China Mexico Trade

The China Daily recently interviewed Felipe Garcia, Commercial Counselor of the Mexican Embassy in Beijing regarding Mexico-China relations. The gist of the interview was that Mexico-China relations would improve under Mexico’s new federal administration because both countries want closer relations and because China knows just what is needed for such closer relations. In the China Daily’s view (and presumably that of the Chinese government as well), closer relations are a near-certainty because the first ambassador met by Mexico’s President López Obrador was from China and because China then reciprocated by inviting Mexico to the China International Import Expo (CIIE) to be held in November 2019.

The China Daily piece, titled With a New Leader, Mexico Eyes Stronger Ties with China is actually emblematic of how the Mexican government still does not understand how to generate more trade with China.

  1. The Chinese Ambassador inviting Mexico to the CIIE says nothing regarding relations between China and Mexico’s new federal administration both because Mexico had been invited to this event long before it had even become clear that López Obrador would be Mexico’s new President — it had been promoted among Mexican business circles for almost a year before this so-called invitation.
  2. The invitation is not that big a deal anyway. Many countries get invited to the CIEE (which is an annual event) and it is not clear Mexico has sufficient resources to promote its goods, services, tourism and investment opportunities at the CIEE. Mexico attended last year’s CIEE not so much because it was invited to do so, but because Mexico’s previous administration had a strong policy of promoting economic diversification abroad and it devoted substantial resources to do so. It is not at all clear President López Obrador shares this same economic view or the same willingness to devote resources to expanding Mexico’s global trade.
  3. The trade numbers given by Mr. Garcia in his interview hide the true shape of Sino-Mexican economic relations (something quite convenient after fiascos in recent years, such as the Mexico City-Queretaro high speed railway fiasco or the Dragon Mart fiasco. The China Daily interview mentions that “[e]ven before the expo there had been good news in the air. Bilateral trade had climbed 11 percent to nearly $48 billion in 2017, and Mexico’s avocado exports to China in the first half of this year, a whooping 9,368 tonnes, had already overshot 2017’s total.” These numbers conveniently ignore that China exported more to Mexico than the previous year and that China’s trade deficit with China is approximately that Mexico exported less than USD$7 billion to China in 2017, while importing more than $74 billion from China in that same year for a whopping $68 billion yearly trade deficit.
  4. The China Daily also uses a “before we had nothing” argument to highlight whatever little has been achieved in terms of Chinese investment into Mexico. The article notes that in 2017, “China’s JAC Motors, a state-owned automobile manufacturer, teamed up with Mexico’s Giant Motors to invest $200 million in an SUV auto plant in the central state of Hidalgo. And after China and Mexico decided to set up a joint investment fund of $2.4 billion, one of the fund’s first deals in 2016 was to invest $140 million in Citla Energy, a new Mexican oil company. According to a widely-cited Atlantic Council report last year, from 2014 to 2016 Mexico saw more than 40 deals valued at over $4 billion from China, a significant jump since no previous year had seen more than five.” But if you put these numbers in perspective, $4 billion is nothing compared to the value of projects currently underway between China and Chile, a Latin American country with a much more developed relationship with China. For instance, China has already invested US $3 billion in Chile according to the World Economic Forum and, as of last November, Investchile was working on “74 Chinese companies and 18 specific projects worth over US$1,800 million in areas such as energy, mining and infrastructure.” Though Chile’s economy is much smaller than Mexico’s it (along with Brazil) are China’s biggest trading partners in Latin America and Chile, at least in part because Chile has a wealth of qualified people that Chile have furthered Chile’s trade relations with China. Chile has even expressed its intention of joining the Belt and Road Initiative (BRI).
  5. Mr. Garcia nicely mouths the same old discourse to “win China over,” by highlighting Mexican exports of agroindustrial products that if not exported to China would almost certainly be exported to various other countries and “Mexico’s strategic location, bordering the US and a beachhead into Latin America [that] could help China’s global reach.” Or as the China Daily puts it: Mr. Garcia that “stressed the importance of bilateral trade…before ticking off in quick succession some of Mexico’s proud exports, like avocados and tequila.”

The China Daily interview irritated me for other reasons, too. Cabinet members in Mexico seem also persist with an outdated and ineffectual view on how to “approach” China. On December 20, during her first press conference as Economy Minister, Graciela Márquez Colín, issued assurances that the new Mexican government would work to make China a “very important market for this country,” as though that same plan had not been official Mexican foreign policy during past administrations. She also stated the obvious, saying that Mexico must look for a way to insert itself into the Asian region, which is a growth locomotive for the coming years,” and that “although [evolution of Sino-Mexican] cultural and educational relations had begun since the 70s, that of trade had been slower.” But the punchline came when she pointed out that Sino-Mexican trade exchanges would teach Mexicans “how to understand this potential market” and given that “there are Mexican entrepreneurs in China…there was a “great opportunity to understand China’s technological and innovation advancements.” Sadly, I view her talking about opportunities to understand China as only confirming how little has been learned about dealing with China from either past administrations or from those Mexicans who actually have been dealing with China for the last two decades.

Mexico’s Undersecretary for Foreign Trade, Luz María de la Mora, stated (as we have heard so many times before) that “Mexico was seeking with China an agenda that responds to the interests of both countries” and that this agenda should be strengthened for Mexico’s export offerings, adding that we are “also very interested in attracting quality Chinese foreign direct investment (FDI) that allowed fostering an initiative of innovative industries development [using] top-notch technology” and pointing out that the CIIE was “a very interesting fair . . . where Mexico . . . could present its products to that Asian country which displays export opportunities.”

Mexico must start thinking of Chinese FDI as more central to our economy, and not just as one of many possible ways to boost Mexican exports. Even if the new administration is putting closer economic relations with China high in its priority list, its ignorance and lack of plans regarding how to accomplish that have so far been its defining traits.

There have been many changes already under Mexico’s new federal administration, including one that will significantly impact Mexico’s economic relations with China and the rest of the world: This is the plan to shut down ProMexico a Federal Government agency tasked with promoting international trade with Mexico and foreign direct investment into Mexico. In my next post, I will discuss the legal and business implications of ProMexico’s closure and various other budget reductions of key Mexican ministries, all with a focus on China.

