “the trade association representing the commercial interests of UK independent television, film, digital, children’s and animation media companies,” is putting on this webinar and it describes it as follows:

To shine some light on how producers can make the most of the opportunities China offers, we have invited Mathew Alderson, Partner at Harris Bricken to take part in a webinar. Mathew is a transactional entertainment lawyer based in Beijing. He has a wealth of knowledge about the Chinese TV and Film industries and will share his experiences about working with China.

Topics to be discussed include:

–    An overview of China
–    Information about SART and how they work in the market
–    The biggest mistakes companies make when working in/with China
–    An explanation of how copyright works in China
–    The benefits of working within the co-production treaty
–    Contracts and Chinese law
–    How companies can protect their IP
–    Chinese quotas
–    Payment in China, tax, and additional costs
–    Legal representation

To register for this webinar, click here. I remind you that it’s free.

PACT (quite accurately) describes Mathew as follows:

Mathew Alderson is a transactional entertainment lawyer in Beijing. He represents major Hollywood studios, major tech companies and gaming companies, as well as independent producers and distributors. Mathew frequently advises UK companies on the structuring of projects in order to minimize the impact of quotas and other restrictions on foreign content in China. Mathew focuses on protecting his clients’ IP and reducing their exposure to payment defaults in China. He handles China theatrical and episodic projects from development through production and distribution.  Mathew is the author of the UK-China Film & TV Toolkit and a frequent contributor to China Law Blog.

We would add that Variety Magazine described Mathew as a “game-changing” lawyer rocking the movie biz for Mathew’s leading- edge work as a China entertainment lawyer.

You do not want to miss this, so go here and register.

China employment lawyersThe issues related to China employee probation are usually more complicated than they first appear and though many of our employer clients and potential clients are telling us “we get it now,” our China employer audits consistently find the opposite to be true.

Let’s consider a hypothetical based on an amalgamation of some document-based HR audits we performed for China employers. Employer and Employee enter into an employment contract that does not specify either a probation period nor a term of employment. The contract provides for a monthly base salary amount. For the first six months of employment, Employer pays Employee an amount less than the base salary amount specified in the contract. Employee later resigns and brings a claim against Employer for the six month difference between her reduced rate and the contract amount. Employer argues it does not need to pay because of a provision in its Employer Rules and Regulations stating that all new employees have a six month probation period during which they receive a reduced salary — it even provides a specific salary amount for the probation period. So the basic issue is whether the employer and the employee agreed on a probation period.

They did not.

There was no explicit agreement between the parties regarding the probation period. Under Chinese law, the probation period is not one of the mandatory items that must be included in an employment contract. This essentially means that an employer that wants a probation period to test out a new employee must clearly describe the probation period in the employee’s employment contract. An employer cannot unilaterally impose a probation period on an employee and that means that an employer that wants to pay a reduced rate to a probationary employee must explicitly provide for that in its employment contract.

Note also that because the cited provision in the employer rules and regulations applies to all new employees it could be deemed illegal and unenforceable for a couple of reasons. First off, it fails to exclude certain categories of employees for whom a probation period is not permitted. For example, Chinese law prohibits an employer from setting a probation period for part-time employees. For that reason, if the employer applies this provision to any of its part-time employees, it is in violation of the law. In addition, the term of the probation period should be proportional to the term of the employment. Specifically, for an employment term of more than three months but less than one year, the probation period cannot be more than one month; for an employment term of one year or more but less than three years, the probation period cannot exceed two months. The employer can only use a six-month probation period for 1) an employment term of three years or more or 2) an open-term employment arrangement. Unless the employer always brings on new employees under either of those circumstances, this provision needs to be revised to accord with the law.

Note another mistake made by the employer in the hypothetical above: it fails to clearly specify a term of employment in the contract. What this usually means is that the employer will be “stuck” with the employee indefinitely as the employee becomes an open-term employee, which basically means there is no definitive end date for the employment relationship.

Our China employment lawyers see problems related to probation periods far too often — well over 50 percent of the time for companies that have or seek to use probation periods. To ensure you as a China employer are in full legal compliance, you should check both your employer rules and regulations and your individual employment contracts. If you find they contain a provision similar to the above, you should update your documents now.

 

China trademark registration

The month of wine-related posts continues!

We started with China, Wine and Tariffs, continued with China Trademarks: Wine Labels in China, and I will now examine the Nice classes to use on wine-related trademarks in China.

