Photo of Dan Harris

Dan Harris is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players, have looked to him for his perspective on international law issues.

China lawyers
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments or phone calls as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a quick general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

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

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

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

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

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

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

Got it?

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

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

Let me explain….

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Use a Chinese distributor

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

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

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

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

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

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

China lawyers
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments or phone calls as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a quick general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

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

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

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

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

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

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

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

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

What are you seeing out there?

Asia Manufacturing Lawyers

With the recent onslaught of tariffs, our manufacturing lawyers are increasingly drafting manufacturing contracts for Asian countries beyond China. In the last few weeks alone, we’ve drafted manufacturing contracts for Vietnam, Malaysia, Indonesia, Taiwan, and India.

This recent increase in manufacturing contracts for countries beyond China has only reinforced how the core legal and business issues tied up with such contracts spans the globe. With so many companies (and clients!) looking to move some or all of their manufacturing to countries other than China, we will over the next few months be writing often about the basic concepts underlying good manufacturing contracts, no matter the country.

One of the issues our manufacturing lawyers perpetually face is pricing. How much will the factory charge for the widget and, more importantly, how much will the factory charge for the widgets a month and a year from now. Oh, and what about currency fluctuations?

Many of our clients (especially those recently stung by trade tariffs) are seeking to lock in pricing. This is a tough one. If you are maybe going to buy 1000 widgets at $34 from time to time with no minimum requirements, no legitimate factory anywhere will  lock in its prices for any extended period, if at all. They simply have no incentive to take a risk for an occasional buyer. On the other hand, if you contractually commit to buy five million such widgets, the factory will be a lot more willing to give you a price lock.

The same holds true for currency fluctuations/risk — which really just translates to price in the end. If you are an occasional buyer of 1000 widgets, you likely will not find a factory that will sell you its widgets for $34 for the next five years, no matter how much the Dong/Rupee/Ringgit/Bhat/Rupiah/Riel/RMB changes against the dollar. If you are buying five million widgets, sharing in currency risks very well might be doable.

Yet many foreign companies believe it possible to get a price lock when it really isn’t. Even worse, many foreign companies believe they have a price lock when they really don’t. Most factories throughout Asia are well-versed in how to convince their Western buyers that there is a price lock when there really isn’t. These factories lure buyers with a fake price lock and then when that price lock really matters, they easily and legally back out.

How do these factories accomplish this feat? Simply by refusing to accept a purchase they are under no obligation to accept. The below email from one of my firm’s lawyers regarding negotiations with a Vietnam factory nicely illustrates this sort of legerdemain:

The discussion on price adjustment is meaningless. If the Vietnamese factory is not required to accept all purchase orders with the locked price, it can simply change its price by refusing to accept your PO. It is standard practice in Vietnam (and pretty much everywhere else in Asia and around the world) for the Vietnamese factory to agree to a low price and in return get certain minimum order commitments from you the foreign buyer. Then when its costs rise (or less common, its currency rises) the Vietnamese factory will refuse to accept your purchase orders until you agree to pay a higher price. A price lock is only meaningful if the factory is required to accept your purchase orders with the locked price. In this case, your factory has rejected that approach, which means you will have no price protection. Your factory fully understands this and this is why they revised the contract as it did.

You must now decide whether you want to move forward with this factory without price protection or see if you can get price protection elsewhere. Or you might even want to see whether your agreeing to commit to buying more from this factory will get you a real price lock or not.

Please stay tuned for our next post in this series.

 

China lawyers
Halfway for a China WFOE is not good enough. Photo by Jacqui Sadler

Earlier this week, I wrote about how China’s economic slowdown should impact how you do business in China and even with China. Today I focus on why this slowdown (and if you are an American company, the US-China trade war which is precipitating that slowdown) are why now is not the time for you to be operating quasi-legally in China.