For more on China-Mexico relations, check out the following:

For more on business relations between Mexico and China, check out the following:

 

*  The above post is by Adrián Cisneros Aguilar. Adrian is the founder/CEO of Chevaya (驰亚), an Asia-Pacific internationalization services company. Adrián has a Doctor of Laws from Shanghai Jiao Tong University and an LL.M. in International and Chinese Law from Wuhan University. He also is our law firm’s go-to lawyer for anything Mexico.

 

international trade lawyersDespite the federal government shutdown, there have been a couple of recent developments regarding the Section 301 tariffs imposed by the Office of the U.S. Trade Representative (“USTR”) on a broad range of products imported from China.

First, on December 28, 2018, USTR published its determination for the first batch of exclusion requests granted for the 25% tariffs imposed on $34 billion worth of Chinese imports (List 1). USTR granted exclusions for 984 separate requests. Based on the USTR’s index of product exclusion requests, USTR also rejected around 1,000 exclusion requests. Thus far, USTR has made decisions on only about 20% of the 10,000 exclusion requests for the first tranche of China products, with the remaining exclusion requests still being considered.

Importers will be eligible to apply for refunds of the 25% tariffs paid on the List 1 products entered after their July 6, 2018 effective date. The product exclusions will remain in effect for one year, expiring on December 28, 2019.

USTR indicated that the product exclusions will be applied on a product basis, meaning all imports of the product will be excluded regardless of whether the importer filed an exclusion request. This is different from the steel/aluminum tariff exclusion request process which limited the exclusions only to the specific products identified by the specific requesting party.

Second, on January 11, 2019, USTR replied to eleven Democratic senators who had asked why an exclusion process had not yet been established for the $200 billion of Chinese products (List 3) subject to a 10 percent tariff similar to the exclusion request process already in place for the prior list of Chinese products (List 1 – $34 billion; List 2 – $16 billion). USTR stated that an exclusion process for the List 3 products would not be established unless negotiations fail to resolve the US-China trade dispute by President Trump’s March 1, 2019 deadline. If no US-China resolution is achieved,  tariffs on List 3 will increase from 10 to 25 percent on March 2, 2019.

These developments show that although some progress is being made on the Section 301 tariff exclusion requests, that process is going to be slow.  USTR has barely made a dent in the thousands of exclusion requests for the first two lists of Chinese products and it has deferred starting the exclusion request process for the much bigger $200 billion list of products. U.S. importers in the meantime will be required to continue paying the 10 or 25 percent tariffs while waiting for USTR to slog through the outstanding exclusion requests or for the U.S. and China to find a way to end the trade dispute. The companies for which my firm’s international trade lawyers filed exclusion requests are incredibly frustrated at not yet hearing back.

If Presidents Trump and Xi reach some agreement by March 1, 2019 the tariffs will likely be immediately lifted, but if they do not reach such an agreement by March 2, the U.S. will then increase tariffs on the $200 billion of List 3 Chinese products from 10 percent to 25 percent and very likely impose 25 percent tariffs on all remaining Chinese imports (about another $260 billion).

More to come. A lot more.

Spain lawyersTwo of my firm’s Spain lawyers are in town this week and they yesterday explained to us the advantages for foreign countries to form Spain entities before going into Latin America and the Caribbean. They explained how Spain has long-standing, well-tested agreements with 19 such countries that not only provide favorable treatment, but require these 19 countries to in all respects treat Spanish companies exactly as they treat domestic companies. This privileged position for Spanish companies has led companies from all around the world to set up a Spain business entity for going into the Caribbean and Latin America.

At the start of the e-commerce boom, our international lawyers did a steady business with mostly European companies that wanted us to set up United States companies for them so that they would appear more trustworthy to American consumers shopping online. Over the years we have also formed U.S. companies for many service companies (especially in the global construction industry) that want to bid on big projects as an American company rather than as a company in a country whose construction prowess is not viewed as highly,

And then there was the period in which we formed countless companies for Chinese businesses that wanted to return to China as a U.S. company so as to be able to secure various tax and other benefits China was giving to foreign companies to spur foreign direct investment. See China’s New Foreign Investment Law — Less Than Meets the Eye. My personal favorite is forming United States companies for foreign companies in countries where domestic businesses are far more likely to get shaken down by government agencies and/or local gangs than foreign companies.

What’s all this got to do with China though?

Let me explain….

If you have not been living under a rock for the last year you know that relations between China and the United States/most EU nations/Australia/Japan/South Korea/Vietnam (just to name a few) have not exactly been great of late. But the frostiness of those relationships is nothing as compared to the tension between China and Canada. Earlier this week, China imposed the death penalty on a Canadian convicted of drug smuggling, after previously having sentenced this person to 15 years and yesterday, China threatened reprisals if Canada bans Huawei from its 5G networks. If you are a Canadian company and you need to realize that “business as usual” in China or even with China is no more.

So let’s just say you are a Canadian company looking to form a WFOE in China today. Do you go into China as a Canadian company or do you at . least consider forming a new company in some other country first and then using that third country company to go into China? Six months ago, our China WFOE lawyers would not even have pondered this question but now we do. This is not a simple question because forming a new company in a third country has all sorts of costs and because China requires you reveal ownership of your WFOE forming entity, forming a new third country company must be done in such a way so as to comply with China’s WFOE laws while at the same time not revealing the downstream Canadian ownership. How to Form a China WFOE: Revealing Investor Ownership is NOT Optional.

What if you are a Canadian company that has for the last five years successfully sold your factory equipment into China? Should you form a new sales entity in a third country so as to increase the likelihood of being able to maintain sales? No way to answer that in a blog post, but certainly this should be considered. If you have a Canadian and a Costa Rican passport, which one do you use on your next trip to China? This one is easy: welcome to China señor.

Welcome to the frenemy era. Welcome to the New Normal.

 

 

US-China Trade War

In an earlier set of posts, I discussed U.S. laws and regulations to a) restrict technology transfers from US companies to Chinese companies (see New Restrictions on High Tech Technology Transfers to China and b) to prevent Chinese companies from investing in U.S. technology companies. See New CFIUS Rules Shut Down Chinese Investment in U.S. Technology. In those posts, I noted that the new rules are not intended to limit the right of U.S. companies to sell technology based products to Chinese companies.