This may seem like an obvious question – if you’re selling wine, then you should register in Class 33, which covers alcoholic beverages (except beer). Class 33 only has one subclass, so you don’t even need to worry about filing in multiple subclasses. A single registration for “wine” will also cover aperitifs, bitters, ciders, sake, vodka and whiskey (and everything in between). And if all you want to do is ensure that you can sell your product in China, then you can stop here.

But for most brand owners, it’s not enough just to ensure that you can continue your operations. You also want to prevent trademark squatters from coopting your mark in other ways. In China, the trademark examination system is quite mechanical: all items in a subclass are deemed similar to every other item in the subclass – and only to those items. There are a few exceptions with certain goods and certain subclasses (i.e., goods in a certain subclass that are considered similar to those in another subclass), but those are predefined and laid out in Chinese Trademark Office (CTMO) publications. Everything else is fair game, because it’s not considered “similar” under CTMO practice.

Also, as we have explained previously in China Trademarks: Register in More Classes, Take Down More Counterfeit Goods, CTMO practice allows (if not encourages) trademark applicants to file in classes far beyond the scope of what they actually manufacture or sell. This is a double-edged sword: it allows trademark owners to extend brand protection as broadly as they like (if cost is no object), but on the other hand it also allows trademark squatters the latitude to engage in mischief, like applying for Star Wars brand instant noodles.

So when you’re filing a trademark application, you should think about two sets of classes: (1) which classes you need to protect your own goods/services, and (2) which classes you want to keep out of the hands of third parties.

If you’re a winemaker, you probably don’t care if someone takes the brand name of your wine and uses it on telescopes. But you probably would care if someone used it (for example) on corks (Class 20) or beer (Class 32). I just did a quick search on the CTMO website and yes, Penfolds has registrations in both classes.

What are you doing to protect your wine brand in China?

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.

At least twice a month, one of our China lawyers will get an email from someone (usually an American or an Australian or a Brit) who has lived in China for one to three years and who now wants to attend a law school to eventually become a China lawyer. This person will ask us which law school they should attend to best prepare for a career as a China lawyer. Oftentimes they will tell us about how such and such law school looks good to them because it offers three courses on Chinese law and are we aware of any other law school with more such courses.

My response is always pretty much the same and it goes something like this:

Don’t worry about choosing a law school with Chinese law courses. Very few of your potential employers will ever look at or care much about the courses you took in law school. Generally speaking, if you want to become a China attorney, the three best things you can do are the following:

1. Get into and attend the best law school you can.

2. Get the best grades you possibly can in law school.

3. Work on your Chinese language skills as much as possible. Being able to read and write Mandarin is far more valuable than being able to just speak it.

Got it?

China trademark registration costs $
                                                                  What’s in your bottle?

In my last post, I wrote that I could do a whole month of posts about wine. Here’s another.

The Grape Wall of China blog recently assembled a page full of “[f]ake, funny, old or odd” wine labels. The labels are all entertaining, but as someone who regularly deals with counterfeit merchandise, the fake ones are what really caught my eye. Typically, the bottles of fake wine really do contain wine and not some other liquid. However, the wine inside the bottle does not match the label and it is usually low-end plonk that (literally) would not pass the sniff test.

The webpage focuses on two particular faked brands: the legendary French brand Château Lafite Rothschild and the Australian brand Penfolds. Both of these brands have enjoyed worldwide success and are well-recognized in China, which is undoubtedly why they have been counterfeited so often and in so many ways.

Some of the counterfeits are straight copies and are hard to tell apart from the real thing – like the 10,000 bottles of Chateau Lafite that police found last year in a single house in Wenzhou. Lafite only exports 50,000 bottles to China each year and nobody believed that 20% of the bottles were languishing in a house in Wenzhou. But the wine resale market is mysterious enough, and the fake labels good enough, that at the time the wine was seized, no one could definitively say the seized wine was fake.

Other fakes are more “inspired by,” which makes you wonder how hard these counterfeiters are trying – or how hard they need to try. No one who speaks English would think that a wine called “CHATEAU OFFICIALLAFITE” is legitimate. But if your market is people who don’t speak English and don’t know much about wine but have heard of Château Lafite Rothschild, then the bar is pretty low.

