China Lawyers

For more than a decade, China has blocked American tech companies from fully participating in China’s Internet boom. If you know China’s Internet-related laws for foreign companies and you have represented foreign companies trying to proft from China’s Internet, you know that in most cases, the reality for foreign companies has been much worse even than the laws. To put it bluntly, the way China treats foreign companies is what has prevented companies like Google, Facebook, Uber, Amazon, and even Apple (FAANG) from succeeding wildly in China. Those who believe it a coincidence that these five companies have done so well worldwide as compared to China either unintentionally or deliberately do not understand how China has treated these companies. Or, as the New York Times accurately put its in As Huawei Loses Google, the U.S.-China Tech Cold War Gets Its Iron Curtain:

The digital Iron Curtain has been long in the making. From its earliest days dealing with the internet, the Chinese government has squelched content it didn’t like. Today, the Chinese internet at first glance doesn’t look much like the one the rest of the world uses. It has different platforms, ideals and business strategies, all tended carefully by censors.

And just as the way China has treated foreign tech companies should come as no surprise to those who regularly do business with China, U.S. retaliation for that treatment has not come as a surprise to many in China:

Others in China point to the country’s own barriers against competitors as a strategy that was going to provoke retaliation sooner or later. At some point, the United States was bound to use reciprocity in dealing with a closed Chinese internet market. One popular blog post explained that reciprocity has been translated into “mutual benefit” in Chinese, which explains why many in China didn’t understand that the idea could be used in retaliation.

Another popular blog post drives the point even more clearly.

“You’ve been opposing the U.S. for many years,” said the headline. “You should be long prepared that the U.S. will oppose you one day.”

A large part (so far) of U.S. tech retaliation has been against Huawei, “a Chinese multinational telecommunications equipment and consumer electronics manufacturer, headquartered in Shenzhen, Guangdong, China …. founded by a former People’s Liberation Army officer.” See Wikipedia. The U.S. is acting against China in two ways. The first is a ban on sales of technical products to Huawei, with the threat that this ban will be extended to other Chinese companies. The second is a ban on purchases of telecom products from Chinese companies, with Huawei as the probable initial target. I discussed the sales ban yesterday in The Huawei Sales Ban: Brrrrr. In this post I consider the purchase ban.

The purchase ban was implemented by an Executive Order issued on May 15, 2019, entitled Executive Order on Securing the Information and Communications Technology and Services Supply Chain. In the Order, President Trump declares a national emergency to counter “foreign adversaries” threatening the U.S. telecom sector by selling certain telecommunications products to persons located in the United States. Under powers granted under the International Emergency Economic Powers Act (IEEPA), President Trump ordered the United States Department of Commerce to issue rules to prohibit the import of offending products into the United States.

The U.S. administration has been working to impose a ban on imports of telecom products from China’s Huawei and this Order is generally seen as the final implementation of that plan. This Order goes well beyond just prohibiting the U.S. government and its agencies from buying Huawei telecom products; it will impose a general ban on purchasing such products by any U.S. person/entity. It is an absolute, nationwide ban.

The Order itself does not refer to Huawei specifically. It refers only to “foreign adversaries” and it gives the Department of Commerce 150 days to publish the foreign adversaries list. We can though assume for now that at a very minimum Huawei will be on that list.

This then means, for example, that rural U.S. telecoms that rely on inexpensive Huawei telecom equipment will be forced to find an alternative supplier. The media is reporting (and I believe rightly) that the result of this ban will a major blow for rural American telecom companies, since no alternative supplier that meets their needs has been identified.

There is much that is not clear about this Order. The uncertainty is at least party due to the fact that this appears to be the first use of the IEEPA national security sanction involving the sale of a commercial product. The 30 Existing IEEPA national security sanctions are listed by the Department of the Treasury on its Sanctions Programs list here and a quick review of those sanctions shows they fall into the more traditional notion of what constitutes a foreign based national emergency. Prohibiting the purchase of Huawei products does not fit easily into the tradition of sanctions under the IEPPA program. This means how this sanction will be applied is uncertain.

The next thing apparent from reviewing the sanctions list is that no country in Asia other than North Korea had previously been placed on it. If, as expected, various Chinese companies, including Huawei get placed on this list, China will be joining pariah regimes such as Russia, Iran, North Korea and South Sudan. This will significantly alter the U.S. relationship with China from business adversaries to political adversaries. This is a major event and it should be seen that way in the United States, particularly since it is not clear there is a general consensus in the United States for placing China in this category.

The following additional open issues are more technical but also significant:

1. The Order requires the Department of Commerce to designate the specific foreign adversaries that will be subject to the U.S. purchase ban. As stated in the Order, a foreign adversary can be a nation state, a company or an individual. It is almost certain Huawei will be listed as a foreign adversary. What is not known is whether other Chinese companies such as ZTE will also make the list. Will the entire PRC be placed on the list? Will entities and countries outside China be placed on the list? At this time we just do not know.

2. The order states its goal is to protect the United States in the following sectors:

— Information and communications technology

— Critical infrastructure

— Digital economy

— National security

As I have noted above, this list goes far beyond any previous uses of the IEEPA. The list moves from the classical definitions of national security to purely economic spheres such as the digital economy. Whatever anyone thinks of that broadened scope, the fact is the U.S. has no experience with this type of regulation coming from an executive order. For that reason, we do not know what its immediate impact will be or its impact in the future. Will the U.S. government eventually convert all economic conflicts with foreign competitors into national emergencies?

3. Though the Order is couched in terms of telecom equipment, its definition of impacted technology is very broad:

(c) the term “information and communications technology or services” means any hardware, software, or other product or service primarily intended to fulfill or enable the function of information or data processing, storage, retrieval, or communication by electronic means, including transmission, storage, and display.

This definition can apply to virtually any modern electronic product. Obviously, it applies to the telecom switches sold by Huawei to the rural telecoms in the U.S., but it also applies to Huawei smartphones. More significantly, it can be read to apply the Internet of Things (IoT) devices that are incorporated in the huge variety of “smart products” currently being imported from China and the rest of the world. Much of the work I and the other China lawyers at my firm have been doing for the last five years has involved IoT devices.

Consider the IoT issue. Say the U.S. designates China as a whole to be a foreign adversary. And say the U.S. follows the clear language of the definition to include IoT devices as products that fall under the purchase ban. Designating of IoT devices as a security threat would not be far fetched. Bruce Shneier outlined the threat from IoT in his recent book Click Here to Kill Everybody. The State of California has recognized this threat by promulgating IoT security rules. Yesterday, the U.S. Department of Security warned of Chinese made drones of secretly gathering up and sending back sensitive military information to China. See DHS warns of ‘strong concerns’ that Chinese-made drones are stealing data. Our China lawyers have done probably at least a half a dozen transactions involving Chinese drones and I mention this to show the extent of the impact this ban might have.

A vast number of products imported from China contain an IoT component. A huge number of the electronic devices imported from China implement a feature that allows it to be controlled by a smartphone or laptop. If the Order is enforced in a completely consistent way and IF the entire country of China is designated as a foreign adversary, a huge list of electronic products imported from China will be banned from sale to the United States. Even if this will not be the immediate impact of the Order, the threat remains that the Order could be expanded at any time to have this impact.

Note also that there is no way to avoid this result. The ban follows the component. It will not work to move production to a neutral country and then have the component shipped from China and incorporated into a product made in that third country. The ban follows the specific IoT (telecom) component. In a world of interlocking supply chains, determining the source of each and every critical component for each and every electronic product produced from each and every country in the world will be overwhelming.

The end result of this Order is uncertainty and risk. Initially, the risk comes from direct purchases of telecom products from China. But as the process works out, the risk may infect the entire world trading system. The final result is hard to predict. What we can say, however, is what we have been saying for nearly a year: relations between China and the United States are on a straight-line decline with no end in sight.

Huawei Sales Ban

As we have made clear on this blog and in our recent public discussions on the trade war, the real economic threat posed by the US-China trade war is not tariffs. The real threat has always been the U.S. government prohibiting sales of products to China or purchases of products from China. Focus on the tariff issue is missing the real risk. As we wrote in Who Pays the Tariffs on China Imports? there are various things companies can do to deal with the tariffs that allow them to continue conducting their business without major dislocation. But when an absolute ban is imposed the impact is usually much more direct and much more severe.

My predictions on this issue have come true. The trade negotiations broke down on a Friday and by Wednesday of last week — right when I was giving a talk on the risks of unilateral bans from the U.S., the U.S. government did exactly what I had been predicting. The U.S. announced two related sales/purchase bans on telecommunications product. The bans are focused on Huawei, the largest telecommunications manufacturer in the world and the largest private manufacturing company in China and yet these bans could easily extend beyond Huawei to cover every high-tech company in China and at some point relatively soon they probably will. It is a serious issue that has been mostly missed or downplayed by the U.S. media, at least so far. But as I will show below, these product ban issues impact virtually every country in the world. It is not just a spat between the U.S. and a single Chinese company.