And yet, there seem to be as many companies operating this way in China right now. For nearly a decade now, we have been stressing the need to have a WFOE if you are going to be doing business in China. Along these lines we have stressed again and again how independent contractors are almost never legal in China and how if you have “employees” in China you need a WFOE. For more on this and for how our tone on this has become increasingly strident as the Chinese government has consistently and unrelentingly stepped up both its enforcement of this requirement and the penalties for failing to comply. For more on this, check out the following posts from the following years:

  1. Doing Business in China Without a WFOE: Will the Defendant Please Rise. In this post from August, 2018, we wrote about how our China lawyers are increasingly hearing of foreigners getting arrested and imprisoned for operating in China without a WFOE.
  2. Doing Business in China with Deportation or Worse Hanging Over Your Head. In this post from March, 2017, we wrote about how our China lawyers were increasingly hearing of foreigners (especially Americans) getting deported from China and being cut off from doing business in China for having operated in China without a WFOE.
  3. China’s Tax Authorities Want You. In this Forbes article from May, 2015, I wrote about how our China lawyers were increasingly hearing of foreigners getting hit for massive taxes for having operated in China without a WFOE.

With all the pressure to have a WFOE in China, our China attorneys are now increasingly hearing of foreign companies forming a China WFOE but then continuing to operate illegally in China. This is more common than you would probably think and it also seems more common than ever.

Let me explain.

Forming a WFOE is not the same thing as operating legally in China. In fact, it is so different that around a decade ago my law firm made the decision not to simply form WFOEs for clients and then walk away. At that time we ceased doing what we called pure WFOE formations. Instead, if anyone wanted us to form a WFOE for them, we would do so only if they retained our law firm for what we called a WFOE formation package. Our explanation for this was that operating legally in China with a WFOE requires a lot more than just a WFOE and we did not want to charge clients to form a WFOE only to have them get in trouble with China’s authorities for operating illegally. One of the things we always (as in 100% of the time) require as part of our WFOE formation work is what we call our China employment package, which consists — of among other things — our drafting dual language China-specific employment contracts for all WFOE employees and Employer Rules and Regulations to go with those. See China Employer Rules and Regulations: A Must Have No Matter Your Size.

Unfortunately, many law firms and companies that do WFOE formations are not concerned with launching China WFOEs that operate illegally from day one. I say this because in the last year or so our China lawyers are hearing more and more from foreign companies with WFOEs in China that are operating illegally in China. I find this very distressing because it strikes me as so illogical. Why spend the substantial time and money to form a WFOE if doing so is not going to make you legal in China? Why form a WFOE telling the Chinese government that you are there only to make it so much easier to be discovered for operating illegally.

What are these WFOEs doing illegally? Two main things, both centered around trying to reduce costs by avoiding taxes. One is setting up a WFOE and doing various things to illegally reduce the WFOE’s income taxes. We get maybe one call every six months from someone caught for this and we tell them that the only solution is to try to negotiate down the total figure for back taxes, interest and penalties, and to do that from outside China. The other thing is China WFOEs that hire China “employees” through their foreign company and not through their WFOE. They do this to avoid having to pay the approximately 40% on salaries China employers are to pay in employer taxes and benefits and to avoid having to withhold the approximately 20% they are to withhold on behalf of their employees for their employees’ individual income taxes.

Way back in 2010, we did a post, Operating Illegally In China. Half-Assing It Does Not Help. In that post we explained how operating quasi-legally so greatly increases your risk of getting caught that you would actually be better off operating fully illegally. Back then, the issue was forming a company with a Chinese citizen (which though less common today than back then, is still an issue). Here was our position on that back then (and now too):

Legally, you pretty much cannot go into business with Chinese citizens without a joint venture. China recently started allowing partnerships, but the impact of that is still not clear.

You pretty much have two options:

1. You form a WFOE and you own it. Forming a company in Hong Kong is no different for China purposes than forming one in the United States, so forget about Hong Kong for a moment. [For an update on why having a Hong Kong company does not cut it, check out American Companies in China without a WFOE and the Impact of Donald Trump and US Tariffs and Why Hong Kong is not the Answer.] Forming a WFOE can be very expensive, in large part depending on the Chinese city in which you will be forming it.

2. You let your fiancé, her mother and cousin own the entire business. You do this and you are exposing yourself to losing whatever you put into the business. Twice, I have had men break down and cry right in front of me because they went into business with their fiancée and her family and they put 3-8 years of their lives into the business, only to be completely and unceremoniously booted out once it really started to make the big money. These are just the ones who cried. I can tell you about the guy who invested millions in condos with his fiancée and her mother, only to leave China for a few weeks and return with all of the condos sold and his fiancée and mother in law gone. Vanished.