Unlike most consumer products, the world contains thousands of wineries and even more brand names. And for those who don’t particularly follow wine, maybe only a dozen are recognizable as wine brands. For Chinese people, the number is even less. Frankly, I doubt the average person in China could name a single winery, with the possible exception of Chateau Lafite. If they know anything about foreign wine, it’s related to geographic areas or appellations (Napa, Bordeaux, etc.). So one response from a foreign winemaker might be: why bother registering a trademark in China? Unless I’m selling thousands of cases, no one knows the name of my winery anyway so there’s nothing to protect. That may be true, but think about it from the perspective of a counterfeiter. They want the biggest return for the least effort. You’ve already built up some brand equity with your brand and your wine label, and even if only a few people in China might recognize your label, it’s a lot easier for a counterfeit wine seller to register your mark and sell “your” wine in China than it would be for them to create a new brand. And all of a sudden you’ve lost the ability to sell wine in China under your own name, which means you’ll need to rebrand to sell in China.

As usual, it comes down to the same issue in China: if you don’t register your name first, someone else will do it for you. The only reason not to register your wine brand as a trademark in China is if you never intend to sell wine there.

China employment law firm
Change your mindset for China employment contracts.

If you have or are going to have employees in China, you need a China-centric written employment contract with each of your employees. Around once a month, one of our China employment lawyers will get a company asking us to “translate our existing employment agreements into Chinese for our China office.” Our response to this request is always the same: “Sorry, we cannot do that because the end result will not work at all for China. You need a China specific employment agreement and our translating what you are using (in the United States or the UK or Canada or Australia or Spain or France or wherever) is not going to work.” At all.

I want to be very clear: translating a foreign country employment agreement into Chinese for use in China is a flat out dangerous thing to do. Even if your translation is perfect and it captures everything you want it to say (which seldom happens), an employment agreement not written specifically for China will contain provisions that do not comply with China’s employment laws or are unworkable in your specific locale in China. For these same reasons, our unwillingness to “just translate a contract into Chinese” extends to every contract we do. See Translate Your Contract For China? The Answer is No.

The most common example our China employment lawyers see in foreign employment agreements of something that will not work under China’s employment system and that can be harmful is a provision stating that the employment is at-will. Under an employment at-will system, an employer is said to be able to terminate an employee for good reason, bad reason or no reason at all, but in China, terminating a China employee almost always requires specific cause both allowed under China’s national and local employments laws and under your employer rules and regulations. Putting an at-will employment provision in your employment agreements will not help you but it can hurt you by making your China management team believe they can fire their China employees for any or no reason at all. We have seen many wrongful termination actions brought by employees terminated by managers who believed they could do so at-will.

If you now think that merely eliminating any references to at-will employment will solve the translation problem, you’re dreaming. China’s entire employment law system is very different from those in Western countries and this necessitates very different employment contracts across the board.

Take overtime pay as another example. If your China-based manager is working under the standard working hours system (this usually means 8 hours on a work day and 40 hours in a week), you must pay or otherwise compensate him or her for any overtime incurred. See China Employee Working Hours and The Things You Cannot Skip. If your manager has been approved by the government to work flexible hours, you may be able to avoid paying overtime, but not always. The foreign country managerial contracts we see usually contain a provision making clear there will be no overtime. If one of your China managers sues you for unpaid overtime in China, you should expect this provision will be Exhibit 1.

Many foreign companies have their own policies on how much notice their employees must give when resigning and these sort of notice requirements are often put into their employment agreements. China though has its own very strict notice requirements and an employer that seeks to require resignation notice longer than China’s own minimum requirements is just asking for legal trouble.

We have also found that using a non-China centric employment agreement causes companies to lose sight of what most matters for China. Seniority, for example, is a huge issue for China employees as it is tied to other important employee benefits, such as statutory vacation days, and statutory severance. It is therefore important as a China employer that you deal extensively and clearly with this issue in your China employee contracts. But because this issue is usually not covered or covered very differently in foreign employment agreements, your using your foreign employment contract as your template for your China employment contracts will mean you either fail to address this critical issue or you will do so very badly. Either way, this will end up hurting you if/when you are sued.

This is not to say that what you have in your existing employment contracts is wholly worthless in formulating your China employment contracts because it isn’t. My firm’s China employment lawyers will often like to review our clients’ existing employment contracts before we start drafting their employment contracts for China. We though want to see those contracts not because we intend to translate them or even because we intend to use them as a template for the China contracts. Rather, we want to see them just because they often broadly outline what is important to our client in its employer-employee relationships.