There are two separate but related actions. I will discuss the sales ban in this post and then discuss the purchase ban in a later post. As the first step in its attack on Huawei, the U.S. imposed a general ban on selling U.S. high-tech products to Huawei. This ban was imposed by the Department of Commerce Bureau of Industry and Security. This is the powerful BIS that I referred to in my earlier post. BIS imposed the ban by placing Huawei and 68 Huawei subsidiaries on the notorious Entity List. This ban will go into effect on May 21, when the notice is scheduled for publication in the Federal Register. You can check out the preliminary notice here.

If your company is placed on the Entity List it can no longer purchase any U.S. made product listed on the Department of Commerce Commodities Control List (CCL). The CCL covers far more than semiconductor chips. It covers a huge list of equipment, materials, software and “technology” and essentially includes virtually any technical product or service you would want to sell to Huawei or any of its 68 subsidiaries. You can take a look at the CCL here. The CCL covers the following ten product categories:

0 Nuclear & Miscellaneous
1 Materials, Chemicals, Microorganisms and Toxins
2 Materials Processing
3 Electronics
4 Computers
5 Telecommunications and Information Security
6 Sensors and Lasers
7 Navigation and Avionics
8 Marine
9 Aerospace and Propulsion

So if you want to sell children’s books to a Huawei daycare center, that’s OK. If you want to sell paper napkins to a Huawei employee cafeteria, that’s OK. But if you want to sell ANY FORM of technical product or service to Huawei, you are banned.

I have set out this list of products to make a point. If you look at the list, you will see it includes virtually every product from the U.S. where the U.S. has a competitive advantage. Consider this: The U.S. complains about its trade imbalance with China, yet we ban the sale of virtually every product for which the U.S. has a comparative advantage. If Chinese companies do not purchase from this product list, about all they can purchase are raw materials and agricultural products. Every company in China can see that it is at risk of suffering under a similar ban. So every company in China is strongly motivated to ensure that it is not dependent on high-tech products from the U.S. By this action, the U.S. is forcing Chinese companies to decouple. China is the second largest economy in the world so if it does decouple from doing business with the United States we can expect to see other high-tech companies from all over the world follow.

It is important to note that this Huawei action is an absolute ban. The technical language states that an exporter requires a license but the BIS notice states that all such licenses are presumptively denied. In other words, don’t bother applying. Note also that the ban applies to any foreign entity that purchases the banned product. So it will not work to sell the product to a manufacturer in Malaysia who then resells the banned product to Huawei or to a Huawei subsidiary. This applies to situations where the banned product is incorporated as a even a small component in a more general product.

For example, right out of the gate, Google has announced it will cease licensing its proprietary Android software to Huwei. This will likely mean owners of Huawei phones and tablets will not receive Android OS updates from Google. Huawei will probably fight back by providing its own Android updates and by in the future providing its own operating software for its phones and tablets. But let’s face it, if Huawei had been able to develop its own operating software remotely as capable as Android, it would have done so long ago. So its now being cut off from Android will almost certainly lead to the overally quality of its phones and tablets declining and an eventual lowering of its prices and its sales. Will this lead to increased sales of Google Pixel phones and iPhones in China? Difficult to say. Will this lead to increased sales of Google PIxel and iPhones and Samsung phones around the world, at the expense of Chinese-branded phones and tablets? Very likely.

This ban on sales to Huawei had an immediate negative impact on U.S. chip manufacturers. Media reports state that on Thursday, the day after the notice, Qualcomm was down 4%, Micron was nearly 3% lower, and semiconductor firms Qorvo and Skyworks were respectively down 7% and 6%.

The impact of the disruption on the supply chain is already being felt. One issue that has already arisen is that many U.S. rural telecoms depend on inexpensive Huawei equipment. If Huawei cannot purchase U.S. semiconductors, it cannot provide this equipment. Though this is the intent of the ban, these rural telecoms are a strong support base for President Trump. In response to their concerns, the U.S. Department of Commerce has already indicated that it might provide an exception to the ban solely for the purpose of manufacturing for this U.S. rural telecom sector.

The Department of Commerce’s announcement of a possible exeption for rural telecomes makes little sense. It is unlikely Huawei would even be interested in a carve-out designed solely to benefit President Tump’s supporters. More important, the U.S. is planning to ban all imports of Huawei telecom products into the U.S. and this ban will go into effect in no less than 150 days. So any reprieve for the rural telecoms would likely be short lived. Moreover, Huawei is reported to have enough semiconductors in inventory so that production will not be interrupted during this 150 day period, so the short term impact on the rural telecoms will be zero. The issue for the rural telecoms is much more significant. An absolute ban is coming and there is no solution. Period. None.

But now consider the deeper issue. Virtually every country linked to China in the Belt and Road Initiative depends on Huawei for its core telecom and network infrastructure. Many or most of the countries in the world developing 5G networks depend on Huawei for their 5G infrastructure. These same countries also depend on other Huawei products, such as cell phones and related networking equipment. If the ban on sales of high-tech products shuts down Huawei, it also shuts down the telecom infrastructure development for many countries.

If the U.S. rural telecoms are concerned about the impact of the Huawei ban on their own systems, we must assume all the other countries and systems involved have similar concerns. What this means is that this U.S. decision will have impacts far beyond the relationship between the United States and China/Huawei.

It is not clear what the immediate impact will be on Huawei. Huawei is a private company, so there is no stock price we can monitor to measure an immediate impact. Press reports suggest Huawei has inventoried a large stock of essential semiconductor chips. Some analysts estimate Huawei may be able to continue production for another nine months without purchases from the U.S. During this period, Huawei has the following two possibilities for a reprieve:

First, during this nine month period, the U.S. and China will finally reach an acceptable trade agreement. A requirement of this agreement would then be that Huawei and other Chinese companies (ZTE) are freed from the risk of further sanction. We do not expect this.

Second, the stated reason for the ban on Huawei is that Huawei violated U.S. sanctions against Iran. This is the same basis for the earlier sales ban imposed on ZTE. If the trade agreement does not get Huawei off the hook, Huawei may be able to enter into an agreement with the U.S. that removes the sanctions in exchange for a major fine and other measures. We do not expect this either.

Both these two possibilities rest on an assumption that the U.S. will be willing to allow Huawei to escape the impact of the sales ban. If the United States’ goal is to shut down Huawei, neither of these possibilities is realistic. If Huawei cannot find another supplier of technology not dependent on U.S. companies, Huawei is probably doomed.

It is then essential to consider the implications of all this. An action of this magnitude will require the Chinese government to respond. Some facets of its response will focus on “tit-for-tat” sales and purchase bans, tariffs and other economic and trade measures. But for China, the response could also result in non-rational emotional actions, such as those we saw recently when China lashed out at Korea, France, Norway, and Japan and, even more recently, against Canada. This might mean boycotts and other attacks against U.S. owned companies and  detentions and other police harassment directed against American individuals.

U.S. companies and individuals operating in China need to take great care during this year as the disputes get worked out. The day before President Trump tweeted out his most recent 25% tariffs against Chinese products, my co-blogger, Dan Harris, wrote about how “Winter is Coming” for US-China relations. From my view on the front lines, I would revise that to say that this Huawei action means winter has mostly arrived. Put on your overcoats and be prepared for a long winter. Let’s hope it is not a new Ice Age.

May 21 UPDATE: As we predicted in this post, the sales ban did result in immediate negative impacts on U.S. companies and purchasers of Huawei products: Google shut down Android and U.S. rural telecoms were shut off from Huawei product they had already purchased. In response to these issues, the United States Department of Commerce on Monday modified the Entities List ban to provide for a 90 day general license for export to Huawei. This license allows Google to provide Android updates and it allows for chip sales solely for maintaining existing networks. The text of the limited license has been posted on the Federal Register. In response, Google has said it will provide updates for 90 days but will go back to shut down mode at the end of that period. Huawei’s reponse has essentially been, So What? The damage has been done and a 90 day reprieve designed to help U.S. companies and consumers is of no interest to Huawei.

China job offer letters

China employers often want to extend an offer letter to their potential new hires to prove they are serious about bringing them on board. Some candidates expect or may even request an “official” offer letter from their potential employer. This is understandable. However, offer letters are neither needed nor required in China and they do not replace an employment contract. For these reasons, when our clients ask us to review their China job offer letters, we see our job as China employment lawyers to be to make sure the offer letters do not harm our client. Most of the job offer letters we are tasked with reviewing would have hurt our clients (some very badly) had we not remedied them.

If your China job offer letter is not written with China’s employment laws in mind you almost certainly would be better off not using a job offer letter at all. Instead, consider just verbally tell your potential employee what you will be offering and then later you can provide that employee with a full-fledge, fully vetted, China-centric employment contract.