Yesterday, however, the U.S. Congress proposed extending the prohibition to include sales of technology products to Chinese companies. See U.S. lawmakers introduce bipartisan bills targeting China’s Huawei and ZTE. The initial targets are Huawei and ZTE. The new legislation has been introduced by a bipartisan group from both the Senate and the House: Senator Tom Cotton (R-Arkansas), Senator Chris Van Hollen (D-Maryland) and Representatives Mike Gallagher (R-Wisconsin), Ruben Gallego (D-Arizona). The bill is titled the Telecommunications Denial Order Enforcement Act and its purpose is to direct President Trump to impose denial orders banning the export of U.S. parts and components to Chinese telecommunications companies in violation of U.S. export control or sanctions laws.” In other words no sales to Huawei or to ZTE.

Senator Cotton focused on Huawei:”Huawei is effectively an intelligence-gathering arm of the Chinese Communist Party whose founder and CEO was an engineer for the People’s Liberation Army. It’s imperative we take decisive action to protect U.S. interests and enforce our laws. If Chinese telecom companies like Huawei violate our sanctions or export control laws, they should receive nothing less than the death penalty-which this denial order would provide.”

Senator Van Hollen expanded to include ZTE: “Huawei and ZTE are two sides of the same coin. Both companies have repeatedly violated U.S. laws, represent a significant risk to American national security interests, and need to be held accountable. Moving forward, we must combat China’s theft of advanced U.S. technology and their brazen violation of U.S. law.”

If enacted, this prohibition on sale of parts and components will deal a crippling blow to both Huawei and ZTE. We have already seen how ZTE was severely impacted by an earlier ban on such sales and of how Congress was so critical of President Trump’s decision to back down on those restrictions. This bill will force the President’s hand and will include Huawei in the ban that threatened to shut down ZTE.

The U.S. has already convinced most of its allies to exclude Huawei from participating in providing equipment for the mobile 5G programs being introduced around the world. Australia, New Zealand, Japan, and England and France have already agreed and Poland and The Czech Republic seem to be on board for the ban as well. Germany was the lone significant hold out. But recent events concerning Huawei getting caught spying in Europe and being accused of stealing trade secrets in the U.S. seem to have turned the tide in Germany and Germany is now ready to join the ban on Huawei 5G. See Germany considers barring Huawei from 5G networks. I’ve been reading much of what the German press has to say about a German ban against Huawei and I predict it will happen, not because of US pressure, but because of the view there that Germany would be better protected by not having Huawei involved with its 5G network.

The potential impact of a US ban on the sale of telecom parts and components to Huawei and ZTE cannot be underestimated. Both these companies are entirely dependent on U.S. made components, primarily in the form of sophisticated microprocessors. This dependence goes far beyond the companies themselves. The Chinese high speed rail networks, air traffic control networks and telecommunication networks all rely on these U.S. made components. A ban on sales to Chinese companies would have a significant impact in China that goes far beyond the impact on the overseas business of Huawei and ZTE. This threat is far more significant than the current tariff dispute. It is also significant that the proposed bill is bipartisan.  These measures are not coming from the Trump administration and they are seeking to force the President to take measures far more severe than the President is currently seeking in the trade war tariff dispute.

What is really going on here? The various anti-PRC measures have focused on Huawei and ZTE as security threats. But the real issue runs much deeper. China is currently embarked on building a Digital Silk Road with the goal of creating an Internet/network/telecoms/GPS system entirely separate from the system currently built and operated by the U.S. and its allies. The Digital Silk Road is designed not to be interoperable with the U.S. led system. It is intended to be entirely walled off and separate.

Huawei and ZTE are the Chinese companies being called on to build the telecom equipment, cables and related infrastructure backbone for China’s Digital Silk Road. I see these recent actions as the U.S. acting to ensure that if the Digital Silk Road is built, it will be built without the assistance of the U.S. and its allies. This means the U.S. and its allies will not purchase Huawei products and technology and there will be no sales to Huawei of U.S. (later European and Japanese) semiconductors and other telecom related technical parts and components. If this plan succeeds, the Digital Silk Road will never be built. This critical issue is at the center of the trade war and it will not be addressed with tariffs. It will be addressed with the sort legislation and boycotts discussed above.

If you are planning to sell semiconductors and other high technology products to China, your plans are at great risk right now. Even if this bill is not signed into law, the direction of U.S. policy is clear.

Welcome to the new normal.

 

China CFIUSMergermarket, a leading U.S. mergers data reporter just published its global M&A report for 2018, revealing that investments from China in U.S. businesses fell by 95% as compared to 2016. A summary of the data in the Report shows the following:

1. Worldwide M&A activity was strong in 2018. “The transactions that did make it to the signing table reached USD 3.5tn worth of activity, ranking 2018 as the third-largest year on record by value. Average deal size saw its second-highest total value on record with USD 384.8m, just below the USD 400.3m peak reached in 2015.

2. Chinese investment in the U.S. virtually collapsed: “Chinese buys of US firms fell 94.6% to USD 3bn from a record USD 55.3bn in 2016.”

3. In response to being cut out of the United States, Chinese companies turned to Europe as a source of acquisition targets. “China’s bids in Europe increased 81.7% to USD 60.4bn from USD 33.2bn last year.”

Chinese companies did not lose interest in the United States. What happened is that the U.S. government’s security review system has made Chinese investment in any form of technology company virtually impossible. New legislation and regulations adopted in 2018 will make those investment barriers formal and permanent. These restrictions will survive any trade “deal” made on the current Section 301 tariff dispute with China. The investment restrictions have become part of the “new normal” in US-China economic relations.

How will this work? Foreign investment in the U.S. has long been controlled by the Committee on Foreign Investment in the United States (CFIUS) review process. This review procedure is managed by the Bureau of Industry and Security (BIS) of the Department of Commerce. In August of 2018, CFIUS’s jurisdiction was substantially expanded by the adoption of the Foreign Investment Risk Review Modernization Act (FIRRMA).

The new law expands CFIUS’s  authority to review non-controlling investments by foreign companies (China) in U.S. companies that deal in critical and emerging technologies. As I previously reported in New Restrictions on High Tech Technology Transfers to China, BIS has begun rule-making to determine what specific technology will go on that list. The comment period for the rule making was extended to January 10, 2019 and as of right now, there are no reports on what exactly will go on the list.

BIS has though provided a listing of the general categories of technologies that will go on the list. I can simplify your review of this list (set forth below) by noting that it includes ANY form of technology in which a Chinese company would be interested.

