Steve focuses on assisting foreign companies in doing business in and with China. He prides himself on working in the “real” China: the world of factories, fish plants, and farms that lie outside of Beijing and Shanghai. Having mastered the Chinese language and legal system, Steve’s unique expertise makes him an invaluable resource to our clients.

Huawei indictments for IP theftThe re-opening of the U.S. government has brought with it a renewed assault on Chinese telecoms manufacturer Huawei and its U.S. subsidiary. On January 28, the U.S. Department of Justice unsealed two indictments against Huawei. The first indictment concerns ongoing claims against Huawei and its CFO, Meng Wanzhou, for allegedly violating U.S. sanctions against Iran. This indictment can be found here.

The second and more interesting indictment concerns alleged trade secret theft conducted by Huawei’s U.S. subsidiary under the direction of Huawei China. The trade secrets indictment can be found here. 

The factual portion of both indictments makes for interesting reading. In particular, the trade secrets indictment should be read by any company that engages in technology based business relations with China. This is because the practices described in the indictment do not apply solely to Huawei. If you want a primer on “how they do IP theft” this is where to start. Note that if Chinese companies do in the United States what is described in this indictment consider what Chinese companies do in China.

Let’s say you have set up a WFOE in China to manufacture a critical chemical. The composition of the chemical and its method of manufacture are trade secrets. You have resisted the demands of your Chinese customers to set up a joint venture in China. You have resisted the demands of your Chinese customers to license your technology to a Chinese entity. The only Chinese persons with access to your technology are your Chinese employees. Since those employees are insiders, not outsiders, your technology is safe. Right? Unfortunately, the answer is no.

What can happen to the Chinese employees of your WFOE in China is exactly what allegedly happened to the Chinese employees of Huawei’s U.S. subsidiary. The local Chinese government will give your employees a detailed list of exactly what your employees must take from the WFOE and the timeframe in which they must complete the task. Though your Chinese employees may formally work for your WFOE, the Chinese government is essentially their ultimate “boss,” in the same way Huawei China is alleged to have been the ultimate boss of the employees of their U.S. subsidiary.

What though if your WFOE employee is an honest person and resists following the local government’s instructions? Or perhaps the employee is not so honest but resists simply because he or she does not want to risk losing his or her job if caught. The local government responds: your spouse works as a nurse in the local hospital and it would be too bad if she lost her job. Your father lives on a pension from the local government and it would be too bad if he lost his pension. Your daughter is applying for admission to the local high school and it would be too bad if she is denied entry. On the other hand, if you provide what we [the local government] have requested, we will ensure none of this happens. Moreover, you and your family will receive benefits. If you lose your job, we will find you another job. Don’t worry about it. Just do what you are told and help YOUR country. The pressure to comply is overwhelming and your Chinese employee complies. Your employee really has no choice.

This is the practice in China. Most WFOE managers in IP sensitive industries with whom I have worked in China understand this and so they do not even try to control their employees on IP because they know who is their real boss. They instead set up a costly system in which none of their Chinese employees is given  access to the WFOE’s IP sensitive information. This makes operations difficult and oftentimes the system’s rules are violated and access to IP is granted. When that happens, the technology gets taken because the pressure from the government never stops, in the same way the pressure from Huawei China is alleged to have never stopped against Huawei’s . U.S. employees. This is what is often meant by “forced technology transfer.”

What then should companies that do business in China or with China take away from these two Huawei indictments? Note first of all that neither focus on security issues related to the Huawei equipment that has led the United States and other countries to ban Huawei 5G telecom equipment. That claim is specific to Huawei and the type of equipment it manufactures.

These indictments are focused on how Huawei conducts business. The U.S. Department of Justice (DOJ) is claiming is Huawei intentionally and as a matter of company policy violated U.S. law. For example, in the trade secrets indictment, the DOJ claims Huawei China directed its U.S. employees to steal trade secrets from T-Mobile and when the U.S. employees did not succeed at doing this, Huawei China dispatched a Chinese based engineer to complete the job. The indictment goes on to allege that when Huawei got caught taking T-Mobile’s IP, Huawei submitted an internal report lying about what happened. Huawei’s technology theft is alleged to have been part of a Huawei China program that paid its employees bonuses for stealing intellectual property.