What are the more common red flags our China employment lawyers typically see in job offer letters? What do our China employment attorneys often see that tell us the job offer letter should not be used or at least should be seriously revised before being used? The following are our big three:

1. The most common red flag we see are job offer letters written as though they were for the country in which our client is based and not for China. Many of these explicitly reference U.S. or Canada or Australia or EU law and that is just not going to fly. In particular, our U.S. clients will often reference U.S. at-will employment and that definitely makes no sense for China. See China Employment Contract FAQs. These sorts of things will only set you up for trouble down the road.

Along these same lines of using non-China law for a China job offer letter, we also often see employers write that “either party can terminate with a month’s written notice.” This does not comply with Chinese employment law and it should not be used. In fact, we generally recommend the job offer letter not discuss termination at all as this is best saved for the employment contract. Pretty much all notice period requirements are also better left to the employment contract itself and left out of your job offer letters.

Rule #1 for a China job offer letter is that it should — if at all possible — include only language that 1) fully complies with China’s employment laws (both national and local) and 2) that benefits you. Just by way of one important example of this maxim: it can benefit you as the employer to include your potential employee’s total compensation and company-provided annual paid leave in your China job offer letter because these are things your employees really care about but including these could harm you if they do not comply with Chinese employment law or even if they do not line up with your company’s Employer Rules and Regulations.

2. The job offer letter does not specify an initial employment term or state whether the employee will be hired on a fixed-term or an open-term contract. Since the terms of the employment contract will eventually control, you can to a certain extent deal with these issues in the contract itself. But normally the offer letter should specify an initial employment term and a probation period (if any). These are important issues and if they not in the offer letter, your potential employee likely will become concerned. So our China employment lawyers usually recommend to our clients that they include a brief section in the offer letter setting out the employment term and any probation period.

3. The probation period set out in the job offer letter is not proportional to the employment term. Getting this proportionality right is not that difficult, but getting it wrong can lead to all sorts of problems. What happens when you seek to terminate the “probationary” employee for failing to satisfy your conditions of employment? Suppose the probation period you set out in your job offer letter is longer than what is legally permitted and your termination occurs after the statutory probation period has passed. Your termination decision will almost certainly be deemed to have been unlawful because it came too late. Your employee will sue and you will lose.

Just as a quick aside because at least 90 percent of our clients justifiably are surprised by this, but even your China employees working for you during their probation period cannot be terminated at will. Foreign companies seldom realize this and so they set their employee probation periods for as long as legally possible (actually, many set them for even longer than legally possible) and they do this believing that the longer it is the better, but that is definitely not always true.

Bottom Line: Like pretty much everything China employment law related, your job offer letters need to be done right and, at minimum, that means they should comply with China’s national and local employment laws. Our China employment lawyers regularly conduct China employer audits and oftentimes these audits reveal that even our own clients have sent out job offer letters (without sending them to us first for our review) that failed to comply with Chinese law and put them at risk.

Don’t let that be you….

 

 

international law

Okay, so on May 3 I wrote about how we would be starting a new series on here listing out eight things to read about China and a lot more. In that May 3 post I talked about how we constantly get emails from readers asking what to read on China and all sorts of things related and even barely related to China and the plan of this series would be to constantly and consistently answer this very question.

But then we got hit with President Trump’s tariff tweet two days later and along with our international lawyers having to put in long hours dealing with the client dislocations that tweet has caused, we also pretty much every day since then have felt compelled to address the pressing trade issues at hand.

Anyway, we’re back to trying this again.

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

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

And though I said this in the initial post on this, it is important enough that I must state it again: Please do not hesitate to comment at the end of this or any other post. We cannot tell you how much we appreciate your comments, good, bad and indifferent.

Here we go, in absolutely no particular order.

  1. Chinese firms are not all serial intellectual-property thieves. The Economist. Because it’s true and because we (most of us who deal with China) sometimes forget this.
  2. China’s population could peak in 2023, here’s why that matters. CNBC. Because demography is destiny.
  3. How to Assess Security Risks While Traveling. The New York Times. Traveling can be dangerous. I’ve experienced a military coup (Istanbul) a typhoon (Korea), three car accidents (Sakhalin Island, Yantai, and Qingdao — never hurt much at all), an anti-American protest with hundreds of thousands of protestors (Korea), catching two spies in my hotel room (Tokyo, yes Tokyo), threatened with death (Vladivostok), held by the police for 7 hours (Vladivostok) been stranded for days because of terrorism (Anchorage, Alaska because of 9-11), been stranded for days (with no heat) because of weather (Magadan) and these are just what I remember. I’m quite sure many (most?) of you-all can recite similar stories. This article should help you prepare for these sorts of events.
  4. How a Chinese venture in Venezuela made millions while locals grew hungry. Reuters Special Report. China’s Belt and Road gone wild in Venezuela. Because this sort of thing simply should not happen and you should know why it just keeps happening. Hint: There is a lot of money to be made from corruption.
  5. The Center-Left Finds Life in Spain. New Yorker. There has been a lot of talk about Trumpian rightists sweeping Europe and doing well in Spain but so far that is not to be and this bodes well for the rest of Europe as well. And because my law firm has offices in Madrid and Barcelona and because our law firm does a ton of work with Spain.
  6. Taiwan becomes first in Asia to legalize same-sex marriage. The Guardian. Because this is BREAKING NEWS and a big deal and because gay rights are human rights and because this is what democracy looks like.
  7. The Dirty Truth About White Liberal Racism. Pacific Standard. Because it’s controversial, true and super important. I spent most of 2018 in Spain and I returned to a United States far more racist than when I left. And until this point I believed that racism had been in a straight line decline since I was a kid. And yet we really don’t talk about it all that much.
  8. Syria bombings: UN says ‘worst fears are coming true’ in Idlib. Al Jazeera. Because three million people are at risk and because hospitals and schools are being bombed and because this isn’t anyone’s lead story.
  9. The Best Way to Load Your Dishwasher, According to an Expert. Cooking Light. Because science is important and because according to my own experiences and my own completely made up statistics, arguments would decline by approximately 40% worldwide if people would just agree on this one really important thing.
  10. My Way or the Huawei. Zeihan on Geopolitics. Because this whole “Huawei thing” could end up being THE key to an upcoming rapid decline in US-China relations and because this piece makes a heckuva lot of sense.
  11. China’s currency is sending a warning signal about the trade war. CNBC. Because it says the RMB has declined 2.7 percent against the dollar just since President Trump’s May 5 tariff tweet and because it fits in so well with what I said in Who Pays the Tariffs on China Imports? President Trump vs. CNN and What YOU Can do NOW to Reduce Your China Prices about how RMB devaluation will — among other things — give buyers of China products a great tool for negotiating prices lower.
  12. Trump’s Huawei Ban Is a Bigger Deal Than His Trade War. New York Mag. Because it is. Because this is what will lock in an ultra-contentious US-China cold war for many many years.

Your thoughts?

 

Who pays for the Trump tariffs?

On May 5, President Trump tweeted that he would be raising tariffs to 25% on $200 billion worth of Chinese products and that he would eventually impose this same tariff rate on pretty much all products from China. Since then, the media has been all over the map on who will be paying for these tariffs. On the one side, we have President Trump and the media favorable to him stating (or at least implying) that “China will be paying these tariffs.” On the other side, we have the media stating (or at least implying) that the U.S. consumer will be paying these tariffs via increased retail prices

Well guess what and no surprise, it ain’t that simple. Truth is a many companies and people from all over the world will be paying the tariff. I say this based in large part on what our international lawyers and international trade lawyers have already seen from the last round of US tariffs.

The onslaught of tariffs is subjecting companies that import Chinese products into the United States to overall price increases and our China lawyers are getting an earful about this from clients that sell their products on relatively thin margins to big retailers like Walmart, Target and Home Depot. Our clients with super strong brand names and eye-popping profit margins are — at least for now — remaining much calmer. Some of our clients have flat out told us that they do not really care about the tariffs. We have a client that pays around $60 for the products it has made in China and then sells those products for $1700 to $2100. How much should it care about a $15 price increase? We have another client that pays 20 cents for the product it has made in China and then sells that product for $12. How much should it care about a 5 cent per unit price increase? So yes, the tariffs do not fall equally on all.

But no matter your profit margin (with some exceptions) and no matter to whom you sell your products, now is the best time to be doing two things: 1) looking into the possibility of at some point diversifying or moving your supply chain out of China, and 2) trying to get your China suppliers to lower your product pricing. Our international lawyers are working nearly non-stop to help our clients diversify their manufacturing to countries outside China — so far this has mostly been to other Asian countries, such as Vietnam, Cambodia, the Philippines, Malaysia, Pakistan, India, Thailand and Taiwan, but also to Mexico, Eastern Europe, Portugal, and Spain and even to Canada and the United States — more so after the announcement of the “new NAFTA” agreement, a/k/a the USMC.

This post is going to focus on who actually will pay the China tariffs, yet in doing so it also sets out some steps you should consider taking now to reduce your China product costs.