1. Biotechnology, such as: (i) Nanobiology; (ii) Synthetic biology; (iii) Genomic and genetic engineering; or (iv) Neurotech

2. Artificial intelligence (AI) and machine learning technology, such as: (i) Neural networks and deep learning (e.g., brain modelling, time series prediction, classification); (ii) Evolution and genetic computation (e.g., genetic algorithms, genetic programming); (iii) Reinforcement learning; (iv)

3. Computer vision (e.g., object recognition, image understanding); (v) Expert systems (e.g., decision support systems, teaching systems); (vi) Speech and audio processing (e.g., speech recognition and production); (vii) Natural language processing (e.g., machine translation); (viii) Planning (e.g., scheduling, game playing); (ix) Audio and video manipulation technologies (e.g., voice cloning, deepfakes); (x) AI cloud technologies; or (xi) AI chipsets

4. Position, Navigation, and Timing (PNT) technology

5. Microprocessor technology, such as: (i) Systems-on-Chip (SoC); or (ii) Stacked Memory on Chip

6. Advanced computing technology, such as Memory-centric logic
Data analytics technology, such as: (i) Visualization; (ii) Automated analysis algorithms; or (iii) Context-aware computing

7. Quantum information and sensing technology, such as: (i) Quantum computing; (ii) Quantum encryption; or (iii) Quantum sensing

8. Logistics technology, such as: (i) Mobile electric power; (ii) Modeling and simulation; (iii) Total asset visibility; or (iv) Distribution-based Logistics Systems (DBLS)

9. Additive manufacturing (e.g., 3D printing)

10. Robotics, such as: (i) Micro-drone and micro-robotic systems; (ii) Swarming technology; (iii) Self-assembling robots; (iv) Molecular robotics; (v) Robot compliers; or (vi) Smart Dust

11. Brain-computer interfaces, such as: (i) Neural-controlled interfaces; (ii) Mind-machine interfaces; (iii) Direct neural interfaces; or (iv) Brain-machine interfaces

12. Hypersonics, such as: (i) Flight control algorithms; (ii) Propulsion technologies; (iii) Thermal protection systems; or (iv) Specialized materials (for structures, sensors, etc.)

13. Advanced materials, such as: (i) Adaptive camouflage; (ii) Functional textiles (e.g., advanced fiber and fabric technology); or (iii) Biomaterials

14. Advanced surveillance technologies, such as Faceprint and voiceprint technologies.

BIS reports that it is considering expanding this list to cover a separate category of “critical infrastructure.” Though no proposed rule on this category has been issued, it is assumed this will include telecommunications, power generation (nuclear power), utilities and transport (high speed rail).

As you can see from the above, the list includes virtually everything a Chinese company would want in the technology sector. Chinese companies are still free to purchase U.S. real estate as long as the building is not located next to the Trump Tower in Manhattan and so long as they can get the money out of China to do so. See Getting Money out of China to Buy a House: Not Your Issue. Chinese companies are also presumably free to purchase nail salons, massage parlors, movie studios, restaurants, retail stores, and hotels. But anything in the technology sector will be hands off. Note that it is not even required that CFIUS ultimately reject the transaction. The public notice required by the new rules and the extended period for review is enough to kill most business deals. This seems to be one of the motivations for the new regulations: kill the deal before CFIUS is required to make a politically motivated decision.

Chinese companies saw the writing on the wall and abandoned investment in the U.S. in 2018. With the new CIFIUS rules on investing in emerging technology, this situation will become permanent. For that reason, U.S. technology start ups looking for investments from China should for the most part plan to look elsewhere.

As discussed above, Chinese companies are now looking to Europe as a replacement for the U.S. market in tech company investments. In my next post (after I meet with a contingent of our Spain lawyers who will be in town) I will discuss the restrictions on investment from China coming on line in Europe.

international litigation lawyersEuler Hermes, the German credit insurance company, recently released its bankruptcy filing projections for 2019 here. The Report states that bankruptcies worldwide increased by 10% in 2018 and it projects an additional 6% increase for 2019.

What surprised me is that the increase in bankruptcies worldwide stems almost solely from an increase in formal bankruptcy proceedings in China. The 10% increase worldwide for 2018 was due almost entirely to a 60% increase in China bankruptcies. In 2019, the projection is for a worldwide increase of 6%, with China once again by far the highest in the world with a projected 20% increase.

This compares unfavorably with the relative stability of China’s East Asian neighbors: Japan, Korea, Taiwan and Hong Kong, which are all projected to have a 2% or less growth in bankruptcies in 2019. China also compares unfavorably with the 0% growth in bankruptcies projected for the United States and Germany, China’s two primary European and North American economic competitors.

What is fueling China’s tremendous increase in formal bankruptcies? The Report cites two factors:

“The [ projected 20% increase] will result on one hand from the on-going softening and adjustments of the Chinese economy, notably in regards to credit growth, Belt and Road Initiative and international trade issues, and on the other hand from the increasing inclination to use insolvency procedures, in particular by the authorities, in order to clean the ‘zombie’ state-owned enterprises (exceeding 20,000 cases according to some studies).”

Weakness in China’s economy in generally well known and undisputed. See The Top Ten Issues for China’s Economy and China’s Economic Slowdown and YOUR Business. I am going to focus here on the issue of “zombie” state-owned enterprises. The zombie SOEs are smaller enterprises owned by provincial and lower level Chinese governments that have been money losers for decades. The central government has been pushing to shut down these SOEs for many years, but the local governments have resisted, primarily to prevent job losses and the resulting social unrest.

The Euler Hermes Report suggests the Chinese central government will increase pressure against these zombie SOES in 2019 by taking even more aggressive steps to forestall local government insistence that non-performing SOEs be kept on artificial life support. We should therefore expect a wave of SOE closings in 2019. Some will make use of formal bankruptcy proceedings. If past practice is an indicator, even more will simply disappear. In both 2018 and already in 2019, the international litigators at my law firm have handled a massive increase in matters where a foreign company has paid its Chinese manufacturer for product only to get nothing (or almost nothing) in return and then to learn that the manufacturer no longer exists. See China Business Scam Week, Part 2: Bricks for Products. You must be on your guard for this sort of thing, starting NOW. See China’s Economic Slowdown and YOUR Business.

This slew of China bankruptcies and disappearing companies is an important issue for foreign companies doing business in China or with China. Many foreign business people believe the risk of a sudden closure of a supplier is limited to privately owned Chinese companies. Many foreign companies falsely believe the Chinese government will protect SOEs from any form of economic downturn and, therefore, SOEs are “safer” than their private competitors.