The DOJ claims Huawei stole T-Mobile trade secrets and violated the Iran sanctions and by doing so it overturned the underpinnings of the U.S. legal system and the world legal order. The DOJ’s press release on the trade secrets case makes this clear:

“The charges unsealed today clearly allege that Huawei intentionally conspired to steal the intellectual property of an American company in an attempt to undermine the free and fair global marketplace,” said FBI Director Wray. “To the detriment of American ingenuity, Huawei continually disregarded the laws of the United States in the hopes of gaining an unfair economic advantage. As the volume of these charges prove, the FBI will not tolerate corrupt businesses that violate the laws that allow American companies and the United States to thrive.”

“This indictment shines a bright light on Huawei’s flagrant abuse of the law – especially its efforts to steal valuable intellectual property . . . to gain unfair advantage in the global marketplace . . .”

The U.S. charges are directed at the impact Huawei’s actions have had on both the United States and the rest of the world. The U.S. seeks to expand its claims against Huawei to go beyond the device security concern to a more general concern with how Huawei (and other Chinese businesses and, most importantly, China itself) violates the laws and regulations underpinning the modern free trade system. This is an ambitious goal that will extend beyond Huawei as a company and even beyond IP enforcement as a specific issue. The trade secret indictment complains of actions that go beyond U.S. jurisdiction. The indictments against Huawei read as a global campaign against how Huawei and China do business.

We should therefore expect additional DOJ enforcement actions against Chinese companies. Ms. Meng’s arrest in Canada should not be seen as an isolated case. Worldwide arrests and extradition proceedings and civil and criminal litigation against Chinese companies and their executives will become more common and not just in the United States. We also will see such actions brought by Canada and Germany and Japan and Australia and Spain and England and others as well. The DOJ and the FBI and governments and private companies from around the world will work together to implement this program. These enforcement and litigation programs will extend to various other Chinese companies. The charges against Huawei should be seen as the first, not the last.

Most U.S. companies previously were reluctant to take this sort of aggressive action against China IP theft because of concerns doing so would impact their business in China. They feared a “tit for tat” response by the Chinese government. With the deterioration of US-China relations, this concern seems to be melting away and decades of pent-up resentment against China’s IP practices could well spill out in a cascade of claims from the US and the EU and others.

Welcome to the New Normal.

UPDATE: It took less than 24 hours to prove out the above. See FBI charges second Apple employee with stealing autonomous car secrets.

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 trade war

The trade war with China continues. The U.S. declared a 90 day truce which ends on March 1. Negotiators from the two sides will meet in Beijing on January 7. Many are looking for a “sign” from the Chinese government on the position China will take in the negotiations.

As stated in the U.S. Section 301 complaint, the United States’ position is that China must make major changes in the fundamentals of the Chinese economic system. So the question is whether such a major change is likely? Or will the Chinese side simply offer the same old thing? To date, no formal proposals from the Chinese government have been revealed to the public. So we are required to look for other indicators.

Normally, the strongest indicator would come from the CCP Central Committee meeting held each November. However, no meeting was held in 2018. This is in itself big news because major reform proposals are usually unveiled at this meeting. See The biggest story in Chinese politics right now — silence over Communist Party’s autumn meeting. The absence of a Central Committee meeting then logically suggests no reforms of the Chinese system are planned for 2019. So if the U.S. plan is designed to precipitate a series of reforms in China, this is not likely to happen.

This conclusion is supported by Chairman Xi Jinping’s recent speech at the meeting commemorating the 40th year of China’s reform and opening-up program. The content of that talk is generally taken as the definitive statement of the Chinese government program for 2019. A copy of the full speech (in Chinese) can be found here.  Foreign response to the speech has not been positive. See Xi’s Scary Interpretation of the Last 40 Years of Chinese History.

What did Xi actually say? He started by listing the obvious achievements of the Chinese economy over the past 40 years. This remarkable economic progress was initiated with the announcement of the reform program at the 3rd Plenum of the 11th Party Congress convened on December 18, 1978. There are two initial points to note. First, the reform and opening up program was initiated at exactly the type of meeting that was cancelled for 2018. This suggests we can expect no such reform for 2019. Second, the achievements listed by Xi are entirely economic. Nothing else counts.

In the talk, Xi concludes that Communist Party guidance was entirely responsible for the success of the 40 year economic development program. No other factor is of any significance. Assuming this conclusion is correct, Xi then quite reasonably concludes that the future of China and the fate of the CCP depends on two things. First, the CCP must remain in absolute control of China. Second, the standard for evaluating the success of the CCP depends entirely on the continued economic development of the Chinese economy.

On this basis, Xi then lists the following nine standards the Chinese government will follow for the near future:

1. The CCP will remain in complete control of the government, military and civil society.

2. The sole measure of CCP success is the living standards of the Chinese people.

3. Marxism will remain the core guiding ideology. That is, input from Harvard trained economists and MBAs will mostly be ignored.

