We have been through many China downturns and they all have one thing in common: they cause the Chinese government to get even tougher with foreign companies. But when it comes to getting tough with foreign companies not complying with China’s laws, our China lawyers have never seen anything like the current one. We think it is due more to China’s better capabilities at catching the non-compliant than to an increased desire to do so. Either way, it is happening out there, and in buckets.
Today’s post will focus on the foreign companies that are getting called out on employment matters. In a subsequent posts we will discuss foreign companies getting in trouble for operating beyond the scope of their formation documents.
In the last couple of months we have received more emails and phone calls regarding companies being “summoned” to their local labor bureaus than we received in the last few years. Though these phone calls and emails are coming from all over China, we have no way to know whether the summons are based on local initiatives or whether they are being directed from Beijing.
The below email is an amalgamation of some that we recently have received:
We are in the ________ industry and I have been coming to China for about 10 years. Our business in Europe kept growing at a good rate and so to improve quality, get better prices and avoid agents getting a percentage from us plus a percentage from the factories and making our goods too expensive we decided to start a company in Guangdong 5 years ago and last year we opened a factory to do most of our production.
We have been using a Chinese accounting firm to help us with our accounting and labour matters. The accounting they do is very strange to me, but they insist this is how all Chinese companies work. On labour contracts they told us that we do not need contracts with all of our workers, but just with a few key members of our staff. So out of our 75 workers only 16 have contracts.
Last week we got a letter from a government labour department, summoning us to their offices in two weeks time because they had received a complaint. One of our workers reported us for firing him for no reason. The letter from the labor bureau says that they are claiming ________ rmb for the dismissal and for not having a contract and for making this person work overtime.
Our response to these is typically along the following lines:
ALL of your employees should have had written contracts (in Chinese). Failing to have a written contract opens your company up to substantial penalties. Are you paying all of the required employee taxes on ALL of your employees? I am very concerned that you are not. Here is an article I wrote recently for detailing how (and why) China is going after foreign companies so strongly on labor tax issues. I would not want to see this one problem escalate into a massive tax issue for your China company and I am very concerned that the labor bureau is just using this one case as an excuse to force you to open up all your books on all of your employees. Trust me when I tell you that we have seen this sort of thing happen countless times before.
We like to nip in the bud situations like the one you describe before they reach the government stage, where pretty much nothing good is going to happen. By “nip in the bud,” I mean that we would try to settle with this employee to try to end the government proceeding entirely. Our goal would be to end government involvement as quickly as possible and then clean up your company so as to prevent future problems. We may be too late for that, but there is at least a decent chance that we are not. The first thing we would try to do is to seek to move the meeting with the government back a few weeks to give us time to try to negotiate a settlement with this one employee.
Internally at our firm we had a discussion among some of our China attorneys regarding this sort of situation and one of them (via a long series of emails regarding multiple companies) wrote something like the following:
Yes, this company is in big trouble. And that is because it took advice from a Chinese accounting firm. But what are these guys supposed to do? It should be completely safe to take advice from Chinese lawyers and accountants. But the opposite is too often true, especially outside Shanghai and Beijing. These firms believe that they are doing right by their foreign clients by telling them to do what their Chinese clients do. Do they not know that foreign companies will be treated differently in China? Do they not care? Or is this a situation where both sides (the accounting firm and the client) are deliberately wallowing in silence when both must know that what has been proposed makes no sense and cannot be legal?
Consider, however if this company had operated legally from day one. It probably never would have opened a factory because it would have been clear that it would not be profitable. We can add this to the examples of operating outside the law in China. But what is the advice we give here? We always advise ignoring these sorts of Chinese professionals and stress the need to operate 100% legally. This advice is sound, but for many companies operating 100% legally means not operating at all in China. This accounting firm helped to bring jobs to China that would not otherwise have gone to China and, more importantly, it brought itself years of good fees. Did the company benefit from this “bad” advice? We don’t even know. But we do know that we have seen many foreign companies that have benefitted by operating illegally for three, five and even ten years before they got called out and shut down. This is just another example of how China makes it easy for you to come in with your money but difficult to leave with it.
But again, it is hard to have a lot of sympathy here because these companies did operate illegally and should have known that they were operating illegally. Some of them have to have known that they were operating illegally, but were happy to use their Chinese “professionals” as their cover because they profited handsomely by doing so. And of course they did benefit by operating illegally and we should not forget that either.
But this sort of thing is part of the new anti-corruption moves and so foreign companies are going to need to change their thinking and fast. Three years ago, this sort of company would not even have contacted us. They would have just gone to their Chinese accounting firm and the Chinese accounting firm would have asked for $5,000 and “presto” the problem is solved for a few more years. For all we know, that has been exactly what this company has done many times before. But doing that now would be the worst thing it could possibly do because it then puts it and its top people at great risk of expulsion and even jail time. But do they even have sufficient funds to really try to clean it all up? And is that worth it to them at this point even if they do? So what can they do? If this is as big an issue as we think it is, their best strategy may just be to pack up their bags and leave today. Just another company caught in yet another China paradigm shift.
Bottom Line. If you want to stay in China, now is the time to make sure that you are operating legally there and to take immediate action if you are not. The Chinese government goes considerably easier on companies that self-report their problems and propose solutions than on companies it discovers with problems.