In terms of your own thinking though, it is best for you to start from scratch. China employment laws are that different and that local and so what you know from Barcelona or Boston or Brisbane or Berlin may not matter or may just get you in trouble.

China scams. China attorneys. China lawyers.

Recent business confidences surveys conducted in China show a downturn in the Business Confidence Index for small and medium -sized manufacturing companies of all types, falling to its lowest level since the 2008 financial crisis. The decline in business confidence is the result of features built into the Chinese economy.

This declining BCI shows that economic stress on SME manufacturers in China continues to increase. This is a long term trend, and any resolution of the trade war likely will not impact this general trend. As a result, China based non-government economists are predicting a wave of plant closures and bankruptcies that will ripple through the entire PRC SME manufacturing sector over the next year. The large state owned enterprises will not be significantly impacted; the impact will be primarily center on small and medium enterprises. This means bankruptcy and closures both in the private sector and in the provincial and local state owned manufacturing sector.

These closures and bankruptcies do not reflect the condition of the Chinese economy as a whole. The companies that will be swept away are weak and technologically backward entities that would have been eliminated many years ago in a fully market economy. The Chinese system tends to keep these weak players alive far longer than is economically rational. Then the life support is suddenly removed and they all die at once. This sudden rise in business deaths is what is being predicted for the next decade.

The concern for foreign buyers of Chinese product is that an increase in closures and bankruptcies will also mean an increase in scams and frauds. When a factory in China knows it will be shutting down, its owners often work to make a final score. They set up a deal that allows them to bring in as much cash as possible in the short term. The owners then take the cash as a final bonus, shut down the company and then move on. No bankruptcy is involved. They just shut the doors.

In implementing their scam, the factory owners are faced with a problem. If they commit fraud against another Chinese person or entity, they likely will be pursued for retribution. That retribution may be criminal investigation and prosecution through China’s criminal justice system. Or the retribution may be informal action carried out by an effective criminal gang system active in China.

Perpetrating a scam on a Chinese entity involves considerable risk. On the other hand, scams against foreign buyers have hardly any risk at all. When a foreign buyer is cheated, the Chinese police often do nothing at all and there is virtually nothing your Embassy or Consulate can do beyond put the names of the offenders on a list. The Chinese courts can do little to nothing as well and the informal methods of retribution are rarely available to foreign entities. For this reason, when it comes time to do that last big scam or series of scams before shutting down the factory, foreign buyers will always be the preferred target.

The scams at this stage follow a regular pattern. The three primary patterns are as follows:

Model Scam Number One: It is typical for Chinese factories to require buyers make an initial deposit on the date it accepts the buyer’s purchase order (PO). A common structure for China suppliers is 30% down and 70% paid prior to shipment. Using this structure, a factory that knows it will shut down will take the deposit, do no work at all and simply fail to deliver. If the factory does this with enough foreign customers, it can collect a substantial sum for funding its owner’s retirement.

This kind of scam is hard to detect and for that reason is very effective. The problem for the scammer is that in a declining market, the total return for the scammer may be disappointingly small. So to milk more from unsuspecting buyers some factories will go for an even bigger score. They go to their buyers and offer to sell their product at a substantial discount. But the price for this discount is a substantial increase in the order amount and an increase in the deposit from 30% to 50%. The Chinese side says: “It is a great deal for you. Make a full year of orders all at once and you will save big money.” Using this scam, the Chinese factory collects a much larger deposit amount and the owners shut down the factory and disappear.

In China Tariffs and What to do Now, Part 1 we focused on how Chinese factories were offering to illegally transship their products to Malaysia or Thailand or Vietnam or Bangladesh or the Philippines (mostly), thus avoiding U.S. tariffs:

But before I discuss what companies do about their tariff problems, it is far more important I start out discussing what they should NOT do. They should not have their China products shipped to Taiwan or to Malaysia or to Thailand or Vietnam or anywhere else and then have those products shipped to the United States as though they are not from China. Doing this sort of transshipping can and does lead to massive fines and to JAIL TIME. I am not kidding. I am starting out with a post on what not to do because the risks from this one thing far exceed the benefits of the things we will be discussing in our subsequent posts.

And yet, many are telling us that their Chinese factories are suggesting these exact sort of transshipments and giving assurances that they are legal or that nobody ever gets caught, neither of which are remotely true. Step back for just a second and ask yourself why you are even considering taking legal advice about United States customs law from a Chinese factory owner or salesperson who has all the incentive in the world to sell you Chinese products and very little incentive to keep you out of jail. Please, please, please don’t fall for that. Please.