4. China will continue to hew closely to socialism with Chinese characteristics. This recognizes that China’s Marxism does not exactly correspond to the works of Marx or Engels.

5. China will follow on and improve the institutions of socialism with Chinese characteristics. No new institutions will be introduced.

6. Economic development is the top priority.

7. China will remain “open” to the rest of the world but it will not accept attempts by other countries to meddle in its internal affairs and it will oppose attempts by any foreign country to impose its will on China. This has to be read as referring to demands from the U.S. and many other countries that China comply with its treaty obligations and follow the rules of international trade and and international relations. China is only obligated to comply with rules that benefit China.

8. The only authority with power to regulate the CCP is the CCP itself. In other words, single party rule outside the constitution and the legal system will continue.

9. Dialectical materialism and historical materialism will be the standards for planning and control of the reform process. Once again, this means no Wharton business school graduates need apply as advisors to the Chinese government.

This set of nine standards is China’s plan for the near future and it should dash the hopes of U.S. analysts pining for a return to the policies of Deng Xiaoping and Zhu Rongji. What does this mean for the U.S.-China trade war and the meetings for next week? It means that if the only solution for the U.S. is for China to fundamentally overhaul its basic economic and trade policies, there will likely be no solution.

However, this rigid view is not the only possible outcome. The truth is that from the standpoint of economic development, China needs the U.S. and the U.S. needs China. Xi’s talk places economic development at the center of Chinese government policy. There is no question the U.S side also sees economic development as a core objective. Given the alignment in those core objectives, it is not unlikely the two sides will put aside ideology and come to some form of agreement. However, that agreement would almost certainly need to be quite different from what is currently being demanded by the U.S. trade representative. What it will look like is anyone’s guess.

Qinqdao Movie StudioI wrote the below post regarding the Qingdao Film Metropolis project in April of 2018. After we ran the post, I received threats of legal action and threats of violence against both me and my family. That led us to take the post down but now that Wanda has completely pulled out of the Film Metropolis project, we have decided this is a good time to reissue the original post together with a short follow-up on what has happened at the project subsequent to its official opening.

Below is my original post, with names deleted to protect Wanda staff who were very helpful to me and who may have suffered for that:

After years of preparation, the Wanda Film Metropolis will formally open on April 28 [2018]. I met Wanda staff last week at the site for a preview of what will be revealed at the opening.

The commercial part of the project includes: a large retail mall, three separate amusement parks (theme park, water park, movie theme park, all indoor in order to be able to operate year round), at least 6 separate hotels, two large exhibition centers, a large marina and a massive number of condos. As noted, nothing except the condos have formally opened for business.

The movie studio project is conducted under the heading of Wanda Studios: Qingdao (青岛万达影视产业园)operates separately from the commercial portions of the Film Metropolis. You can check out the studio complex on their beautiful website at www.wandastudios.com [still live].

Since websites and reality are often different, here is what I saw on the ground in Qingdao.

a. Projected opening data is April 28. Management expects to begin formally renting out studios soon after opening. They indicate that some of the larger studios have already been used for Chinese domestic film productions.

b. The entire studio project is 2500 mu (400 acres). This is very large for China. The location is on the same side of the main road as the main sales buildings, away from the ocean, running up to the mountains to the west. This is different location from what had originally been proposed. So for us folks who have been following the project for years, it takes a bit to find the studio complex.

c. 30 separate studio buildings have been built. Another 10 are under construction. Construction will be complete in October. The individual studios range in size from 10,000 square meters to 1,500 square meters. Each studio has a full sound stage, attached dressing rooms, full support set up (electronics, lighting, ventilation, etc). Ceiling height is 18 meters. The studios were designed by a London architect and are built to meet an international standard. Management indicates that normal Chinese studios are built for about 2000 rmb per square meter. These studios are built at 10,000 rmb per square meter.

While I am not familiar with film studios, I have done construction projects all over Asia and the U.S. I did my normal construction analysis, and the construction and facilities build out appears to be excellent. The claim that the studios are build to an international standard seems justified. Management claims this is the largest studio facility in the world. The claim seems also seems reasonable to me.

d. The studio complex has a main headquarters building that can house a staff of 1000 persons. The cafeteria can feed 1000 persons at a shift. Current staff is 200. The cafeteria complex is not being used. Presumably all of this will get into gear when formal rentals start in May of 2018.