I will begin by explaining who will pay the 25% Trump tariffs and I will use a widget as my example, with the following assumptions.

  1. Assume China Factory was manufacturing its widgets and selling them for $100 each before the tariffs.
  2. Assume European Widget Company was buying these widgets from China Factory for $100 each before the tariffs and selling almost all of those widgets in the United States wholesale to Big Box Retailers for $140 which they in turn sell at retail for $280.
  3. Assume China Factory/European Widget Company will now have to pay a 25% tariff on its widgets that go to the United States and further assume this means European Widget Company’s total cost for the widgets (as landed in the US) just went up to $125 because of the US tariffs.

What happens next? Does China Factory turn around and say to European Widget Company “we feel your pain and we badly want to alleviate that (and because China the country is now further subsidizing China Factory) we will cut our widget prices to $75 so your landed US costs will remain at $100, resulting in no change to your US pricing? Under this scenario, China will pay the tariffs.” Is this realistic? Of course not.

Does European Widget Company say to China Factory Company, “Hey that’s really too bad about the U.S. tariffs. Because we so love the US and China we will just pay you the same $100 we have always been paying you for the widgets and we will keep selling them to the US Big Box Retailers for $140. We will incur all losses from the tariffs so neither China nor the US will be impacted in the slightest.” This scenario is equally implausible.

Now let’s throw in some more assumptions, based on what happened with previous rounds of US tariffs against Chinese goods and what to a certain extent is already happening in this round of US tariffs against Chinese goods:

  1. China reduces its income tax rates for Chinese export manufacturers, thereby reducing their overall costs by 4%.
  2. China reduces its VAT rates for Chinese export manufacturers, thereby reducing their overall costs by 4%.
  3. China pushes down the value of the RMB, thereby increasing by 2% the RMB Chinese export manufacturers get from their Dollar and Euro sales.

So right there we have a 12% reduction in costs for China Factory. Note that the numbers above are rough calculations and individual valuations will vary.

What should and what will the European Widget Company do in light of the above numbers? It will go to China Factory and say something like the following:

Monsieur, as you well know, times are tough selling widgets to the United States because of the new and onerous tariffs. We essentially have to pay 25% more than if we were to purchase them from any country other than China. Speaking of other countries, did I tell you we’ve been looking at having some of our other products made in Vietnam or Thailand? I went to both countries last week and they were so nice and they have such great food and I was surprised at how many people in both countries speak French. Do you realize that if we were to have  our widgets made in Vietnam or Thailand we’d be free from the 25% tariffs and free from all this acrimony and risk tied in with the US-China relationship. I have a friend who says the United States and China will at some point cease all trade between them. I don’t think that is possible, do you?

But I keep hearing that China’s recent income tax reductions and VAT rebate increases and RMB devaluations — and who knows what else the Chinese government is doing and will do to subsidize you Chinese manufacturers — has reduced your manufacturing costs by 15% to 20%. With all this it seems you should cut your pricing to us by 20%. I know this will cut into your profits a tiny bit but our profits are going to get cut as well no matter what you do and no matter what happens. Because we have had such a great relationship with you for the last 8 years (including our willingness to overlook your early indiscretions, like when you (1) sold our product in the grey market out the side door; (2) registered OUR trademark in China and we had to convince you to assign it to us or (3) you reduced the steel content in our widgets from 20% to 5% to save money and we only learned of this by enduring massive customer returns of our widgets due to failures and then as compensation you offered us a 5% discount on our next set of purchases), don’t you think it only fair that our two companies share in the profit losses here? Gosh I would hate to spoil our relationship that took us so long to build by moving our widget production to Thailand or Vietnam, which is what my General Manager says we should do.

And in the end, China Factory reduces its prices to European Widget Company by 12% and their new contract makes clear all pricing is in RMB, though payments will be made in Euros.

European Widget Company, is now paying $88 for widgets for which it previously paid $100. If you add the 25% tariff to the new $88 price, European Widget Company is now looking at a new $110 US landed price.

Does European Widget Company then go to its Big Box Retailer buyers and say, “Hey, you have always been great so I am going to keep selling you our widgets for $140 so your profits are not impacted?” No. Does European Widget Company go to its Big Box Retailer buyers and say, “Hey, because of the 25% tariffs I will need to increase my sales price to you by $25 and so I am now going to charge you $165 per widget?” Let’s imagine European Widget Company does this. How will Big Box Retailers respond? There is a 99+ percent chance they will tell European Widget Company “no way” and then talk about how ,”Maybe we should start having our own widgets made in Vietnam or Thailand” and they very well might. For this reason, this scenario is very unlikely.

A more realistic scenario would be for European Widget Company to go to Big Box Retailers and say that its costs have gone up and it is working hard to diversify its widget production outside China, that it has done some exploratory trips to Vietnam and Thailand and will soon be testing some widget manufacturers there, but in the meantime, it needs to raise its prices by $7 and can that price increase work. The Big Box Retailers will say no and trot out their own Vietnam/Thailand/Malaysia/Pakistan/Mexico/Indonesia/India/Philippines/Taiwan scenarios and in the end agree to pay $2 more per widget. And then Big Box Retailers will flip around and raise its retail widget prices anywhere from zero to five dollars.

So in the end, the China government, the China Factory, the European Widget Company, the Big Box Retailers and the Consumers all end up paying some portion of the 25% tariffs. Of course the portions will vary depending on profit margins and on the market and on the industry and on the product and on supply and demand and on the price elasticity of demand and on Chinese government subsidies and tax cuts and RMB devaluations and on the companies involved and on a whole host of other things. But the above scenario is not an unrealistic one and it mimics some of the scenarios our international lawyers saw play out during the last round of tariffs.

So what about the flip side? What about the soybean farmers in the United States who are now likely to get socked by Chinese tariffs against their soybeans? Here is how I see that playing out. These farmers will likely be hurt badly in the short term, but they may end up barely being impacted in the long term. How can that be, when the U.S. was at one time selling approximately $15 billion in soy beans to China annually, which constitutes around 60% of U.S. soybean production? The soybean farmers will all be wiped out, right? Wrong. I am not for a minute going to tell you that America’s soybean farmers will be just fine because that is not likely to be the case. But I am going to tell you that soybeans are essentially a commodity. This means that if the U.S. stops selling soybeans to China, China will get its soybeans from other countries, and the subsequent vacuums created in non-China markets will be filled by U.S. soybean farmers. I mention this not to minimize any impacts but to make clear that U.S. soybean farmers are not going to lose $15 billion a year in sales.

Bottom Line: U.S. tariffs on Chinese goods will in most cases lead to increased pricing/decreased profits for pretty much everybody in the product supply and selling chain. But the impact on your business will depend at least in part on the steps you take now.

5-18-2019 UPDATE. In China’s currency is sending a warning signal about the trade war, CNBC.com writes that the RMB has lost 2.7% of its value as against the dollar, just since President Trump’s May 5 tariff tweet! Are you making your China product supply contracts dollar or Euro denominated?

Manufacturing in Thailand

One of the advantages of our having published 4,789 blog posts (Our first post, INTRODUCTION TO OUR BLOG, was on January 4, 2006, was 4,879 days ago!) is that we have blog posts on just about everything. This is extremely helpful in responding to client inquiries. If a company writes us about what sort of contract they need for manufacturing their products in Vietnam, I send them Overseas Manufacturing Contracts (OEM, CM and ODM) and then give them a flat fee quote for us to draft just such a manufacturing contract for Vietnam. If a company asks us how best to maneoever away from their existing China factory, I send them Changing Your China Factory? Be Careful, along with an explanation how my law firm’s China lawyers can help with the transition and our estimated legal fees for doing so. When someone asks us for a China contract template, I send them China Contract Templates for $99 Each and a brief explanation of why a template will not work for their particular situation. When someone has a Sinosure problem (which are happening incredibly frequently these days), I send them China Sinosure: What You NEED to Know. I could go on and on.

But with the tariffs and all the changes that have been happening with China these last six months, we are actually struggling to keep up with posts that make sense to send in response. Since President Trump issued his May 5 “tariff tweet” companies that buy products from China for export to the United States have been scrambling to figure out their options for fighting against the tariffs or for having their products their products transhipped in such a way as to legally qualify them as having been made in a country other than China. For fighting against the tariffs I send them Today’s 25% Tariffs Against China Products: A Roadmap on What YOU Should do Now and for what it takes to qualify their products as having been made in a country other than China I send them China Tariffs and What to do Now, Part 3 and Avoiding the New Tariffs on China Products: Watching the Substantial Transformation Sausage Get Made.