My emails often lead to pushback, with the person complaining of how China makes things so difficult for the “little guy” and then their explaining how they know of how these things usually turn out for the foreigner, but in their case it will be different because:

a. Their girlfriend/fiancé/wife’s family would never be anything but above board.

b. Their girlfriend/fiancé/wife’s family is so “connected,” it makes sense for them to go into business with them.

They then usually ask us to write up a contract that protects them “as best as possible.” We tell them that we will not do that because those contracts are usually not enforceable in China and we are not in the business of writing contracts we know will not work.

In that same post I wrote about an email to me from my co-blogger, Steve Dickinson, to me, which went as follows:

If these people are going to go illegal in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don’t work in China, because you and I have won enough China contract cases to know that they do.

It is because the Chinese judges are totally on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking that somehow they are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember John Smith’s [yes, it is an alias] company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His US LLC [and with it, the China WFOE] were just purchased by _______ [a pretty big name U.S. company]. The reason the purchase was successful is that the whole company was “clean” and therefore it could be purchased by a foreign public company.

I then went on to say that “as lawyers we are never going to tell our client to go full illegal, but in my role as a blogger, I have to think going full illegal would probably make better sense than paying a lawyer to draft a void contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.”

We also used to frequently see the same sort of thing by companies seeking to justify operating illegally in China with a Representative Office instead of a far more expensive WFOE. We has this to say about this situation way back in 2010:

Every couple of weeks my firm gets an email or a phone call from a small business that is seeking to justify forming a Rep Office in China instead of a Wholly Foreign Owned Enterprise (WFOE). These small businesses typically go into advocacy mode explaining why their business can and should be a Rep Office in China. They then go on to explain that they simply cannot afford to form a WFOE in China due to the minimum capital requirements, the legal fees, and the taxes.

They then want me to condone their Rep Office plans but I never do.

In fact, the increasing number of these requests has caused me to get even blunter than usual, and my most recent response exemplifies this:

What you are describing doing as part of a Rep Office is definitely not proper for an RO. Not even close.

In terms of minimum capital required, because it is Dongguan, it is likely to be pretty high. Sorry.

You pretty much have two choices. You can operate completely off the grid and risk getting shut down, or you form a WFOE. Probably the worst thing you could do would be to form an RO that operates illegally because that will just draw attention to how you are operating illegally.

I get the sense that the people contacting us on these things are hoping that they somehow have found THE loophole that nobody else has found and that if only they can get the blessings of an attorney for what they are doing, that their operating illegally will somehow not be illegal. I wish I had some magic oil I could sell (for a helluva lot of money) that I could sprinkle on illegal China businesses to make them legal, but I have no such thing.

Those who think they are going “sorta” legal by forming what is clearly an illegal Rep Office in China are very similar to those who think they are “sorta” protecting themselves legally by doing a “sorta” joint venture with their girlfriend. I wrote about those people in a post, entitled, “Operating Illegally In China. Half-Assing It Does Not Help.

I went on to explain how forming a Rep Office that then operates as though it were a WFOE “will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE.” I then made clear my frustration with these sort of quasi-legal schemes:

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written to tell me that “so and so” entity formation company is willing to form the Rep Office for them, as though this mere fact means my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE.

It is frustrating to hear about the latest round of foreigners believing that going half-way with their China WFOE is enough, especially as most of these people we are hearing from do not even know they are operating illegally because they were told otherwise by the “experts” they hired. These companies that are hiring and paying their China employees outside their WFOEs seem to believe the following make what they are doing legal, but they don’t:

  1. Setting up a Hong Kong business and paying the employees from that. Wrong. This is no different than paying your China employees from the United States. If you are going to have employees in China you need to pay them through a legal China entity, not from overseas. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also, China Expat Pay: Splitting with Hong Kong is 100% Illegal and 200% Dangerous.
  2. Hiring only expat employees in China. Wrong. Expats working in China need to work for a legal China entity just like everyone else.
  3. Hiring only Hong Kong or Taiwan (or Singapore?) citizens. We have heard this one many times over the years, in large part because citizens from these places often claim to their employers that they can and should be treated differently because they are from these places. Wrong. A China-based employee is a China-based employee and a China-based employee needs to work for a legal Chinese company, be that a WFOE, a Joint Venture or a Chinese domestic company. Yesterday, in China Employment Law Update: China Work Permits no Longer Needed for Taiwan, Hong Kong and Macau Residents, our lead China employment lawyer, Grace Yang, wrote about how citizens of these places no longer need work permits to work legally in China. Just since then our China lawyers have received a couple emails from people who seem to believe this work permit change means people from these regions can legally work in China without being directly employed by a legal China entity. Wrong. This work permit change has no impact on this.