My impressions are:

a. Nothing at all is going on at the complex at this time. So there is no way to predict what will happen down the road.

b. No one knows who owns the land and facilities. No one knows what is the financial objective. Wanda is, however, in full management control.

c. Management states that they want to attract foreign movie projects. The elegant English language website is evidence of this. However, at the site, I did not see any evidence of any attempt to deal with any language other than Chinese and or for provision of services to any company arriving from outside China. But, I don’t need help with Chinese, so it is possible that these services are available and I just was not exposed.

d. The major logistics issue is that the studio complex located far from Qingdao in a beautiful coastal location that is in the middle of nowhere. That means: no carpenters, no electronics technicians, no retail supply of equipment (no wood, no nails, no paint, no electric drills, no lights, no speakers, no recorders, no cameras, no nothing). The explanation of management is that the film producers will bring in all the equipment AND workers that are needed. I have done construction and engineering projects in China in places where you cannot even buy a nail or a screw. It can be quite frustrating. It is not clear that the management understands this issue and has made any concrete plans to deal with the issues.

e. Having said the above, the studio buildings themselves are quite impressive. It is kind of strange to tour all that expensive stuff and then not see a single project that is actually in operation. The concern is i) will anyone come and ii) if they come, how will the logistics be handled? However, management is confident, on the “build it and they will come” philosophy that is typical in China.

It is a great thing to see this project finally come to fruition. We wish them well.

My update is as follows:

A full update on the status of the project has been published on several Chinese websites. A good version with nice photos can be found here. For obvious reasons, I have not personally visited the site subsequent to its May 2018 opening.

As this very thorough article reveals, much has happened since its opening in May. As related to my post, the key events are as follows:

1. Wanda has completely pulled out of the project and will no longer manage the film studio or the amusement/retail/tourism/condo phases of the project. All management has been shifted completely to Sunac China, the real estate developer that purchased Wanda’s leisure/amusement division in 2017. Wanda staff had indicated to me that Wanda was committed to remaining in management control so as to maintain Wanda’s dream of creating an Asian Hollywood. With Wanda’s departure, the locals in Qingdao are confused and uncertain about the future of the Film Metropolis.

The project is currently under the control of Sunac and the local government. Sunac is a real estate developer and the government is a typical Chinese local government. Neither is noted for its vision in the area of film. For Sunac, the emphasis is on condo sales and other real estate related activities. For the local government, the emphasis is on film projects in other areas of Huangdao. This is typical: local governments in China tend to abandon failed projects started by their predecessors.

2. As predicted by Wanda staff, the film studios are quite active. However the concerns I expressed in my post remain:

a. There is no indication any completely foreign production companies have shown any interest.

b. The domestic film studios have been provided with substantial financial incentives. However, those incentives will soon be exhausted and there is no current plan for a replacement. It is not clear that any Chinese film studio would be financially capable of making use of the film studios at the stated “rack rates.”

c. As I noted in my post, the studios are located in a rural area. As I suggested, no local sourcing of materials or skilled workers has developed. Film studios have been forced to source in Qingdao city or more commonly in Beijing. This is a hardship for the studios and it means there is little benefit for the local economy. The locals with whom I have spoken report not knowing what is going on in the film studio complex: it is basically sealed off from the local economy.

d. Sunac and the local government have taken over complete control of the film studios. Wanda no longer plays any role. The new owner’s future plans are not clear, particularly after the subsidy program terminates.

3. Wanda either abandoned the Film Metropolis project or it was been pushed out. Either way, Wanda is gone and Sunac is now working to “De-Wanda” the project. The plan is to remove the Wanda name from every phase of the project but the new name and the new direction from Sunac and the local government remains unclear.

We will report back if we learn more.

China's Economy Top Ten IssuesA group of Chinese economists from Beijing have circulated a “top ten” list of the difficulties faced by the Chinese economy in 2018. This list has been removed from all media in China, but it has been released outside China (as far as I can tell, in Mandarin only). For obvious reasons, the economists who drafted this list have chosen to remain anonymous.

It is of interest to see what Chinese economists themselves see as the important issues for the Chinese economy. This is a list for 2018, but it sets the stage for 2019.

The top ten (per these Chinese economists) is as follows.

1. Trade war with the United States. China has consistently maintained a major trade imbalance with the United States. China sells but does not buy. The imbalance grew even more extreme in 2018. This is a core factor leading to the trade war. This is because the U.S. has shown it will not allow a major trade deficit to continue with any country. It is therefore clear that the trade war with the U.S. will not be resolved until the trade deficit issue is resolved. Since such a resolution does not seem to be imminent, the trade war will likely continue, exerting great pressure on the Chinese economy.

