One of the things my firm’s China lawyers are always saying and seeing is how China is constantly getting more legalistic, especially with foreign companies doing business in China. I used to believe this would lead foreign companies to become more careful, but this has not happened. Too many foreign companies — for all sorts of different reasons — remain far too nonchalant and increasing legalization only increases the likelihood this attitude will eventually harm them. In this series of posts (of which this is the first), I will write about the most common incidents our China attorneys see involving foreign companies that get into trouble in China for being careless or sloppy or just too trusting.
As for the title of this post, I have been studying Spanish for the last six months or so and oftentimes when I give a wrong answer my teacher will ask “¿Estás Seguro?” which means “are you sure?” I always respond by saying, “no, porque….” because I know she would not be asking this question if my answer were 100 percent accurate. I am asking the same question regarding China company formations because we far too often see instances where a foreign company believes one thing but the reality is something else entirely.
Forming a China company is a prime example of this, both with WFOEs and Joint Ventures. What usually causes the problem to bubble to the surface is different as between a WFOE and a Joint Venture, but what caused the problem in the first place is nearly always the same: the foreign company trusted without verifying.
The WFOE Problem. The WFOE problem is a somewhat simple one. The foreign company believes it has formed a WFOE in China (oftentimes long ago) and that it is now operating completely legally there. The foreign company typically then has a problem with its most important China “employee” and it wants to terminate that employee. The first thing our China employment lawyers usually do in this situation is to look at the official Chinese government corporate records for the WFO so as to get a better handle on the employee’s authority at the company. Sometimes we discover there is no WFOE.
At this point, the legal issue is no longer terminating an employee of a WFOE; it’s figuring out what makes sense in light of a messed-up China situation and a company’s present-day China goals. You cannot terminate an employee from a company that does not exist.
How does a company get to this point? What leads a company to believe it had a China WFOE when it didn’t? Ninety percent of the time the fatal mistake was trusting the person the company now wishes to terminate. That person claimed to have formed a WFOE for the foreign company but never did. Maybe he or she (though in my recollection it’s always been a he) formed a Chinese domestic corporation he owns. Or maybe this person never formed any Chinese entity at all. In any event, the foreign company paid money to this person believing this money would be used to form a WFOE. Virtually always, the company then paid more money to this person believing this money would go to pay rent and personnel and taxes and other business expenses. Probably some of the money went to these things, but it is likely a good chunk of it went straight into the pockets of the person who lied about having formed the WFOE. Not sure why, the companies in this circumstance seem to be disproportionately Northern European. Just putting that out there.
The Joint Venture Problem. This is really two different problems. One, the non-existent Joint Venture, which is very similar to the WFOE problem, but usually a bit more complicated. The putative JV partner is put in charge of forming a China Joint Venture and it either does never forms any company at all or it forms a company in Hong Kong (or even in the United States, believe it or not!) that the foreign company believes to be a China Joint Venture. The foreign company thinks that the Hong Kong or US company owns a company in China and it thinks this corporate structure is itself a China Joint Venture. It isn’t and the China entity into which the foreign company ends up pouring time and money and technology is not in any respect owned by the foreign company. The foreign company then at some point becomes concerned about never having received any money from its Joint Venture and now the Joint Venture has gone completely silent and is not even responding to emails or the Joint Venture is now successfully competing directly with the foreign company. See China Scam Week, Part 6: The Fake Joint Venture.
Two, the foreign company trusted its Chinese Joint Venture partner and the lawyer its Chinese Joint Venture partner chose to prepare the necessary Joint Venture documents. Now there is a problem and those documents were written in such a way as to favor the Chinese side so completely there is nothing the foreign company can do to resolve it. See China Joint Ventures: The Tide is Out.