Doing business in China with employees in China? Don’t do it half right because you are only increasing your risk.

 

China attorney

In 2012, I wrote an article for the Wall Street Journal, entitled, China’s Slowdown and American Business. There was a slowdown happening in China at that time and the China lawyers at my law firm were “feeling it” from the emails and phone calls we were getting from foreign companies doing business in or with China. My WSJ article sought to address the issues our lawyers were seeing back then. Since that article, China has gone through intermittent slowdowns and during each of those we see pretty much the same same issues each time. Because China is again going through an economic slowdown — due in large part to a trade war that is only going to get worse– I thought now would be a good time to reprise that article and write again about how to handle a China economic slowdown. For more on China’s economic slowdown, see this CNN article from today, The trade war is deepening the gloom at Chinese factories.

China lawyers
China’s Economy is Slumping

The Wall Street Journal chose the following subheading for my 2012: “Hardly a week goes by without complaints about payment problems or bankrupt debtors.” If I were to choose a new subheading for this post today, it would be “Hardly a day goes by without complaints about getting  bad product and hardly a week goes by without someone asking about what will be required for them to shut down their China WFOE.”

The following are the key points from my Wall Street Journal that apply with at least equal force today:

Regulation. The best assumption to make is that the Chinese government will respond to the slowdown by attempting to minimize citizen discontent so as to keep its hold on power.

Sourcing Problems. The slowdown is changing Chinese company interactions with foreign companies. Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering—in particular in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard. Hardly a week goes by without one of the China lawyers at my firm getting a call from a Western company experiencing problems. Sometimes the Western company has paid for a product and the company it paid no longer exists. Sometimes the company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.

Foreign managers need to understand what is happening in their own industries within China. This might mean visiting your Chinese factory, warehouse or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent.

The key is to be proactive: If you find yourself in a bad situation with a Chinese company going under, there usually is no remedy after the fact. Bankruptcy in China more often than not consists of a company shutting down in the middle of the night and its owner fleeing to another town.

The key to weathering China’s slowdown will be for foreign companies to go back to basics …. focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level. Above all, no Western company doing business in China should blithely assume that a slowdown won’t affect it.

Updating the article, the biggest change from 2012 to today is the massive increase in Chinese companies willing to risk their relationships with the very same foreign companies with whom they currently do business. We wrote about this previously in Your China Factory as your Toughest Competitor. But it is now not just factories; our China lawyers are seeing this in all industry sectors, especially technology. Our China lawyers have become fond of pointing out that “since you will essentially be educating your Chinese party in how to compete with you, you need contracts that will at least limit what they can do when they do so.”

Why are China companies now so willing to risk losing out on business with existing customers to go into business competing with them? When times are bad, greater risk becomes necessary to pay employee wages and to stay alive.

China’s manufacturing sector has taken a hit from migration of international business to lower wage and cheaper countries across South East Asia. Since President Trump’s first round of tariffs, our international manufacturing lawyers have seen a near 50% increase in work involving Vietnam (mostly), Indonesia, India and Malaysia. And with one or more of these countries coming up in so many of our conversations with clients, we are quite certain this migration to SE Asia will only increase, no matter what happens on the trade war front. With manufacturing moving elsewhere, many Chinese companies rightly believe they need to do something different and heir seeking to compete with their own customers is that something different.

We are getting at least two calls/emails every week from companies seeking help in trying to remedy/stop their Chinese suppliers from using their molds or their information or their customers to compete with them. We have gotten more calls in the last three months from companies whose China factories are now directly competing with them than in probably the three years before that combined. Chinese factories are more confident and willing now than they have ever been about going out into the world with their own products, and more willing to toss their foreign customers to the curb early. In nearly all instances there is little we can do. Though it might be possible to sue these Chinese companies, without rock-solid China-specific contracts in place, such lawsuits seldom make economic sense. See China Contracts: Make Them Enforceable Or Don’t Bother.

China IP theftIn a very short and very helpful video — The big secret in Chinese/Western negotiations? — China negotiation expert Andrew Hupert explains two things of which you should be aware when negotiating with Chinese companies.