2. The disappearance of Made in China 2025. From 2015 to 2017, the Chinese government touted its Made in China 2025 program as its core policy for development of the Chinese economy. Due to pressure from the U.S., Europe and Japan, public discussion of the program has virtually ceased. Foreign opposition to this program has been based on the following two factors:

a. The advances in technical expertise outlined in the program do not rely on Chinese domestic innovation. Rather, the program relies on forced technology transfer and IP theft. Objection to this approach is at the core of the United State’s Section 301 complaint against China. You can read the United States Trade Representative’s most recent Section 301 report in full here.

b. The Made in China 2015 program is widely viewed outside China has having been implemented to position China to be able to use technology to project Chinese power.

Without resolution of a. and b., it will be difficult for China to openly revive the Made in China 2025 program and nothing has been proposed in its place.

3. Frozen domestic real estate market. The Chinese domestic real estate market has been used to help finance both the central and local governments. The constant rise in real estate prices has been treated as a “blood transfusion” for both the local and central governments. But the end in price appreciation has been reached and continued price inflation will lead to a bubble. But popping the bubble now would cut off necessary funds for the government and would cause social problems in a population that has never experienced a real estate crash. For that reason, China’s real estate policies are frozen in place.

4. RMB value is between a rock and a hard place. The RMB weakened during 2018 and is now approaching 7.0 Yuan to the Dollar. The RMB is a managed currency, so the central government has to decide: should it let its value rise or fall? The pressure is intense to devalue, but that leads to some unpleasant results. With a weakened RMB, China risks being branded a currency manipulator by the U.S. and others. A weakened currency further encourages capital flight, which is already a problem for the Chinese economy. A weak RMB also means higher prices for oil, coking coal and mineral ores. But maintaining the value of its currency would require China make use of its dwindling foreign exchange reserves to support the RMB value.

5. GDP, debt and failure to deleverage. China currently maintains strong GDP growth by infusing debt into the economy. Even with this pump priming, many Chinese and other economists believe China’s GDP is not growing at the stated rate of 6.5%. Some even believe its economy is not growing at all. This means its economy has stopped responding to the debt infusion and yet the government continues to pump debt into the economy. This will likely eventually lead to some form of debt-induced economic contraction. The alternative is to start the deleveraging process now. But the economy is so bloated, any government induced deleveraging will likely cause a recession, a result that will lead to social problems. So China is at a crossroads on the debt issue. There are two roads to take, and both will likely lead to dead ends.

6. Local government debt. Local governments in China are not permitted to impose taxes. They finance their infrastructure and investment programs by issuing debt. Much of this debt is “off the books” debt issued by special purpose financing entities ultimately owned by the local government. Though the official local debt is estimated at about 20% of GDP, most economists think real number is closer to 100% (or more) of GDP. The central government has proposed resolving this problem by allowing local financing entities to declare bankruptcy. With a debt level at 100% of GDP, the bankruptcy approach is not feasible because of the negative impact this would have on the banking system and the local economies. But a continuation of this debt is not sustainable, leaving local governments with no viable alternatives for funding.

7. Collapse of non-bank capital markets. Since private businesses and private citizens have little to no access to bank financing, a non-bank capital market has grown in China as an alternative. In 2018, the three main components of that market collapsed: a) P2P lending, b) private company corporate debt (bonds) and c) private equity funds. This collapse has already resulted in some social unrest. More important, no alternative to this type of funding has been proposed.

8. Collapse of public stock markets. The Shanghai stock exchange was created to help funds selected stated owned enterprises (SOEs). It later evolved into a system to extract money from private investors. Chinese stock prices have never really been based on market factors. Prices have been set and manipulated by the central government. Small private investors have remained in the system, treating the stock market as a casino that ultimately favored the bettors. In 2018 it became apparent that it is not true that the government would guarantee the stock market would always increase in value. When this became obvious, the “smart money” quickly left the market. This then left only the private, small time investors and the government controlled market makers. Again, when it became apparent that the market makers had lost their ability to prop up the market, even the small private investors began exiting the market. This led to a sharp decline in all public stock market indexes. Not only has this led to a decline in the market, the financing provided by this market is also drying up.

9. The decline of the private sector. Under the leadership of Zhu Rongji, the watchword for the Chinese economy at the turn of the millennium was that “the private sector advances while the state retreats.” Over the past decade, this policy has reversed. Under the current government, the watchword seems to be that “the state advances while the private sector retreats.” The goal is for SOEs to control most of the more important sectors of the Chinese economy. But Chinese SOEs are generally less profitable than private companies, this transformation brings with it a decrease in entity profitability.