But as the Euler Hermes Report shows, this belief is not based on the facts. Chinese government policy is to protect a group of about 200 “state champion” SOEs. Virtually all other SOEs (without regard to which type of government is the owner) do not benefit from Beijing’s protection and these other SOEs are fair game for closure. China’s central government periodically imposes a program designed to clean up the balance sheet and close non-performing (zombie) SOEs. This type of clean up program is projected for 2019.

What does this mean for foreign buyers? First, it means that long term suppliers of critical products and materials will suddenly disappear without notice, leading to predictable chaos in the supply chain. Second, it means the affected Chinese SOE then has a very strong incentive to make a final fraudulent sale in order to extract a profit from one or more foreign buyers. This profit is then pocketed by the managers who then disappear. This type of scheme has been employed almost as standard procedure in the past and there is no reason not to expect this type of fraud will be used during the 2019 SOE clean up campaign. We wrote about the need to watch out for this sort of scam in China Business Scam Week, Part 2: Bricks for Products:

These things happen with companies that want to make a few final sales before they file for bankruptcy or just shut down and disappear. Just imagine the profits to be made from three $350,000 sales for which no product is ever provided. So just imagine the incentive for the owners of the Chinese manufacturing company to sell and not supply to foreign companies right before (or sometimes even right after) they shut their doors for good.

The China lawyers in my law firm call this the bricks for product scam because the first time we ever saw it was more than a decade ago when a U.S.-Norwegian fish company bought about a million dollars in fish from a Chinese company and every container consisted of a thin layer of fish wrapped around a core of bricks. The local SEOE company that sent the fish for bricks had shut down and its managers had fled town and were nowhere to be found. Or at least that is what the local government told us. In that case (as in most that we see), there were plenty of warning signs, all of which were ignored.

The standard technique is to offer a discount for a larger than usual sale amount and then deliver nothing or almost nothing. Sometimes nothing at all is shipped. In other cases, a fraudulent shipment is made: a container full of bricks, barrels full of water or sand, or a refrigerated container full of rotten fish or fruit. By the time the foreign company discovers the fraud, the Chinese company (often a local SOE) has already been liquidated and its owners/managers have disappeared. Much of the time, little can be done.

However, if the Chinese company formally declares bankruptcy (which does happen) and if it has some assets left (which also does happen) and if you have a China-centric manufacturing contract (see On SMEs Trusting China Manufacturers. Don’t. Just Don’t.) you at least have a chance at getting some or all of your money back. Even better, of course, is to delay payment until after you have confirmed delivery of conforming product.

Bottom Line: The message of this post is that the danger of paying and getting nothing from your Chinese supplier comes from BOTH private companies and from SOEs. Based on my own experience, I see the SOEs as a greater danger. When you get an offer from a Chinese supplier that seems “too good to be true,” it is. Extreme care is required.

China criminal law

Yesterday we wrote on how our China attorneys were hearing (mostly by email) of increasing arrests of foreigners in China and of how clients and readers were writing asking if they should go to China or not. Yesterday’s post, Five Things to do to Avoid Getting Arrested in China, was an effort to address those issues. At the end of that post, we pointedly solicited reader help on what more people can do to avoid arrest in China. We have received a number of emails from people, most of which said little more than “just don’t go.”

But we also received a very thoughtful comment here, expertly detailing the risks of working in China without dotting all of the i’s and crossing all of the t’s.

As someone who has lived and worked in China for a number of years, I do not think that being American or Canadian escalates the situation. We have seen recently a number of South Africans and people of other nationalities get caught too.

It is important to remind people that they are subject to Chinese law while in China and that the authorities can impose consequences including that of having issues for one to leave the country if the consequences are not served. The officer usually has control as to the consequences given. The embassy or consulate can just make sure that you have not been harmed physically but do not have any other power to remove you from the situation.

While the working illegally issue commonly happens to teachers, it is not limited to them, but also people in other professions. This comes in the form that you mentioned regarding not holding a work permit and residence permit, but also in the form of working for a company that is not the one tied with such documents (such as an agent puts you under their books).

I would add the caution regarding contracts that mention that the individual can come on any visa and that it can be converted to be allowed to work because that is a huge red flag. These days most non-“Z visa”s cannot be converted within China to a work permit and residence permit type of visa, the only one that allows working legally.

In addition, the job title is important as it regards to teachers. Many people have started English language companies which is basically a consulting or a culture company and will hire a teacher in another position because of not being able to legally employ them as a teacher and if the company is inspected, then this can create an issue for them.

There is also some basic information I would recommend that people keep in mind, besides those that you mentioned –

(a) Binding language is Chinese. English is a convenience.
(b) Only their employer can assist with cancellation of work permit receipt and release documents for the employee to move on to another job in the future. Leaving the country and starting again isn’t necessarily an option anymore because often times these release documents are still required.
(c) Implementation of many laws differs down to the city and/or district level.
(d) In your text when you say “the wrong visa” this is supposed to mean a visa that is different from the purpose of your visit

If one has set up a company and has a company to company agreement with another firm and they are the subject of providing the service to the client, I would say that this is usually a suitable method of working with multiple companies, BUT if there are special provisions for the industry then it is VERY risky (e.g. teaching related). It’s important to note here that freelancing is not allowed in China.

To summarize this comment from a China lawyer’s perspective: your China employment relationship is very complicated and done wrong you can end up in jail. The only relevant portion of your employment contract is the Chinese portion and if you do not speak Chinese you have no clue what it says and, most importantly, you have no clue whether the English language portion accurately translates the Chinese portion (I can tell you right now that the odds are about 100 to 1 that it doesn’t). And even if you are able to read the Chinese portion, unless you have a comprehensive knowledge of China’s employment laws and the employment and employment related laws that relate specifically to your potential new employer and to the specific locale in which you are working, you really do not know what you are doing and you should seek out qualified assistance in the form of a China employment lawyer fluent in both Chinese and in whatever language in which you are comfortable communicating.

I will now respond below to specific portions of this comment, all of which I have italicized.

“As someone who has lived and worked in China for a number of years, I do not think that being American or Canadian escalates the situation. We have seen recently a number of South Africans and people of other nationalities get caught too.” I 100% agree that the risks apply to foreigners of all nationalities in China. I only highlighted Canadians and Americans because of the recent spat of people from these countries being arrested for what many view as retaliation for the US-China Trade War and for the Huawei arrests. If your country is in China’s disfavor, you are at increased risk.