Chinese companies and the U.S. importers of their products often believe they can get around United States tariffs  by transshipping the products to Malaysia, Vietnam, Philippines, Sri Lanka, Thailand, Bangladesh, India, [or some other country] before sending them on to the United States. Their plan is to relabel the products with a new country of origin and then export the products to the US free of China , without US Customs and Border Protection (“CBP”) ever being the wiser.

I bring this up because many of the same factories that are making this transship offer are at the same time offering to discount their prices in return for a large increase in the deposit. This sort of “double” offer to illegally avoid tariffs and raise the down payment amount is a terrific indicator of a brewing scam.

Model Scam Number Two: Chinese factory sells a standard product: usually something like a chemical or a basic raw material or a food product. As with scam number one, it pumps up its orders by offering a substantial discount — sometimes even too good to be true. In exchange for the discount, the factory requires full payment before shipment. Then the factory ships a non-conforming product, collects the payment and disappears.

The below are some examples brought to the attention of our China lawyers by foreign companies that were scammed:

  1. Container of custom cut food product: 25 containers, neatly packed. The first layer of these cartons contain conforming product. The rest of the container is filled with bricks.
  2. Barrels of a granulated chemical (say citric acid). The top two inches in each barrel is conforming product and the rest is filled with sand. Or barrels are for a liquid chemical (say sulphuric acid). The barrels are filled with salt water.
  3. Containers filled with frozen food product, which when thawed, reveal that the food is rotten. In my own experience, this happened with 8 containers of frozen salmon. The decay was so bad that the containers were declared a hazardous waste site and the buyer was required to pay the substantial cost of a hazardous waste clean up.

Model Scam Number Three. The owners of the Chinese factory contact a foreign customer (oftentimes a regular buyer who gets all or most of its product(s) from the dying Chinese factory) and offer to sell their business at a unrealistically low price. In exchange for this low price, the deal must close very fast. This fast close means no time for due diligence and no involvement of experienced and trustworthy China lawyers or consultants.

The foreign buyer pays the purchase price by wire transfer to the Chinese factory. Then the buyer travels to China to inspect its factory and here is what they find:

— The factory building was rented, not owned. The building is stripped. Not only has all the machinery been removed, but even the window glass and plumbing fixtures are gone.

— The bank account has been emptied by the former owners and they have disappeared.

— The landlord shows up and demands a full year’s rent on the factory that has not been paid. 200 hundred workers show up and demand 6 months back salary. The local government shows up and demands one year in back taxes. To make it even “better” the local government colludes with the workers to take the passports of the foreign owners, lock them up in a local hotel, and then announce that they will not be able to leave town until all back payments are made.

The above sort of scams are committed in China all the time. However, their frequency and severity increases whenever there will be a wave of factory closures and bankruptcies. This is what is predicted for the next couple of years for China, so particular care is now required. For some of the things you need to be doing now to reduce your chances of problems stemming from this wave, check out last week’s post, China’s Economic Slowdown and YOUR Business: The Times they are a Changin’.

And be careful out there.

Forming a China WFOE
Forming a China WFOE is not kids play

If I were to list the ten biggest/most common mistakes the China lawyers at my firm see committed by foreign companies doing business in China, not forming a WFOE and forming a WFOE unnecessarily would no doubt both be on that list.

Let me explain….

We have written constantly about the risks of doing business in China without a WFOE. For more on that, check out the following:

Today’s post is going to focus on the mistake of forming a WFOE in China when no such WFOE is actually necessary or advised, an incredibly common and very expensive mistake.

It is expensive and time consuming (usually 3-5 months) for foreign-owned businesses to be formed in China. The following is the most basic list of what you need to do to form a Chinese WFOE and then operate it legally and safely in China:

  • Determine whether your business model is legal for a foreign business in China.
  • Form and register your WFOE in China. This will typically be a WFOE, a Representative Office, or a Joint Venture.
  • Lease property (a prerequisite for the registration process above).
  • Draft an employee manual and execute written employment agreements with all of your employees.
  • Open a bank account with a Chinese bank.
  • Figure out and pay all of your taxes, including company taxes, employee taxes, and social insurance payments for your employees.