10. Three engines of the economy become three horse carts. Investment, domestic consumption and exports have for the past two decades been the three engines of China’s economy and all suffered substantial decreases in 2018. The fall of one pillar would be a significant blow, but the fall of all three at the same time has had a significant impact. At the same time, the three burdens of the citizens have increased over the past decade: a) social security in old age, b) education in youth and c) health care in between. With the three “turning to horse carts” citizen unrest is starting to grow.

Please note again that this list of ten comes from Chinese economists and it was written in Mandarin for Chinese consumption. Though it is not my list, I (and the other China lawyers at my law firm) have noted pretty much all of these factors present in China in 2018. When China joined the WTO, in 2001, the plan was for China to transition from a planned economy to a market economy. This move to a market economy never occurred and this list shows that it is not likely to occur and the likely results of this.

How to avoid the china tariffsAs has been widely reported, the United States and China agreed to a temporary “cease fire” in the current round of tariff escalation. This happened this weekend at the G20 meeting in Argentina and the formal results of the meeting are not known. However the White House has issued a press release that outlines the basic terms of the deal that was cut in Buenos Aires.

On the tariff issue, there are two components to the G20 agreement:

First: The U.S. had threatened to raise tariffs on $200 billion in Chinese product from 10% to 25% effective January 1, 2019. In exchange for the United States not raising tariffs in January, China has agreed to purchase a “substantial, amount of agricultural, energy, industrial, and other product from the United States” so as to reduce the trade imbalance between the the U.S. and China. Note the following regarding this:

First,

  1. The list of products has not been determined.
  2. The purchasing dates have not been determined.
  3. This kind of agreement is standard. China obtains concessions in return for agreeing to purchase products but it never does purchase the products as promised. There is zero doubt the US negotiators are well aware of this predilection.
    The trade deficit is not the core basis of the United State’s Section 301 claim against China. So even if China makes these purchases, this does nothing to address the issues that support the imposition of the existing and proposed tariffs.

Second, the parties will enter into negotiations over a 90 period. These negotiations will be designed to resolve the issues that actually do form the basis of the U.S.’s Section 301 claim against China. As summarized by the White House, the US and China will discuss forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture. None of these issues can be resolved by China merely increasing its purchases of U.S. goods and services. The White House release then states in absolute terms:

If at the end of this [90 day] period of time, the parties are unable to reach an agreement, the 10% tariffs will be raised to 25%.

As someone who has been involved with these sorts of China IP issues for decades, I view the odds at near zero that China will make significant and meaningful changes in their system on the issues that will be discussed.  This means that if the White House is serious about its absolute deadline the chances of the tariff rate being increased come March are nearly 100%. However, tariffs are very unpopular in the U.S. business community, so it is not at all clear what Trump will actually do 90 days from now.

All of this means the new normal is still operative for China-United States business relations and U.S. companies that are doing business in China should us the next 90 days to make their plans on (a) how to begin or continue relations with their Chinese counterparts and (b) whether and how to move to other countries to mitigate the continuing China risk.

What will you do?

China high technology transfers

As we have been writing pretty much since the US-China (and to a lesser extent — but soon to be much greater extent — the EU-China) trade war started, the new normal for China will go beyond imposing tariffs. Other measures will be adopted by the U.S. government (and by the EU) to address the issues of forced technology transfer and intellectual property theft. One of those measures is prohibiting the transferring of key technologies to China pursuant to proposed U.S. federal rules. With the initiation of rule-making by the U.S. Department of Commerce, it is clear the new normal has gone beyond the prediction phase; it is already happening.

So what is going on with the proposed rules? On November 19, 2018 the U.S. Bureau of Industry and Security published a notice of proposed rule-making to identify emerging and foundational technologies. These technologies would then be subject to various restrictions on transfer to foreign persons, particularly persons located in China.

The rule-making is mandated by the recently adopted Export Control and Reform Act of 2019 (ECRA), adopted on August 13, 2018. The process is mandated by Congress and is a core component of U.S. national policy. The rule-making and the subsequent control measures have not been dictated by the current administration. A change in the administration or in the composition of congress will have little to no impact on this core policy.

What will happen is that the proposed controls on the transfer of emerging and foundational technology will be extended to include prohibitions on investment by foreign persons in U.S. high tech companies. This will be done by applying the same definitions of emerging and foundational technologies to controls both inbound and outbound investment as currently administered by CFIUS. This will be done through the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) which was adopted on the same date as the ECRA.

Welcome to the new normal.