But what we are also getting are a whole host of requests/questions regarding manufacturing in other countries. For example, in just the last week, two companies have written to ask us about what it takes to manufacture in Thailand using either contract manufacturers or by setting up their own factories in country. Though we have our own Thailand Business Specialist — John DiDominic, someone we have known and worked with for literally decades before he formally joined our team — we just have not written all that much on here about Thailand. Mostly because before the tariffs there was a lot less call for it. And much of what we have written on Thailand is so out of date as to be of questionable value. The same mostly holds true for Vietnam as well, even though we have our own Vietnam Business Specialist as well, with whom we have been working for close to a decade. We are feeling even farther behind on posting about many other countries with which we have done substantial business over the years and particularly since the trade war began. Mexico, Cambodia, the Phillipines, Malaysia, and Indonesia spring immediately to mind.

Anway, our plan is to start writing more often these other countries because there is clearly a demand for information about them, at least based on the number of inquiries we have been receiving and the legal work our international lawyers have been doing. Our plan will be to write about what we are doing and that is for two reasons. One, this makes things a lot easier for us. Two, this is great evidence of what is timely and relevant. One of the first things we plan to write about on here is what is involved in switching product outsourcing from China to Thailand. These posts will likely deal with what products work best in Thailand, how to find a good Thai manufacturer, and what is different about Thai contract manufacturing as compared to China contract manufacturing. We also will write about what it takes to set up your own factory in Thailand. We will eventually also write about forming companies in Thailand and the basics on doing business in Thailand. We intend to do similar posts for many other countries as well. We also will write about the relevant contracts for these countries, mostly focusing on what makes each of these countries different. Just by way of one example: we plan to write soon, about NNN Agreements for Mexico and how we treat those differently from the China NNN Agreements we draft.

This post was spurred by my wanting to respond to a client who asked me this morning whether we had written anything doing business in Thailand and to send him the links to those posts if we had. I was able to find two. One quite recent one by our Thailand Business Specialist, John DiDominic, entitled, Doing Business Outside China: It’s Thailand’s Time, which serves as an excellent introduction/overview on doing business in Thailand. The other was a guest post by David Dayton that we ran about eleven years ago (almost to the day), entitled China vs. Thailand Outsourcing Smackdown, comparing manufacturing in China to manufacturing in Thailand. I thought it would be fun to re-run David’s post below in the hopes that we will get reader comments on the differences between China manufacturing and Thailand manufacturing and knowing that John will soon be updating it. The below is that post:

David Dayton over at the consistently enlightening Silk Road International Blog did an interesting post comparing China to Thailand for manufacturing, entitled, Thailand vs. China. [link no longer works].

David is eminently qualified to make this comparison because his Master’s Degree focused on “Comparative Chinese and Thai Corporate Cultures,” he is fluent in both Thai and Mandarin, and has spent considerable time doing business in both places.

Dayton starts his post off by quoting a friend saying that “Every thing in Thailand is slow except for the internet.” “Everything in China is fast except for the internet” and he then sets out the following eleven comparisons:

1. Legal requirements for export are not nearly as burdensome in Thailand

2. Thailand’s infrastructure is at least as good as China’s — ports, airports, tollways. Nothing new, I know, but this is one of the major drawbacks of working far inland in China or even close to large cities in Vietnam or Cambodia. The big plus in Thailand is that there are no inter-provincial tariffs or restrictions on the flow of goods like there is in China.”

3. Even with the recent wage increases labor is still more expensive in Thailand than in China. I’m seeing cost differences of about $50 to $75 a month between factory workers in China vs. Thailand.

4. The environment is much more “international” in Bangkok than it is in Shenzhen — more so than even Hong Kong, There isn’t as much English on signs but the exposure to “the West” is certainly as much or more. Bangkok seems to be becoming more western and Hong Kong more Chinese.

5. The advertising is much more sophisticated in Thailand than in China where it’s still a relatively immature industry. I was consciously amazed at the higher quality of both radio and outdoor media advertising in Thailand.

6. Nationalism is alive and well in both countries, but Thailand’s flavor is much less strident. China seems to be a bit more angry, with something to prove, while Thailand is much more comfortable with its unique place in the world.

7. I’m constantly told the same thing when I tell people in Thailand that I live in China: “You know, labor is more expensive here, but you get better quality work too.” Almost to a person, this was the response I heard — more than 10 times in just one day.

8. Thailand has a very well developed export base for automobiles, machinery and electronics, though China has some of this too.

9. Staffing in China is difficult in terms of retaining top-level local employees as well as in finding and retaining low-end factory labor. Thailand has a similarly tight market in top-level employees. The service levels are much higher in Thailand as is education in general. Professional standards seemhigher in Thailand as well.

10. The traffic in both Thailand and China is horrible, but each has its own perils. In China you are literally taking your life in your hands when you get into a car. Thailand is completely different. The traffic in Bangkok is so bad at almost all times of each and every day that it is estimated to lower Thailand’s annual GDP by multiple points!

11. Banking (I can’t believe I’m going to say this), but hands down China has better banks, both in terms of service and accessibility. In China if you need a bank, you can get one open from 8AM to 5PM 7 days a week. Thailand is 9AM to 3:30PM five days a week and off every holiday possible.

What do you think?

Yes, what do you think?

China WFOE formation and doing business in China

At the beginning of the US-China trade war we were one of the few voices saying this war would last a long time, with essentially no end in sight, and we took a lot of heat for that. More than seven months ago, in China the US and the New Normal, we essentially said that foreign companies needed to buckle up for a long ride because trade relations between the United States and China would get a lot worse and stay bad for a long long time. We also talked about how foreign companies were starting to look beyond China and we strongly encouraged they continue to do so. I only wish more had listened:

We are telling the truth about companies (not just American companies) looking to leave China because part of what we do is help companies legally fulfill their goals and their plans. My firm’s international lawyers help companies negotiate their exits from China and we help companies figure out where to go instead of or in addition to China. We also help companies looking to set up in other countries, do deals involving other countries, protect their IP in other countries, and draft necessary contracts in other countries. In the last few months our international lawyers have been being kept nearly as busy with countries like Vietnam, Cambodia, Indonesia, Thailand, Malaysia, Turkey, India and Pakistan as with China.

The above is but an introduction to what we see as China’s diminished future for foreign companies. Since pretty much the inception of the US-China trade war we have been saying that we do not see its end because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not see China changing on these things, we did not see the trade war ending.

Vice-President Pence’s speech on China earlier this week has only reinforced for me that the trade war between China and the US will not be ending any time soon, if ever. The New York Times has called that speech the Portent of a New Cold War between the United States and China and China’s own Global Times wrote an article entitled, Pence speech shows Washington’s tougher policy on China. Don’t blame us. We are just the messengers. Things are getting very tough between China and the United States right now and the trade war is just a symptom of that, not the disease.

The United States is aggressively and unabashedly doing what it can to isolate China and to remove it from the world of international trade. The new free trade agreement between the United States and Canada is further proof of this as it essentially blocks Canada and Mexico from engaging in free trade with China. See What Trump’s new trade pact signals about China. Word is that shutting out China is going to become a regular thing in all new U.S. trade agreements. See US Commerce’s Ross eyes anti-China ‘poison pill’ for new trade deals. Will the EU and Japan and Latin America play ball on this? I predict that most if not all of them will.

So yes, the above is why we will continue to write about what North American and Latin American and European and Australian businesses should be doing to deal with the new normal regarding China. We are writing these things because we value our credibility and because we presume our readers value our no-holds barred advice — threatening emails or not.

We eventually came to the view that companies were focusing too much on a US-China Trade deal as though that would, standing alone, lead to a return of the good times between China and the United States and (one day before President Trump’s May 5 “tariff tweet”) we wrote The US-China Trade War: Winter is Coming, in which we laid it on thick about how doing business with China is becoming bad for business:

Ask those who write about China about the hate mail they receive. I think of this blog as hewing pretty close to center when it comes to China and yet hardly a day goes by where someone doesn’t challenge us with a question like “how can you support a regime that does xyz horrible thing?” Many of these come as messages on our China Law Blog Facebook page and an increasing number of them include gruesome pictures of executions and slaughtering of dogs, etc., purportedly from China. I have no idea if those pictures really do come from China or when they were taken, but I would guess many businesses with close China connections receive similar messages. And I know from talking to reporters that a huge number of foreign businesses do not want their customers to know they are either in China or doing business with China. Why? Because doing business with China can be bad for doing business elsewhere and this is getting worse and will only continue to get worse. Yesterday the United States called out China for interning three million Muslims in concentration camps and I am quite certain this sort of calling out is will continue and even escalate after a trade war resolution.

When I was in student government back in my college days, the big issue was apartheid in South Africa and our student government voted to have the college divest from any of its investments in South Africa. That didn’t happen but many companies did pull out of South Africa so as to placate their customers/clients. We are seeing similar things happening with Saudi Arabia these days and there are China stirrings as well. I am NOT saying this will have a major impact on most companies, but if you pitch your company as socially conscious and you are not thinking of ending your dealings with China, you are behind the curve. What if you are just a run of the mill start-up or SME? What should you do? Should you flee China now to avoid social problems later? Almost certainly not. But if you can, let’s say, slowly and relatively painlessly move your supply chain elsewhere, you absolutely should seriously consider that. Everything being equal, would you not rather tell your customers (and even your own kids) that your company does business with Mexico or Thailand as opposed to China?