It is complicated and expensive to form a WFOE in China and it is complicated and expensive to operate a WFOE in China. Very. To do so in most cities, you need good office space and you need employees and you need to meet with the tax authorities four times a year and you need to calculate and pay all sorts of taxes and….

To make matters even worse, shutting down a WFOE makes forming one seem like a piece of cake. See Closing Down a China WFOE: You Can Run But You Can’t Hide (Part 1) and Closing Down a China WFOE: You Can Run But You Can’t Hide (Part 2). Let’s just say that I once heard a China accountant at a seminar analogize it to a colonoscopy. Not kidding.

Because forming a China WFOE is very expensive, there are scads of companies in every tier 1 or tier 2 China city that exist solely or mostly to form China WFOEs. This means that if you go to one of these companies to form a WFOE the odds of them telling you that you do not need a WFOE are slim to none. The odds of them questioning you on why a WFOE might or might not make sense for you and then analyzing whether it does or does not are about the same.

The result of this is that countless foreign companies go through the pain and expense of forming a WFOE they don’t need, then operating a WFOE they don’t need, and then closing down a WFOE they never needed in the first place. Ugh.

Even worse are the entity formation companies that encourage foreign companies to start with a Representative Office that the foreign company does not need and then a year or two later encourage that foreign company to shut down that Rep Office because a WFOE is now allegedly needed and then charge for shutting down the Representative Office and for forming the new WFOE. This allows the entity formation company to charge for two additional processes that were never needed in the first place — forming and shutting down the Rep Office. Ugh. Note: Rep Offices cannot directly employ anyone nor can they get paid in RMB and just to give you an idea of the utility of China Rep Offices, we have not written about them since 2013!

My law firm and most law firms (both foreign and Chinese) do not play these tricks. What we do before forming any company in China (WFOE or otherwise) is to determine whether any such company makes sense at all. In Forming A China WFOE: The Agony and the Ecstasy, I wrote the following:

At least once a month, one of our China lawyers will get a call from someone asking us to form a “China company” for them before they start doing business in China “next month.” Half the time when we get this sort of call, the better solution is not to form a China entity at all.

That “half the time estimate” is still true but I should also mention that many times when our China lawyers get a call from someone having a problem with their WFOE, additional discussion reveals they should never have formed their WFOE in the first place. Ugh.

Do YOU need a China WFOE? Generally speaking there are two main situations when a China WFOE is legally necessary and a third situation where it can make good sense to have one, even though not legally required.

It is legally necessary to have a China WFOE (or some other legal Chinese entity such as a China Joint Venture) if you will have one or more employees in China. Note that you should assume that anyone you are paying in China as an “independent contractor” is in fact an employee. See Four Common and Dangerous China Employee Hiring Myths, in which Grace Yang, my firm’s lead China employment lawyer, lists “Hiring without a Chinese legal entity (WFOE or Joint Venture) is fine so long as you only bring on independent contractors.” as Myth 1.

It is also legally necessary to have a China WFOE (or some other legal Chinese entity) if you are going to get paid in RMB.

If neither of the above are or will be true for you, you probably do not legally need a WFOE.

There are though many instances where a WFOE is not legally required yet forming and having one still makes sense. If you sell products or services to universities, banks, hospitals, governmental bodies, SOEs or Chinese businesses with any sort of governmental ownership it might make sense for you to have a WFOE, even if you are not legally required to do so. These sorts of businesses are often pressured by the Chinese government to buy from Chinese entities and if you don’t have a WFOE your sales could be way less or non-existent. We also have seen instances where having a WFOE is worth the money and pain because it increases sales by convincing Chinese buyers that you are in China to stay and that there will be someone local to whom they can go if ever they have problems.

But just to complicate things even more, our China lawyers often see instances where a foreign company formed a China WFOE to hire employees in China and/or to get paid in RMB in China and yet would have been better off without having done so. These are cases where the foreign company did not realize that it had better options for accomplishing its China goals without need for a China WFOE. The following are the two most common examples we see of this:

1. Foreign company forms a WFOE in China to sell its widgets. Foreign company hires two employees in Shanghai to do this after having been convinced that it needs a WFOE because it will have employees in China and because it will be getting paid for its widgets in RMB. In Want Your Product In China? Try Using A Local Distributor, an article I wrote for Forbes Magazine, I emphasized the benefits of selling widgets to China through a distributer, rather than going it alone:

When foreign companies want to get their products into China, they often think they only have two choices: go it alone via a China WFOE or form a joint venture with a Chinese company.