The proposed rule-making is designed to identify emerging and foundational technology to be subject to licensing by the Bureau of Industry and Security. The media have mostly focused on the inclusion of artificial intelligence in the list of proposed technologies, but the list goes far beyond AI and actually covers virtually every innovative technology currently being developed in the United States. Go here for the full listing of 14 technology categories,

It is important to get clear on what the rules are designed to do and what they are not designed to do. Press reports have stated that the new rules would prohibit exporting physical devices that embody foundational technology. The suggestion has been that exporting smart phones from the United States that use Siri technology would be prohibited. In the same way, exporting video games that incorporate AI game techniques would be prohibited.

These statements are incorrect. The rule-making is based on Section 1758 of the ECRA. Unlike other sections of ECRA, Section 1758 does not apply to the export of physical items. Section 1758 applies only to the transfer of emerging and foundational technology. It does NOT apply to the export of devices that incorporate such technology.

Section 1758 is very clear on this point:

1758 (b) (4) (C) ADDITIONAL EXCEPTIONS.—The Secretary shall not be required to impose under paragraph (1) a requirement for a license or other authorization with respect to the export, reexport, or in-country transfer of technology described in paragraph (1) pursuant to any of the following transactions:

(i) The sale or license of a finished item and the provision of associated technology if the United States person that is a party to the transaction generally makes the finished item and associated technology available to its customers, distributors, or resellers.

(ii) The sale or license to a customer of a product and the provision of integration services or similar services if the United States person that is a party to the transaction generally makes such services available to its customers.

The new rules under Section 1758 will not prevent U.S. companies from selling high tech products to Chinese person. What will be restricted or prohibited is the transfer of the underlying technology to Chinese persons.

These rules will have a major impact on technology companies dealing with China. Currently and under the new rules, Chinese companies are generally free to purchase high-tech products from U.S. manufacturers and service providers. But U.S. companies have mostly had little success in direct sales to Chinese persons/entities. Chinese persons/entities will usually only purchase from Chinese companies, so U.S. companies are forced to transfer to Chinese entities to make their sales. After these “forced transfers,” the technology is then “assimilated” for the benefit of the Chinese side.

ECRA Section 1758 is designed to end the forced technology transfer regime, at least for emerging and foundational technologies. Since virtually every technology of any interest to a Chinese buyer will fit into that category, Section 1758 has the potential to eliminate nearly all technology transfers to Chinese persons/entities. However, Section 1758 will not prevent Chinese persons/entities from purchasing high technology goods and services from U.S. companies through normal cross border sales transactions.

Most countries in the world (See Europe, the United States, Australia, Canada, almost all of Asia and of Africa) do business this way. The impact will be that Chinese persons/entities will be forced to behave in a more standard way in the global market economy.

On the other hand, most technology transfer projects currently being considered between U.S. companies and Chinese persons/entities will be impacted by the proposed licensing of emerging and foundational technology transfers. Even technologies not within the current very broad listing could eventually be pulled into coverage. Though all of this is in the preliminary rule-making stage, the outlines of the policy are clear and virtually inevitable. This means that every U.S. company considering technology transfer to Chinese persons must consider the impact of this licensing regime. And like I said, the EU is making similar moves. See EU moves to protect interests against predatory China in the Financial Times. 

This is the new normal.

China lawyers
Image by Florian64190

The trade and investment relationship between the U.S. and China is going through permanent change, with the current round of tariffs just the start. As the tariffs fail to bring a resolution, we should expect the United States to implement other restrictive measures, including, some combination of the following:

  • Prohibiting the selling or licensing of technology to China.
  • Prohibiting Chinese companies from purchasing all or part of U.S. technology companies;.
  • Prohibiting Chinese students from attending U.S. schools and universities
  • Prohibiting the hiring of Chinese nationals by U.S. business
  • Ending cooperative research programs with Chinese scholars and researchers.

This will be the “new normal” in China/U.S. business relations and U.S. companies that do business in or with China should start now to prepare for this new reality. Many companies are waiting to react because they believe this conflict is a temporary political problem and will soon blow over. This view is a mistake.

The tariff measures are the first step in a much more general conflict over the entire Chinese system. The U.S. objects to virtually every aspect of China’s economic/trade/investment system. Rather than take on the entire Chinese system as a first step, the current tariff dispute with China has been narrowly defined.

The USTR 301 Report bases the US tariffs on two concrete issues: China’s well-documented propensity to engage in forced technology transfer and IP theft. When confronted regarding these two issues, the Chinese government response has been to simply deny every claim. In its White Paper responding to the 301 Report, the Chinese government flatly denied every claim in the report. On forced technology transfer: it does not happen and U.S. companies that transfer their technology to China do so voluntarily based on their own business calculations. On IP theft: it does not happen and accusations of trade secret theft and cyber-hacking are simply lies.