Just as many companies boast of how their products are organic or cruelty free, companies seem almost eager to let the world know that they have stopped manufacturing in China or are doing all they can to accomplish that. See the Wall Street Journal article, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, whose theme is that the smart money wants to invest in companies that are out of China, getting out of China, or at minimum, have a plan to do so.

The post concluded by emphasizing that trade deal or no trade deal, US-China decoupling had begun and would only continue and now is the time to decide what to do about that:

How though should your business respond to all of this? To quote an old investment adage, “the trend is your friend,” and right now the trend is for the West and China to continue decoupling. This means the most important thing for your business is to be cognizant of this and to monitor it. We keep writing about this because we see it as likely to impact nearly all foreign companies that do business with China, even those from countries whose relations with China are much better than those between the United States and China. No matter in what country your company is based, if you do business with the United States — especially if you have your products made in China and then sell them to the United States — your business is at risk of becoming entangled by the decoupling.

If you want to see your company go into China or have its products made by China or increase its China presence, you should be prepared to explain to your company’s decision makers why you believe your business will not fall prey to US-China tensions. If you are having your products made in China, you almost certainly are already looking to reduce your China exposure, but in doing your cost benefit analysis for that, consider whether yours is the sort of business whose sales might increase merely by being able to tell its customers/consumers that your company does no business with China. And yes, this is going to sound self-serving (and it is, but it is also true), you need to more than ever make sure you are not doing anything that might make you an easy target of the Chinese government. In other words, make sure your company is in full compliance with China’s laws, particularly its tax, environmental, employment and bribery laws.

Weeks even before this “Winter is Coming” post, I was interviewed for an April 21, 2019, Wall Street Journal cover story, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, in which I made clear my view that “There is no way any deal between China and the U.S. will cause everyone on both sides to say, ‘We were just kidding,’” said Dan Harris, managing partner at Harris Bricken, a law firm that specializes in investment with China. “The tariffs and the arrests and the threats and the heightened risk have impacted companies and that will not go away.”

We got a lot of heat for all of the above as well.

On the day of President Trump’s tariff tweet, I wrote The US-China Cold War Starts Now: What You Must do to Prepare, consisting mostly of my “initial” thoughts regarding what I am now calling a cold war:

My first thought based on the last few days is that this trade war is at its core a fight between the United States and China for who determines from where products are purchased. I am obviously not the first person to say this but I have to admit that this did not really hit home for me until yesterday One of my law firm’s Spain lawyers off-handedly mentioned something along these lines to me months ago, but it took me until now to realize how true it is. Both President Trump and President Xi are using their presidential powers to influence global buying decisions. Okay, I agree that when I say it like this it seems obvious, but I’m not so sure that it was or even is until you hear the following explanation. But hey, if I’m all wrong on this, just let me know — as the saying (sorta) goes: “there are no bad ideas here.”

Earlier this week I read how President Xi controls China’s economy. Well duh, right. No, I mean like really controls it, down to just about every nib. China wants to pay Canada back for Canada’s abiding by international law in arresting Huawei CFO Meng Wanzhou. See The Huawei Indictments are the New Normal. China chooses to do this by essentially telling its businesses that they better not buy any canola oil from Canada and, pretty much just like that, they don’t. This is on top of China already having taken hostage two Canadians and snap-deciding to sentence to execution another Canadian whose previous sentence was 15 years in prison. In other words, President Xi and those at the highest echelon of China’s government can snap their fingers and thereby create a new business reality.

Lacking in such nearly unmitigated power, but wanting that same power for himself, President Trump has been using tariffs to essentially accomplish the same thing. He has been raising tariffs against China and then negotiating with China and then threatening to raise tariffs against China and then raising tariffs against China, all the while pressuring various U.S. governmental bodies to increase their pressures against China products via non- tariff actions like anti-dumping and countervailing duties (AD/CVD). See Yet Another International Trade (AD/CVD) Petition Against China: This Time it’s Metal File Cabinets.

Make no mistake about it, President Trump is doing whatever he can to convince American companies — really any company from anywhere in the world that sells its products to the United States — to stop doing business with China. In ‘We’re freaked’: Trump startles US businesses with fresh tariff hike, CNN does a great job explaining (I think unintentionally) how this all works by focusing on how Trump’s last minute tariffs will harm U.S. businesses that did not prepare for this.

I then compared those who were ready for this cold war with those who were not:

Essentially, we have on the one hand businesses saying President Trump’s new round of 25% tariffs and his threatened (and likely to occur!) next round of 25% tariffs were a complete surprise on the one hand. And on the other hand, we have the Trump administration disputing this and accusing those who say this of having not made much of an effort to read the tea leaves regarding impending US tariffs against China.

I have to at least somewhat side with Lighthizer and Mnunchin on this because we have on this blog been relentlessly downbeat about US-China relations by basically screaming to anyone who will listen that you must start looking beyond China for your products. We have done this as recently as Sunday, in The US-China Trade War: Winter is Coming to more seven months ago in China, The United States and the New Normal.

So to at least some extent, those who just assumed that China-US relations would soon return to how they were before the United States initiated its first round of tariffs were either not reading enough or were too much ignoring or just misinterpreting what they did read. Nonetheless, I completely get where these complaining companies are coming from because most of my own law firm’s clients that were having their products made in China last year are still having their products made in China right now. In large part this is because leaving China is neither fast nor easy.

Some of our clients have left China entirely, moving their production to Thailand, the Philippines, Mexico, Indonesia, Vietnam, India, Sri Lanka, and the Ukraine, among others. Some of our clients have diversified their supply chain away from China, while remaining in China. Others are working on exiting China or diversifying away from China. Many though — and for various reasons — feel they have no choice but to remain in China for the short term and even beyond. So yes, there are some companies that should have left China 6-12 months ago but didn’t, but there are more companies that simply could not leave China fast enough to avoid this next round of tariffs.

In September 2018, in How to Leave China and Survive, we wrote about how difficult it is to cease having your products manufactured in China and how that can be done in way that minimizes myriad potential problems. I would urge anyone looking to move away from China to read that carefully before instituting any actions that might lead anyone in China to think you might be leaving.

But if you are going to leave China, where should you go and how even should you go about determining this? And what can you do to try to secure an exemption from these new tariffs? In China/U.S. Tariffs and How to Fight Back, one of our international trade lawyers explained how to try to secure an exemption to previous tariffs and much of what was written there will apply to this new round of tariffs as well.

Yet even in this post in which we decreed the dispute between China and the United States to be a cold war and even as we highlighted the need for foreign companies to reduce their China exposure, we noted how for some companies, now is the time to actually go into China:

And just as we are seeing so many of our manufacturing clients beating down the doors to get out of China, our China WFOE formation work is at its highest level (by far) in the history of our firm. In other words, we are on the one hand working to get many clients out of China while at the same time working to get many of our clients more deeply embedded into China with their own Chinese companies. Who are the companies going in? Mostly tech companies and companies that sell their products and services to China. Most of these companies either do not care much about the tariffs or are going into China because of the tariffs. For example, one company that does a lot of manufacturing in China is going into China to start selling its made in China products there, while at the same time looking to have its products made outside China for selling to the United States. As I am always saying, lawyers thrive on change, whether the change is for the better or for the worse.

Then earlier this week — in the midst of ever increasing gloom and doom regarding trade — we wrote a post, Why NOW Is a Good Time to Double Down on Doing Business in China, explaining why it is that our China WFOE lawyers have literally never been busier and explaining in considerable detail why now is a good time for many sorts of companies to form a China WFOE to set up shop in China to better conduct business there:

Relations between China and the West are declining and yet Western companies are moving as fast as they can to go into China? What is up with that? I will tell you….

Our client companies that are going into China know what is happening with China and in China and those things are actually fueling their decisions  to go into China and to do so quickly. Those same things are fueling decisions by other clients to increase their footprint in China. These companies are telling us that they are doing so much business with China or will be doing so much business with China that it makes no sense for them to just walk away. That being the case, they are rightly concerned that if the only business they do with China comes from their corporate entities outside China, they are at extreme risk of getting cut off by changing tariffs and/or Changing trade relations. But if they are actually doing business in China through their own Chinese company (such as WFOE or a Joint Venture), they will be much better protected against the vicissitudes of international trade. And they are correct.