“It is important to remind people that they are subject to Chinese law while in China and that the authorities can impose consequences including that of having issues for one to leave the country if the consequences are not served. It is very important to remind people that they are subject to Chinese law while in China and I would also mention that Chinese criminal law is very different from US or EU or Canada or Australia criminal law. Last month I guest lectured for two days (and had a blast) at Warsaw University Law School. My second day lecture (4.0 hours!) was on Chinese laws that differ Western laws and how those differences impact foreign companies doing business in China. One of the things I briefly discussed was how China criminalizes certain things that are not crimes in the West. The following slides provide three examples of this.

 

If you are going to be living and working and doing business in China, you must know the laws and you must not violate the laws. I would also add that it can be relatively easy to face criminal charges as an individual for the wrongdoing of your company. We most often see foreign businesses get into criminal trouble in China is for violating China’s customs laws (See China’s Detention Of Foreigner For Alleged Customs Violation Should Be A Strong Warning), doing business in China without a legal entity (See Doing Business in China Without a WFOE: Will the Defendant Please Rise). For foreign individuals, it is undoubtedly for not having a proper employment visa.

“While the working illegally issue commonly happens to teachers, it is not limited to them, but also people in other professions. This comes in the form that you mentioned regarding not holding a work permit and residence permit, but also in the form of working for a company that is not the one tied with such documents (such as an agent puts you under their books).” I 100% agree. The only reason I highlighted foreign English language teachers is because they are so susceptible to being duped into working illegally in China, either because they do not even realize they are doing so or because they buy into the idea that they are somehow safe because “everyone else is doing it.”

“I would add the caution regarding contracts that mention that the individual can come on any visa and that it can be converted to be allowed to work because that is a huge red flag. These days most non-Z visas cannot be converted within China to a work permit and residence permit type of visa, the only one that allows working legally.” Very true. Our China employment lawyers constantly receive emails from foreigners planning to go to China to work and then, if it works out, their employer will help them get a Z visa. Our advice is that you should generally not go to China as an employee unless and until you are certain that you will be working there legally from day one. Many Chinese companies LOVE bringing on illegal employees because this gives them tremendous power over these employees. I explained how this can play out in Trust Your China Employer. Just Kidding:

Our China employment lawyers often get requests from individuals looking for help negotiating an employment contract with a Chinese domestic company. The first thing we like to do in this sort of situation is to make sure hiring our client by the Chinese company can and will be done legally. But when we suggest the necessity of our making sure of this, the response is often that we have nothing to worry about because the Chinese company would not be doing this illegally.

WRONG.

Truth is many Chinese companies prefer to hire foreigners illegally to legally because doing so can save them a ton of money and is usually pretty low risk — at least for them.

I thought of this when I read a very thoughtful and well-written article today, entitled, The detention of two Irish women who were working side jobs at an unlicensed school in Beijing shines a spotlight on the illegal English education market in China. The article (as you probably have guessed from its very long and descriptive title, is about two teachers from Ireland who were detained in prison for more than a week for working illegally in China. Both these teachers had visas that allowed them to work full-time in China, but only with their one employer who secured these visas for them. These two teachers had taken lucrative part-time teaching jobs on the side and it was those jobs that got them arrested.

The big takeaway for anyone looking to take a job in China though should be the sections entitled, “Illegal employers have no qualms about hiring foreigners illegally” and “when the illegality is discovered, it is the foreign worker who gets the blame.”

The article talks about someone who “ran an experiment” by applying for every English language teaching job listed in Beijinger Magazine and clearly stating he could not qualify for a work visa. Only one out of the twenty potential employers declined his application! In other words, 19 out of 20 were happy to have this foreigner work for them illegally. The article notes that under  China’s immigration law, foreigners who work illegally in China can be fined 5,000 to 20,000 yuan and detained for between 5-15 days and then deported. “A lot of the burden and blame falls” on the employee who works illegally in China and therefore, as the US Embassy website makes clear, “it is up to each individual to evaluate potential employers before signing a contract.”

Binding language is Chinese. English is a convenience. Correct. The binding/official language of a dual language contract will almost always be the Chinese portion, no matter what the English language portion of your contract might say. We discussed this in Dual Language China Contracts: Don’t Get Fooled!

Can’t believe this is still happening, but it does, and in numbers that would likely surprise many people. The “this” to which I am referring is foreign companies signing dual language contracts without knowing exactly what the Chinese language portion of their contract says. This is really risky dangerous and below I explain why.

Many dual language Chinese-English contracts are silent on which language controls. For some unknown reason, foreign companies far too often just assume that the English language portion controls or they just assume that it does not matter because the meaning of both the English and the Chinese portions is exactly the same. Wrong, wrong, wrong.

What language controls when you have a dual-language contract?  If both languages say the same one language controls, that one language will control. If both the English language and the Chinese language portions say the Chinese language portion controls, the Chinese language portion will control. Similarly, if both the Chinese language and the English language portions say the English language portion controls, the English language portion will control. These are the easy and safe examples.

It is everything else that so often cause problems for American and European and Australian companies in  trouble.

If both your English language and your Chinese language portions are silent as to which portion controls, the Chinese language portion will control in Chinese courts and in China arbitrations. In real life this means that if the English language portion of your joint venture contract says that you get 10 percent of the joint venture’s revenue  but the Chinese portion says you get 10 percent of the profits (which will of course be way less than revenues) you will have no legal basis for claiming anything more than 10 percent of the profits. Not surprisingly it is joint venture contracts and licensing agreements where our China lawyers most often see this sort of meaningful dichotomy between the English and the Chinese portions of the contract.

Of the hundreds of dual language contracts proposed by Chinese companies and reviewed by one of my firm’s China attorneys, we’ve never seen a single one where the Chinese portion was less favorable to the Chinese company than the English portion. But we’ve seen plenty where the Chinese portion is better or much better for the Chinese company than the English portion. Chinese companies love using a contract with an English portion that is more favorable to the foreign company than the Chinese portion and then relying on the English speaking company to assume that the English language portion will control.

But what if the English language portion explicitly states that it will control? This works right? Not necessarily. If the Chinese language portion also explicitly states that it will control, the Chinese language portion will control under Chinese law. If the Chinese language portion is silent or says that the English language portion controls, the English language portion will control.