China’s consistent and complete denial of every statement in the 301 Report has been maintained by every layer of the Chinese government. There has been no movement at all. For example, in the forced transfer area, the Chinese government has refused to even consider opening the network, e-commerce and cloud computing markets in China to foreign based businesses. In the IP theft area, the Chinese government has refused to cooperate in investigating and extraditing those sought under recent U.S. indictments in several high profile cases.

There is a reason for China’s hardline position. Its forced transfer and IP “assimilation” regimes are at the core of China’s economic system. The current leaders of China understand this and that is why they cannot even suggest a compromise on these critical issues.

With China standing resolute and with there being no hint or likelihood of this changing quick resolution of the US-China trade war will require the U.S. trade team to capitulate. U.S. businesses have waited twenty years to see real improvement in the Chinese system only to see things grow steadily worse. China has lost nearly all of its former supporters in the U.S. business community. Since China has lost its main body of support in the U.S., there is very little pressure on the U.S. trade team to back down. It is therefore unlikely it will.

The situation is critical and nearly all foreign companies that operate in China should be analyzing how they can best deal with the trade situation. These companies need to make concrete plans for dealing with the impact the US-China trade war is having and will have on their business operations. Many companies believe they must either abandon China or pretend nothing is happening and go on with business as usual. For nearly all companies neither of these approaches make sense.

Some companies will continue to work with China based the same way they have for the past decade. For these companies, their major adjustment should be that they quit dreaming anything will change. For other companies, developing supply relations outside of China will become critical. For some of these companies a move out of China will be required. Others will be best off splitting their production between China and other countries.

What is consistent for pretty much every company that operates in China is the need for it to evaluate its operations in China under the New Normal of increasingly restrictive trade and investment measures. In assisting our own clients with this sort of evaluation we’ve been targeting the following:

1. How will current and future tariffs impact the business. For some of our clients, the tariffs are largely irrelevant. For others, the impact is so severe that failing to move quickly could lead to their demise.

2. What can be done about the tariffs? Is an exclusion from the tariffs possible? Will the Chinese factory agree to a price adjustment? Should the supply chain be moved to another country? Should the company shift the sales of its products to countries (other than the U.S.) where tariffs are not being imposed?

3. If the supply chain needs to be moved to another country, a careful analysis is required. Will you need to build a factory in that other country or can you purchase your products from an existing supplier or contract manufacturer? Is the infrastructure and legal system in the target country adequate for your needs? How long will it take to move and what will be the cost? As high as the costs are going to get to manufacture in China, this analysis often reveals China is still many companies’ cheapest and best choice.

4. China currently requires many technology companies to license their technology into China. For example, such licensing is essentially required in the network, cloud, SaaS sector, e-commerce and fin-tech sectors. The Chinese government has made clear this policy will not change. Companies in these sectors that have held off on “going into” China in the hopes of a change in policy should now either accept the licensing requirement or just abandon China as a market.

5. Many U.S. companies engage in co-development of technology and products in China, working with many types of Chinese entities. Over the past 15 years, the Chinese court system has been largely receptive to protecting the contractual rights of foreign entities, provided that the contracts are properly drafted. See China Contracts: Make Them Enforceable Or Don’t Bother. Will Chinese courts continue to enforce these manufacturing contracts, especially on behalf of American companies? Or will U.S. companies need to look to different ways to protect their innovations that do not rely on the Chinese legal system? Fortunately, all signs still point to continued contract enforcement.

6. Will new rules (either from the U.S. or from China) make it difficult or impossible for U.S. companies to sell or license their technology to Chinese companies? For U.S. companies that want to bring in Chinese investment, what will be the impact of restrictions that are currently being proposed? For U.S. companies that rely on hiring large numbers of Chinese professionals, what will be the restrictions? For U.S. education and research institutions that want to work with Chinese researchers, will that be possible? What about Chinese scholars who have become naturalized citizens of other countries? Will they also be banned?

Every party from the U.S. that works with China in any way should be asking themselves at least some of the questions above. Foreign companies that sell their Made in China products to the United States should be doing the same. China will not be completely and permanently cut off from business relations with the United States, but the nature of the US-China relationship has changed and it is not going to return to the way it was for a long long time.

The US-China business relationship is fluid and its final configuration has not yet been settled. Nonetheless, businesses that wait for a final resolution will be left behind. Now is the time to evaluate and take action.

What is your company doing to get ready?