Way back in October — when many still believed China trade would quickly revert back to the way it had always been — we did a post, Six Key China Business and Law Trends setting out what we were seeing then, which is pretty much exactly what we are seeing now:

Our China lawyers had a team meeting yesterday and as is so often the case at such meetings, much of the meeting involved our talking about what we have been seeing lately. We mostly focused on the following trends:

  1. Six months ago, we rarely worked with our firm’s international trade lawyers. Sure, we would occasionally call one of them in to help with a sticky customs issue or a client concerned about getting hit with antidumping or countervailing duties, but these days we find ourselves working with them constantly. Companies that are getting hit or will soon be hit with having to pay 25% tariffs are looking for help in figuring out how to have their Made in China products made elsewhere so that they can legally avoid having to pay the tariffs. See China Tariffs and What to do Now, Part 1 and China Tariffs and What to do Now, Part 2.
  2. Six months ago, about 90% of the international contracts we drafted involved China or the EU. That number is now nearing 60% as our existing and new clients are diversifying outside China.
  3. International litigation is on the rise. We are reading about this and we are seeing it. This is happening because of the uncertainty and the disruptions stemming from the tariffs. With disruptions and uncertainty comes disputes.
  4. China is more open to foreign businesses than it has been in years. Forming a WFOE is a bit faster, cheaper and easier than it was just a few years ago, especially if your WFOE will be operating fully legally. Check out The NEW Steps for Forming a China WFOE.
  5. Chinese factories are copying and selling their foreign customers’ products faster than ever before. Almost every week we hear of a Chinese factory that sold its foreign customer’s product before or right after shipping out the foreign customer’s first order. The tariffs are causing Chinese factories to question the viability of a long-term relationship with their foreign buyers and they are simply calculating that they can make more by selling their customers’ products online themselves. In the past, our lawyers did not push back when start-up companies wanted to test their product in the marketplace before spending for a contract to protect against their Chinese manufacturer competing with them. Now though we make very clear that this a very bad idea because by the time market strength has been determined, there may no longer be a product to sell. See China Trademark Theft. It’s Baaaaaack in a Big Way, China and the First to Market Fallacy, and Protecting Your Product From China: The 101.
  6. Following the law makes sense if you are going to be doing business in China. The number of companies coming to us with big China legal problems has gone way down but the number of companies coming to us to proactively present big and small China legal problems has gone way up. This is a good thing because it means foreign companies have come to realize China has gotten both serious and effective at enforcing its laws as against foreigners. See Doing Business in China Without a WFOE: Will the Defendant Please Rise for a good example of where China has really cracked down against foreign companies and see China Employer Audits: The FAQs for a good example of the sort of thing foreign companies are doing in China to avoid future legal problems

As it becomes clearer and clearer that trade with China has permanently changed, what China does with foreign businesses in China is going to become more and more key. China can essentially go one of three ways on this:

  1. It can turn even more inward and make it as tough as possible on foreign companies. It can enact new laws to accomplish this. This would hurt China’s economy.
  2. It can stay the same, with the same being fairly encouraging of foreign direct investment by foreign companies that follow Chinese law.
  3. It can open up further to foreign investment to benefit its economy and to garner allies for reinvigorating China’s trade relations with the West

So far, China has consistently taken the third way and gone out of its way to welcome Western businesses into China and assure them of their economic security. Indeed, China has enacted laws designed to make it easier for foreign companies to do business in China.

And as so many of our clients that are going into China (via WFOEs or Joint Ventures) or increasing their China footprint by adding branch offices and employees there, “being in China is good for our China business.” Chinese consumers and Chinese companies prefer buying from foreign companies that have boots on the ground in China. This has always been true and it very likely always will be true. Foreign companies with boots on the ground in China are perceived as being more committed to China (because they are) and as being better able to stand behind their products and/or services (because they are). Or as one of our clients told us, they believe that by making a strong commitment to bolstering their China presence now, they will be greatly rewarded by their customers who will view them differently from their competitors that are either not there at all or are looking to leave or to reduce their presence there.

In the final analysis, what makes sense for your business will depend on your business and your industry but for many businesses now is indeed the time to fish or cut bait with China and for many businesses, doubling down on China is the way to go.

Well guess what? It looks like those foreign companies that have gone into China are mostly thriving. The Financial Times did a story this week on how how foreign companies in China are generally thriving despite China’s economic slowdown and they have statistics to back this up:

Foreign companies operating or selling in China bucked the country’s slowdown trend last year, even as the world’s second-largest economy appears to have decelerated more than official figures suggest. China’s biggest economic slowdown in three decades is provoking angst among companies that have become used to its booming economic expansion. Overall, the revenues of 2,891 foreign non-financial companies grew 19.8 per cent last year, compared with 13.9 per cent in 2017, according to data from financial intelligence provider FactSet.

The rest of the article — which is mostly a very long introduction to a four part series on China’s economy — mostly just discusses how much worse China’s economy is than its official economic statistics would indicate. But for us the big takeaway is that despite China’s declining relationship with the United States and the rest of the world and despite China’s declining economy, business for foreign companies in China is booming. The reasons we list above for why now is actually a good time for foreign companies to go into China are likely the reasons why business is so good for foreign companies that are already there.

What are you seeing of foreign businesses in China these days?

UPDATE: This just in. President Trump has signed an executive order declaring a national emergency over threats against U.S. technology. Following this order, the U.S. Department of Commerce announced U.S. companies cannot sell or transfer technology to Huawei Technologies and its affiliates without a license to do so from the Bureau of Industry and Security. It is widely believed this will greatly reduce or even eliminate U.S. company purchases from Huawei and it may also make it more difficult for foreign companies with U.S. connections to buy from Huawei as well. I have added this to this post because it so well illustrates why we are of the view that a “trade deal” between China and the United States will do little if anything at all to stem the slide in US-China trade relations. For more on this breaking news, go here.

China retaliatory tariff lists and exclusionsOn Monday, China’s Ministry of Finance announced it would be increasing tariffs on roughly $60 billion worth of U.S. goods in response to President Trump’s decision to increase tariffs to 25% on various goods from China. China said it would by June 1, 2019, raise its tariffs to as high as 25% on U.S. products currently subject to 5% and 10% tariffs. The U.S. Department of Commerce tracks Information about China’s retaliations in response to the U.S. Section 301 tariffs and it is expected to include links to China’s official announcements. Our international trade lawyers are being told by Department of Commerce officials that it is in the process of updating its China retaliatory tariffs compilation table and that will eventually set out (in English) exactly what the tariff increases will be for the U.S. products.

In the meantime, China’s Ministry of Finance has posted its new tariff sheets on its website, but in Chinese only and thought that is what we are using with our own clients, it would be too big a task for us to translate all 5,000+ products for this post. But if you can read Chinese, go here for the list of 2,493 products facing a 25 percent tariff, here for the list of 1,078 products facing a 20 percent tariff, here for the list of 974 products facing a 10 percent tariff, and here for the list of 595 products whose tariffs will remain at 5 percent. UPDATE: Quartz Magazine has published an English language list of the products subject to the 25% tariff here.

Chinese companies impacted by China’s Section 301 retaliatory tariffs will can apply for exclusions of certain products through this process. It is reported that a key consideration for granting a product-specific exclusion is the lack of an adequate substitute for the U.S. product. Applicants for these exclusions are to submit their exclusion requests through the China Tariff Policy Research Center of the Ministry of Finance website. Exclusion requests for certain excluded products are to be submitted from June 3, 2019 to July 5, 2019 and exclusion requests for other of the products are to be submitted from September 2, 2019 to October 18, 2019.

If you are looking to have your product or products excluded by these increased China tariffs, you should work with your international trade lawyers and with your China importers and their international trade lawyers to get an exclusion request submitted. What percent of these exclusion requests will succeed? Who knows?

 

China IP protections

The trade talks between the United States and China broke down on Friday with no agreement. As a result, tariffs were raised to 25% and future U.S. tariffs on additional Chinese products are extremely likely. The Chinese side responded with retaliatory tariffs on a host of U.S. products. The parties will continue to negotiate, but there is no clear path to an agreement.

One of the core disputes centers on Chinese theft of U.S. intellectual property. It is reported that the talks broke down because of U.S. demands that the agreement contain enforcement provisions that would require the Chinese side to implement any agreement on IP protection. The U.S. required a) that Chinese laws be changed to implement the commitments and that b) an enforcement mechanism be established that would allow the U.S. to directly penalize China for inadequate implementation of the agreed IP protections. The Chinese side refused on both counts and the talks broke down.

Though the talks with China have broken down, the Chinese side fully understands that IP protection remains a key issue in its relations with all countries. It is not an issue restricted to just the United States. This can be seen by President Xi Jinping’s comments in his April 26 opening remarks at the recently concluded Belt and Road Forum. In those remarks, President Xi commented forcefully on China’s intention to protect intellectual property of all countries:

[W]e will intensify efforts to enhance international cooperation in intellectual property protection. Without innovation, there will be no progress. Full intellectual property protection will not only ensure the lawful rights and interests of Chinese and foreign companies; it is also crucial to promoting China’s innovation-driven and quality development. China will spare no effort to foster a business environment that respects the value of knowledge. We will fully improve the legal framework for protecting intellectual property, step up law enforcement, enhance protection of the lawful rights and interests of foreign intellectual property owners, stop forced technology transfer, improve protection of trade secrets, and crack down hard on violations of intellectual property in accordance with law. China will strengthen cooperation with other countries in intellectual property protection, create an enabling environment for innovation and promote technological exchanges and cooperation with other countries on the basis of market principles and the rule of law.