As we noted in China Contracts: Make Them Enforceable Or Don’t Bother, it usually makes sense to draft contracts with Chinese companies in Chinese with an English language translation. But this also requires that if that contract is going to be enforced in China (as should usually be the case), you absolutely positively need to be certain that you know exactly what the Chinese language portion of that contract actually says. No matter what the English language portion of your contract says, it behooves you to know exactly what the Chinese language portion says as well.

In other words, if you are not truly able to read and understand Chinese, you probably do not know what your contact says. And if it is an employment contract that you do not fully understand, you could be putting yourself at serious risk.

“Implementation of many laws differs down to the city and/or district level.” Again, correct. And this is particularly true of China’s employment laws. See China Employment Law: Local and Not So Simple.

Bottom Line: Living and working and doing business in China is way more legally complicated than ten years ago. This means that the likelihood of you going astray of Chinese law is considerably higher as well. When you then add in that China’s ability and desire to catch foreign companies and foreigners operating illegally in China is higher now than it has ever been, you can see why it is so critical that you make sure that both your company and you are operating in China within the law. If you are not already operating legally, you need to start doing so now and if you cannot, you probably should leave China or not go there at all.

What are you seeing out there?

 

 

 

China lawyersWith all the arrests of Canadians and Americans and English teachers (we are getting 1-2 emails from arrested English teachers every week), our China lawyers have been getting a slew of emails from clients and readers asking whether they should or should not go to China and what they should do to avoid arrest if they do go.

I personally am never quite sure how to answer clients who ask me this question. I cannot tell them “just go and don’t worry” because even though the odds of their having a problem are exceedingly low, the last thing I want to do is have someone get arrested and then blame me for not having “told them so.”  So what I usually say is that they need to balance their need to go to China against the risks. How though do you calculate the risks?

There is no one way to calculate the risk of getting arrested in China, but the following are what can change that calculus one way or the other.

  1. Going to China on a U.S. or a Canada passport increases your risk.
  2. If you have a China WFOE that has not paid all its taxes and or is otherwise not in full compliance with China’s laws or has announced that it will be closing down, your risks are higher.
  3.  If you should have a WFOE in China but you don’t have a WFOE in China See Doing Business in China Without a WFOE: Will the Defendant Please Rise.
  4. If you go to China on the wrong visa or you overstay your visa, your risks will increase. WARNING: The English teachers who write us are from all over the world but what they all have in common is that their employer did not properly hire them. Two years ago, we absolutely never heard of English teachers getting arrested for this, but nowadays we hear about this all the time, even though the bad actors are their Chinese employers. Fortunately, these teachers are being jailed for only a week or two and then they are allowed to leave.
  5. Do not do anything illegal while you are in China. Do not buy or consume illegal drugs, including cannabis. Do not get into a fight, even if provoked. If your taxi driver or your bartender or anyone else tries to rip you off, seriously consider just paying the overcharge and move on.

The risks are really low, but it does pay to be careful.

What else?

China Template Contract

One of the most important things our China attorneys do with every contract we write is to determine who exactly it is on the other side. Oftentimes, this is no small feat.

If things go smoothly, our client asks us to write a contract with XYZ Mainland Chinese Company and we research XYZ Mainland Chinese Company and determine there is such a company and once we’ve done that, there is rarely an issue. This sort of smoothness happens around 85% of the time.

The other 15% of the time we find really funky things. Oftentimes we find there is no XYZ Mainland Chinese Company and in that situation we tell our client to go back to the alleged XYZ Mainland Chinese Company and ask them why there is not. Their usual answer is that their company is actually XYZ Hong Kong Company or XYZ Taiwan Company. This difference can make the entire transaction illegal for the simple reason that doing business in China without a Chinese company can itself be illegal. See Doing Business in China Without a WFOE: Will the Defendant Please Rise. This difference can also mean that you have zero contractual protection against whatever the HK or Taiwan or whatever company might do. See e.g., Hong Kong: Toto, We’re Not in Mainland China anymore.

With the downturn in China’s economy, our China lawyers are increasingly having to parse China deals that do not have a legitimate Chinese company on the other side? Why is this? Tax avoidance. The new thing we are seeing is individuals from companies wanting to be the signatories to deals with foreign companies. When we question why this is being proposed and make clear that our clients cannot do this, the individual sometimes responds by claiming that he (so far it’s been only males) is registered with the local tax authorities as a sole proprietor or 个体户. If true, this registration would likely solve the problem but so far it has not once been true.

If you do business with an individual not registered as a sole proprietor or with a foreign company without its own China company entity, you expose your company to the following real risks:

  1. If you do business with an individual not registered as a sole proprietor you will likely be deemed to be that person’s employer. This means you must pay approximately 40% in employer taxes and benefits and you must withhold and pay to the government an additional 25% (or so) in employee withholding.
  2. You could be deemed to be doing business in China illegally and that means you need to pay company income taxes and even worse can happen. See Doing Business in China with Deportation or Worse Hanging Over Your Head.
  3. The individual or foreign company can likely breach your contract without any legal repercussions, at least in China. For example, if this individual or company steals your IP, are you really going to sue in China based on a clearly illegal contract?

This is one (of many) reasons why whenever someone requests that we sell them a template contract our answer is ALWAYS the same: Not going to do it. Not at any price. Too risky for you and for us. See China Contract Templates for $99 Each.

Myanmar

Robert Walsh, sometime Seattle resident and long-time friend of our law firm (we worked on a number of China deals together and we — Dan and Steve — met up with him on our last trip to Myanmar), has spent the last four years in Myanmar, where he operates a vibrant business consultancy. Robert is fluent in Chinese and Korean and, amazingly enough, Burmese (multiple dialects), having learned Burmese while working in the U.S. Embassy in Yangon many years ago.

We have written a number of Myanmar-focused blog posts for China Law Blog over the years and if you want the full flavor of what has been going  on there, I urge you to go back and read those as well. In 2013, it was Myanmar Foreign Investment. Difficult And Expensive, But Opportunities Are There. In 2014, it was Myanmar: Open For Business? In those posts, we talked about how Myanmar is a difficult place in which to do business and many of companies going there are bigger companies looking to get in now and make money later. In 2017, in A Report from Myanmar from an old China Hand we talked about how much had changed, due in large measure to the relaxation of sanctions. Last year, in Doing Business in Burma/Myanmar: An On the Ground Report, Robert wrote how optimism in and about Myanmar is waning as things just keep getting worse there.