The first is to realize that most Chinese companies are not so much looking to do a long-term deal with you, but rather, to secure your IP. In our “free look scheme” series we wrote about how Chinese companies will feign interest in doing a deal with you when what they really want is your IP for as little cost as possible. Essentially, China free look schemes are methods employed by Chinese companies to get a “free look” at your intellectual property and trade secrets. In part 1 of this series, we looked at how Chinese companies use their purported interest in investing in a foreign company to convince the foreign company to give the Chinese company access to the foreign company’s IP. In part 2, we explained how Chinese companies use Memoranda of Understanding (MOUs) to get free looks at foreign technology. In part 3, we explained how Chinese companies use Joint Ventures (real, fake and non-existent) to get at foreign technology without paying for it. In part 4, we noted how there are plenty of legitimate Chinese companies seeking legitimate deals with foreign companies and then explained how to determine whether the Chinese company with which you are dealing is serious about doing a real deal or is just trying to get a free look at your IP. And in part 5, we addressed how best to deal with the risk of a China company free look scheme.

This is sort of part 6 and it deals with how to negotiate away from a free look scheme.

Hubert starts by noting how once you have been “partners” with a Chinese company for more than six months your China partner probably thinks it can earn more without you. Hupert goes on to say that Chinese learning curves are much steeper than western learning curves and because of this, Chinese companies are usually not terribly afraid of you leaving them and going it alone. Once they see your IP, they are over-confident about their ability to make use of it. I completely agree with Hupert and would only add that Western companies tend to be over-confident about the ability of their Chinese counterparts to take what little IP the Western company gives and run away with it and start competing.

Hupert then discusses how your Chinese partner likely believes that without its help, you will not be able to function in China and once it sees your technology it typically believes it is “competing on a more or less even playing field with you as far as the product is concerned.” I love how Hupert says that if (as is so often the case) it seems that your Chinese counter-party is spending most of its time trying to uncover your intellectual property and asking questions about your business processes, it’s because they are. Again, I completely agree. I can remember many times where one of our clients did not believe its Chinese counter-party was seeking to take its IP and was eventually proven wrong, but I cannot remember a single time where a client believed its Chinese counter-party was seeking to take its IP and that was not the case.

Per Hupert, the second thing of which you should be aware is that to protect your interests, you want your Chinese counter-party to work with you all the while believing you will provide new technology and even more valuable ideas to it in the future. But at the same time, you also want your Chinese counter-party to fear that you may team up with a different Chinese partner. “This hope-fear dynamic is your best best for building a good, healthy relationship in China.” Again, I completely agree and in fact, I add the following PowerPoint slide to nearly all of the talks I give on China:

How to Structure Your China Deal

I put this PowerPoint slide in nearly all of my China talks because — like Hupert — I see this as the key to negotiating deals with Chinese companies that work.

For more on negotiating with Chinese companies check out the following:

Or go all out and spend $4.99 for the Kindle version of Hupert’s book on negotiating with Chinese companies, 10 Common China Negotiating Mistakes: A Survival Guide for Front Line Negotiators and Team Leaders.

China lawyers
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments or phone calls as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a quick general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

What with all the US-China tensions and trade tariffs,

our China lawyers are getting an increasing number of questions from U.S. companies regarding Sinosure. To grossly summarize, they go something like this: “We have received an email from Sinosure’s lawyers saying we owe XYZ China factory $371,456. We do owe them some money but not this much because this does not include the $123,675 that should have been subtracted for the poor quality product we received but could not use. Should I just send them the money we owe them?”

Short Answer:  No. If you send them the money you say you owe the odds are overwhelmingly that you will be pursued for the rest. Also, if you are going to pay anyone anything in China you need a full-fledged Chinese languageChina-specific settlement agreement making clear your payment will resolve all outstanding issues both with Sinosure and with the XYZ China factory. Most importantly, you will want that settlement agreement to be signed and chopped by both Sinosure and by XYZ China factory.

For more on how to deal with Sinosure, check out China Sinosure: What You NEED to Know.

We Chat business for foreign companies

Every couple months one of our China lawyers will get an email from someone asking us one of two things:

1. Does my company really true need a China WFOE to get a WeChat business account?

2. What is the bare minimum China WFOE I can form that will still allow me to get a WeChat business account?

Our short answer to the first email was “yes” and our short answer to the second email was that even the bare minimum China WFOE is still time consuming and expensive to form and time consuming and expensive to operate.