Go here for the complete text of President Xi’s talk.

President Xi’s remarks were made before an audience that did not include anyone from the United States. President Xi made these remarks to his Belt and Road supporters. It is therefore clear that the Chinese government sees IP protection as an issue of general concern to all countries that deal with China.

On April 27, the day after President Xi’s speech, a group of Chinese IP protection agencies announced a new “Strike Hard” program, titled Sword Net 2019. This program has been initiated by four Chinese government agencies: China’s National Intellectual Property Administration, the Cyberspace Administration of China, China’s Ministry of Industry and Information Technology and China’s Ministry of Public Security. This Sword Net program is set to run from April to October 2019.

The Sword Net program is focused on copyright infringement in China, an area that has been a major problem for China for decades. The Sword Net program will focus on the following three areas of copyright infringement that currently infect Chin’s Internet and social media (WeChat):

1. Plagiarizing media outlet news stories, usually by direct translation into Chinese.

2. Filming movies in cinemas and selling pirated videos.

3. Illegally selling photographs by online picture agencies.

These commitments on IP generally and on copyright specifically come from the very top levels of the Chinese government. Is this not sufficient to show that the PRC government is serious about dealing with its pervasive IP infringement/theft issue?

The answer is NO. Since the mid-1990s, it has become a ritual for the Chinese authorities to announce some sort of “strike hard” campaign (usually with a cool name) focused on wiping out copyright infringement. In the 1990s, the issue was DVDs. In the early 2000s, the issue was luxury goods. This latest program is focused on online infringement.

But none of these cool-sounding campaigns have had any real impact and China remains the most significant infringer of copyright in the world and pretty much any film or musical piece or book or photograph or just about any other sort of content can be downloaded in China without restriction or cost. In the market for textbooks and other educational materials, China is a major infringer. It is a rare Chinese college student who purchases a authorized copy of a textbook. Other educational materials are freely available on the Internet. Both India and China has been identified as the major infringers in the education market, but internal research by our own clients indicates the level of infringement in China is at least twice as high as in India.

What this means is that after 20 years of “strike hard” programs and promises from the PRC central government, hardly anyone with China experience believes China when it acts all serious about cracking down on IP infringement. And certainly it should come as no surprise to anyone (including especially the Chinese government) that the U.S. authorities seeking to negotiate a trade agreement with China would be willing to rely on a bare commitment from the Chinese side that it will “take care of it.” The U.S. trade negotiators are justifiably seeking IP protection commitments from China that are based on statute, that include a strong enforcement mechanism, and that are verifiable by the United States. The Chinese side has said “just trust us” but there is no basis for that sort of trust. It is this entirely justified lack of trust that is the source of the trade war and the source of the break down in talks. And this is not just coming from the United States either. Our own clients from Europe, Australia, Canada and Latin America have all expressed their hopes to us that the United States “hang tough” on this so that they too can benefit.

Since both China and the United States seem fixed in their positions on intellectual property, it does not appear there will be a short term resolution to the IP theft issues. Without a resolution on that key issue, a quick resolution of the 301 agreement discussions is not plausible. As we stated the day before President Trump issued his Tweet imposing new tariffs against Chinese products, winter is coming. I suggest you get prepared.

US-China international trade lawyers

It should come as no surprise that international trade lawyers all across the United States are having to put in late nights and weekends lately 1) explaining to clients President Trump’s 25% tariff on Chinese products, 2) helping them figure out whether their products are or are not on this tariff list, and 3) helping them figure out what their options are if their products are on this tariff list. I have been cc’ed on a ton of these emails in the last week and the below is an amalgamation of them, put forth here to help companies that import from China understand what at least some of the common issues are that they are and will be facing.

Like I said, the below is an amalgamation of a slew of emails, with any and all identifiers stricken. I have set them up as coming from HB INTERNATIONAL TRADE LAWYER (the HB is for Harris Bricken — my law firm) and our various clients are referred to as CLIENT.

 

CLIENT: I figured you would be the best people to consult for this. If the Trump tariffs do happen we would like to know what our legal options to combat/reduce this? Also, what if we suspect a competitor has been skirting the tariffs already? Can we report them effectively and anonymously?

HB CHINA LAWYER: I will turn you over to one of our international trade lawyers and you should get an email from one of them shortly. As you can imagine, they’ve been extremely busy since the trade war began and but I know they have dealt extensively with exactly the issues you raise (how to deal with the trade war legally and how to handle competitors who deal with it illegally). It is theoretically possible to make an anonymous complaint, but I’ll defer to our international trade law team on whether that’s advisable in your particular situation.

 

HB INTERNATIONAL TRADE LAWYER: It sounds like you are interested in learning more about (1) whether you can get a tariff exclusion/ exemption for your particular products; and, (2) whether you can report your competitors who may be illegally circumventing the tariffs by mis-declaring the country of origin or product description.

For #1, it would be helpful to get a list of the products for which you wish to seek a tariff exclusion. For each product, please provide a description of the product as listed on your invoices/website, and also identify the HTS (Harmonized Tariff Schedule) code used to identify the product for US imports. The tariffs identify which products are covered by the HTS#s.

For each product, are you aware of any US producers of this product?  Any third country producers of this product?

What is the estimated total US consumption of this product for the past three years 2016-18 and for the next few years (2019-21).

For #2, trying to report the wrongdoings of others is challenging because of the difficulty in getting hard evidence that proves it. Though it is possible to build a case from circumstantial evidence, it would still be necessary to somehow demonstrate a factual basis for a claim that a Chinese product is being mis-declared as a different product or from a different country. We should discuss by telephone the kind of information you already have to see whether it would be worth trying to pursue this kind of action.

Let me know if there is a good time for us to talk.

 

CLIENT: The below answers your questions as best we can.

          Product Information. Final assembly is done by a main factory based in ________, China. The product then gets shipped via containers to fulfillment centers around the world, including to three different U.S. states.

We get the following product from China:

Product One: ____________________

Description: ___________________________________________________________.

HTS: ____________________

          Other Producers. There are other much smaller producers but the entire supply chain for everybody is pretty much just in China.

          Other country producers. Korea and Taiwan also produce this product, but only the ultra-high end and only in pretty insignificant quantities. We are hearing talk of Thailand and Vietnam and maybe Indonesia starting to produce as well, but we have yet to see this.

          Estimated Consumption. Estimated yearly US consumption for 2016-2021:

2016: $____

2017: $____

2018: $____

2019: $____

2020: $____

2021: $_____

What if we shipped the container to Vietnam and then swapped our product into another container. Will we still be liable for the tariffs? One of our factories is insisting this will “fix” the tariff problem but I find it hard to believe it can really be that simple. But what if we ship our product to a factory in Vietnam and they check each one to make sure they are in good order and then they tighten the screws on them, etc., and then load them onto a new container and ship them to the United States? Would this relieve us of having to pay the tariffs?

 

HB INTERNATIONAL TRADE LAWYER: Thanks. This is good information that we can use to figure out how best to make an exclusion request for your products. USTR should be announcing the schedule/process for the List 3 ($200 billion) products that are now facing a 25% tariff that should be similar to the exclusion process for the previous two tariff lists.

As to the last part about circumventing the tariff, these are clearly fraudulent actions that likely would trigger civil penalties and perhaps even criminal charges. Regardless of whether you swap containers in a third country or move your product to a factory in a third country to repackage/ relabel the goods, fundamentally the products still will have a China country of origin and these actions will not legitimately change that. If those goods are declared as having a Vietnam origin on a US customs entry declaration, that would be a materially false declaration that would subject anyone involved to potential monetary penalties under US Customs laws and possibly even criminal prosecution.

I think these are probably the likely scenarios that your competitors may be engaging in. To the extent you are able to get any solid information about other companies doing this kind of illegal transshipment, this could be used to bring a claim that would lead US Customs to go after these competitors.

It is possible to change the country of origin of the product to Vietnam, but to do so there has to be enough production/processing that occurs in Vietnam so as to constitute a “substantial transformation” of your product. You might be able to have certain parts produced in China, but other parts produced in Vietnam that are significant enough so that the product could then be considered to have been “made in Vietnam.” But if your product is simply assembled (e.g., screwdriver operation) of parts that were all made in China, that very likely would NOT be enough to make that product a Vietnam origin product. Substantial transformation is a highly fact-specific analysis that does not have a simple formula, but rather is done on a case-by-case basis.

To give you a better idea of what substantial transformation really entails, I urge you to read this blog post written by one of our customs lawyers back in 2015, entitled Made in China? You should also read this blog post, China Tariffs and What to do Now, Part 3, written by one of our international lawyers about six months ago. I suggest we then set up a time to talk.