Yesterday, Robert emailed us an article from the Irrawaddy (for more on this newspaper and its interesting history go here) about “China’s ambassador to Burma going up to Kachin State to throw his weight around.” In response to that, we asked him to provide us an on the ground report of China’s activities in Myanmar. The below is Robert’s report:

Over the past five years I’ve had front row seats to watch how Chinese companies in Burma operate, as SOEs, as SMEs and as outright outlaws.  The latter predominate.

The Chinese SOEs were initially focused on getting a beachhead at Kyaukhpyu on the Rakhine coast NW of Rangoon. Between 2012-2014 a pipeline running from the coast across Burma to Yunnan was built. There were on again/off again plans for a railroad paralleling the pipeline, but nobody could figure out what good it would be for anybody local.

I’ve previously described other Chinese mega-projects in Myanmar, but the only place where anything is happening is a bizarro 5000-acre resort-industrial zone-Las Vegas in the Jungle sort of thing on the Thai border across the river from Mae Seot being done by Jilin Yatai Group. For background on this project go here. I am baffled how the Chinese are doing a very large project by working directly with an ethnic armed organization, on Burmese soil, and without much in the way of compliance with Burmese foreign investment laws and procedures. I am even more baffled with how Yatai’s operation is being done in an area where the local armed groups haven’t exactly hammered everything out with the government yet.

Other Chinese SOE projects like the Myitsone dam and other hydropower projects are stalled, largely due to pushback from locals in the intended project areas. The Myitsone dam project has gotten nationwide pushback because it would affect the entire watershed of the country and China does not have a great track record on either domestic or overseas hydropower projects, especially when it comes to having environmental impact studies done that are deliberately superficial. As of this writing we know of six such projects that are going nowhere. For a really great story on a really botched Chinese dam, check out It Doesn’t Matter if Ecuador Can Afford This Dam. China Still Gets Paid.

The major feature of all these Chinese projects in Myanmar is that Chinese SOEs think engagement with locals is not needed and so long as the right people in the Union government are paid enough under the table any and all objections should cease. The Chinese are not alone in this approach, as many international NGOs also take the same approach, pouring out largesse in Naypyidaw, while leaving crumbs to filter down to project areas. Up in Putao, people are fighting against various conservation NGOs because they have paid off people in the forestry department in Naypyidaw to expand the national parks in a way that drives people off the land. For an example of this, see Over 200 villagers march to demand the abolishment of Hkakhaburazi National Park.

For Chinese SMEs and outlaws looking to do something here, compliance with local law is the last thing on their minds.  Their collective mode of operations are as follows:

  • Acquire the land via local straw buyers.
  • Acquire the land with payoffs to the military, especially where a hapless local is occupying land that the military or affiliated cronies can easily seize. In many cases in Kachin and Shan State this occurs even more quickly if local farmers have been forced out due to conflict. A family can return home from months in a refugee camp to find their land under bananas or rubber plantings.
  • Import of seeds, cuttings, and/or seedlings without following agriculture rules on phytosanitary safety. This is a big deal because it is being done on such a massive scale.
  • Use illegal agrochemicals, some of which have been banned in China for decades. This has led to massive contamination of ground water.
  • Divert local water sources to Chinese plantations, basically robbing locals with longstanding arrangements. Bananas are awfully thirsty.
  • Develop industrial/agricultural/mining operations in areas outside direct government control, such as those controlled by various ethnic armed organizations. This allows the Chinese outfit to do whatever it wants, especially with gold, silver, and antimony mining. Entire riverbeds get messed up this way.
  • Operate in areas that have REALLY been out of government control for decades, such as the United Wa State Army (UWSA) areas in NE Shan State. These areas run by a notorious drug-trafficking army have been pretty much annexed by China. RMB is the preferred currency, Chinese banks and mobile systems are used, and there are few if any border controls. It’s my understanding that the Chinese Communist Party’s International Liaison Department is responsible for maintaining the relationship with UWSA, which could be a vestige of past relations when the UWSA was still the Burmese Communist Party. Christians and missionaries are repressed in these annexed areas.

In general, the Chinese approach is basically “how much will it cost me in bribes until I’ve squeezed all the juice out of this lemon?”

As local opposition to Chinese activity in Burma heats up, several features of Burmese political and commercial culture will act as countervailing factors:

The Burmese do not intend for any foreign entity from any country to make any money here via foreign investment (FDI) — nothing personal against Chinese. This is just how things have been set up under the foreign investment laws and this is local practice. Burmese generally view FDI as an extension of some sort of foreign government donor program and they bitch mightily when the flow of FDI slows, as it has for the past couple of years.

To the best of my knowledge the Burmese government still has no procedure for issuing debt guarantees for foreign debt. This makes it impossible for China to ensnare Myanmar with a debt load that facilitates de facto annexation of property, as has been done elsewhere (See the New York Times article on Ecuador above). What grates on the Chinese about the Myitsone dam project is that cancelled or not, China will not recover any of the costs already put into that project, as the Burmese government never made any commitments to pay if things went South. And China has almost  zero leverage. Burma will be one place where the give and take over the Belt & Road initiative is likely to be all give — by China.

As far as infrastructure development, the Chinese have done virtually nothing here that the Burmese people need, want, or sought. Everything  currently under discussion would directly benefit China, be it a highway, railroad, or hydropower dam and pretty much all the Burmese know this. So China is in no position to be able to accuse the Burmese for being “ungrateful,” as they like to do with Tibetans, Vietnamese, North Koreans, Ecuadorians, or whoever is their ingrate of the week.

Taiwanese companies are also here and they have a decidedly better reputation for compliance and how they handle local matters. In many cases, these are Sino-Burmese repats. There still might be a Taiwanese government  high school running up in Lashio and I used to know people who graduated from it. The Taiwanese businesspeople I know and work with here are studiously make certain to distinguish themselves from the Mainlanders.

Sooner rather than later I expect to see a nationwide backlash against China — such as occurred in the 1960’s — and it . will likely be ugly indeed. See The backlash against China is growing: warnings against ‘a new version of colonialism’ stood out for their boldness, they reflect a broader pushback against China’s mercantilist trade, investment, and lending practices. Heads on pikes and businesses reduced to smoking rubble are not outside contemplation. All it will take to light the match is for the Chinese ambassador to say something stupid like he did the other day in Kachin State.