But today folks, our answers just changed. Because people, starting today, our short answer to the first question will be “no” and our short answer to the second question will be “why are you even asking us this question when no China WFOE is necessary to get a WeChat business account.

What gives?

What gives is that what has long been rumored — and like almost everything else related to China, falsely believed by many anyway — has now occurred. It is now possible to for a foreign company to get a WeChat business account a/k/a a WeChat Official account without needing a China WFOE. It does not allow WeChat Pay or APIs yet, but it has the core WeChat features. In other words, you can get your business on there and market, market, market.

China Skinny (I have told you before and I will tell you again that this is one of the very few China newsletters worth subscribing to) came out yesterday with an article on the new rules for getting an official WeChat account and, most importantly, step-by-step instructions on how to do exactly that.

It will cost you $99 but compared to having to form and operate a WFOE, it will no doubt be worth it.

 

 

China tariff lawyers

In talking with one of our international trade lawyers yesterday I learned that September 6th is the next key date regarding the $200 billion round of tariffs against China imports. This is the due date if you want to submit comments on your particular category of products in an effort to get that category removed from the tariff list.

It is already too late to submit comments regarding the first two tariff lists — the first $34 billion list and the second $16 billion list. However, if your product is on either of these lists, you still can make a product exclusion request. The product exclusion request process for the Second list will be similar to the process set up for the first list, but no deadlines have been established yet.

Decisions on exclusion requests typically require/hinge on the following:

  • Identify the product you want excluded.
The U.S. list of targeted products is identified by the Harmonized Tariff Schedule (HTS) number used to declare the product when imported into the United States. A company must identify the commercial name of the product, the HTS number for the product, and any other industry designation of the product under a recognized standard or certification (For example, ASTM or DIN).
  • Describe the product based on physical characteristics.
Physical characteristics can include, but are not limited to, chemical composition, metallurgical properties, and dimensions. This description distinguishes your products from other products subject to tariffs. A significant concern when considering exclusion requests is whether granting a specific exclusion request will create a loophole which other products will also be able to exploit.
  • The basis for requesting an exclusion.
Reasons for the exclusion request include, but are not limited to, the following: The product is unavailable from a domestic U.S. supplier; thus, imports are needed to fill a demand no U.S. supplier can meet. There are certain requirements only the 
import supplier can satisfy. The company has been put on allocation by domestic suppliers. There are no alternative suppliers in a country outside China.
  • The names and locations of any producers of the product in the United States and in foreign countries.
  • Total U.S. consumption of the product by quantity and value for each year for the past three to five years (2013 – 2017)
  • Projected annual consumption for the next few years (2018- 2020), with an explanation of the basis for the projection. 
Total U.S. production of the product (or possible substitutes) for each of the past three to five years.
  • Discussion of why the U.S. products (or possible substitutes) cannot be used in place of the imported products.
  • A viable narrative detailing why your company deserves the exclusion it is requesting. This typically includes the history of your company (e.g. fifth generation family-owned), the products produced by your company, the strategic significance of your company’s products, the number of workers in your company, and your company’s annual sales.

Successful comments result in the removal of tariff line items from the tariff list, contrasted with successful exclusion challenges which result in the removal of specific products from the tariff line item. In other words, the requirements for the exclusion process are much more product specific. This means if you have nine different types of widgets, you will need to make nine different product exclusion requests. 
The reasons given by the USTR for invoking the China tariffs center around Chinese practices of stealing or extorting intellectual property from U.S. companies. There have already been many opposing comments and exclusion requests submitted for the first two waves of proposed China tariffs noting that the tariffs have no relation to the premise of protecting U.S. companies. Many have also objected to the catastrophic effect these tariffs will have on certain American companies while likely having very little effect on how China respects U.S. intellectual property.

It is important to note that out of the first round of $50 billion in tariffs, comments led to $16 billion (32 percent) being removed. If your product or products are on any of the lists, it almost certainly behooves you to try to get them off. Your biggest risk of doing nothing is having to go up against one or more of your competitors that did do something and succeeded and whose costs are now a lot less than yours.

But you do need to reach out to an international trade lawyer FAST.