Joint ventures are notoriously risky, while a WFOE can take three to five months to form, leaving you with a company in China to operate (that includes bookkeeping, hiring employees, etc.).

But there’s actually an easier option. Companies can enter into a distributorship relationship with a Chinese company (or companies).

Use a Chinese distributor

From a business perspective, taking most products into China (be they industrial or consumer) is a massive task for any foreign company. China is a big and diverse country and it should be viewed as many markets, not just one. Using an experienced Chinese distributor is oftentimes the best way for to sell your product in China.

And from a a strictly legal perspective, distribution (and reseller) relationships between foreign and Chinese companies are fairly straightforward.

Distribution contracts with Chinese companies can have much in common with U.S. distribution agreements, but they also almost always also have stark and important differences.

Licensing your brand name and/or your technology is another excellent (and far less risky) way to profit from China without setting up and operating a WFOE there. See China Technology and Trademark Licensing Agreements: The Extreme Basics.

2. Foreign company forms a WFOE to hire one or two people to handle its China quality control. There are many very good and very inexpensive QC companies in China and oftentimes that is a better way to go. And here’s the thing. Oftentimes if you want a QC person in each of the two or three cities in which you are having your products made, you need to form a separate WFOE (or at least a branch office) to be able to legally hire employees in all of those cities and then deal with China’s highly localized employment laws.

Bottom Line:  Forming and operating a WFOE in China is difficult and expensive and you likely have all sorts of other options. It would behoove you to explore those options before you form your WFOE.

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.

What with all the US-China tensions and trade tariffs, the most common questions our China lawyers are getting these days from clients are whether they should keep having their products made in China and “what should we do about the tariffs?” We will deal with this second question first by simply referring to the following posts we recently wrote on this subject:

As for the second question, we’ll start out by giving the lawyer’s favorite answer: it depends.

For our clients that make clothing or furniture or basic beauty products or basic kitchenware or rubber duckies or the like, we can say that in the last five years well over fifty percent already moved elsewhere, to places like Vietnam, Pakistan, India, Malaysia, Thailand, The Philippines Cambodia, Turkey and even Laos. In the last couple weeks our international lawyers have been checking in with these clients and flat out asking how they are liking their new countries and the word coming back is that they are not without problems but they prefer them to China and they are — for the most part saving money by doing their manufacturing in these places. But what if you are making electronics or auto parts or IoT devices or medical devices or pharmaceuticals or skincare or vitamins or the like? Incredibly few of these companies have moved out of China in the last few years and though many of them are now looking to do so, it does not seem that will or even can occur in the short term as there are very few factories outside China that make these things on a contract basis. We have though had discussions with many companies about setting up their own factories in these countries and the big issue for them — no surprise — is whether their moving will so much cut them off from the components they need to make these products as to cancel out any potential savings. Some of these companies in these industries are looking at Eastern Europe, Spain, Portugal, South Korea, Taiwan and the United States.

Overall though, it seems as though most companies that have moved some or all of their production outside China — usually with a fair amount of trepidation — are surprised at how easy it ended up being and how quickly they have adapted to the change. There have been some though who once outside China found their costs went way up, usually due to supply chain difficulties, and moved back.

That is where the “it depends” part becomes so relevant. Things like doors and door handles and windows seem almost to be the perfect middle ground as some have moved out of China already (mostly for Vietnam and Taiwan) and some are looking at moving out and yet some who moved out have returned and some who looked at moving out have — at least for now — decided to stay.

Interestingly enough, we are hearing increasing talk of foreign companies looking to buy their Chinese factories either to try to reduce costs or because the owner wants to retire and there is fear that the factory will go downhill after that. In doing their cost-benefit analysis nearly all of these companies are accounting for the tariffs as a permanent condition and we think that wise.

On the legal side, moving is relatively easy in that a good manufacturing contract is a good manufacturing contract and it is relatively easy for us to take an existing NNN Agreement or Product Development Agreement or Manufacturing Agreement or Mold Ownership Agreement and modify them to work for another country. It is though very important (with most of the countries listed above) that you secure a trademark for your company name, your brand, your product name and your logo in the new country to which you are moving and it virtually always makes sense to do that as soon as possible.

The above is why our final answer is “it depends.” We will over the next few weeks and months be writing often on what is involved in moving your production from China.

What are you seeing out there?