Basics of China Business Law

China criminal law

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

WRONG.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What are you seeing out there?

 

 

 

China Template Contract

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

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

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

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

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

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

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

China employment lawyerIf you are a China employer, you need a set of Employer Rules and Regulations that are not only enforceable and up-to-date but also practical for your specific locale in China. Employer rules and regulations are so important because China does not have employment at will and this means that without enforceable rules and regulations you as an employer generally cannot discipline or terminate your employees.

Let’s consider a recent case in Guangzhou City. In this case, the employer required all employees clock in and out with their fingers on a time clock system. An employee made a mold of his fingers and asked a co-worker to clock in and out on his behalf for several days in a row. The employee failed to show up at work during those days without any justification. The employer terminated the employee on the basis of a serious breach of the employer’s rules and regulations and the employee brought a labor arbitration claim.

The employer was able to produce a copy of the employer’s rules and regulations, the employee’s acknowledgement of receipt of the employer’s rules and regulations, witness statements, fingerprint records showing there were clock ins and outs with the employee’s fingerprints, and security footage showing the employee himself was not present at the clock ins/outs, and WeChat screenshots of the employee’s video and phots posts showing the employee was sightseeing at a tourist attraction during the days at issue.

Notwithstanding all of this (granted, the employer failed to produce all of the evidence at once), the employer lost at labor arbitration for failing to produce sufficient evidence proving the lawfulness of its unilateral termination decision. The employer appealed to the court and lost there as well and was ordered to pay the employee a substantial amount in damages to the employee for unlawful termination.

Finally however, the appellate court reversed the lower court’s ruling (and that of the labor arbitration board) and held that the employer did not have to pay any employee damages. The appellate court first emphasized that the employer bears the burden of proof in an employee dispute that arises from the employer’s unilateral termination decision. It further stated that since unilateral termination on the basis of an employee’s wrongdoing is the most severe punishment by an employer and since the employer is usually better positioned to obtain evidence, employers will be held to a high standard in that regard. But in the end the appellate court ruled the employer had come forward with enough evidence to support its claim that the employee was absent from work for days without a proper reason and had used a co-worker to clock in and out for him. Therefore, even though the employer rules and regulations did not specifically list having another employee clock in/out with a finger mold as employee misconduct, the employee’s behavior violated the good-faith principle and the employer was justified in making the unilateral termination decision.

The big lesson from this case is that if you want to minimize future employee problems and avoid costly employee litigation, you should make sure right now that you have comprehensive and enforceable employer rules and regulations and you save all evidence that may be used in any future employment disputes.

Though the appellate court finally ruled in favor of the employer on the basis of the employee having failed to act in good faith, I’m convinced that the employer having a thorough set of rules and regulations and having strived to maintain good employee records was a major factor in the decision. Nonetheless, as a China employment lawyer who spends much of my day helping China employers avoid employee disputes I cannot resist pointing out how the employer in this case would likely have made its life considerably easier had it maintained clearer attendance records and required the employee provide his signature as confirmation of such attendance records, kept the pay stubs that corresponded to the days actually worked and had the employee sign such documentation during the course of the employment relationship. In other words, as a China employer (especially if you are a foreign company), it is critical that you document everything every step of the way as though you are right now preparing for an employee lawsuit down the road.

 

China lawyersAbout once a month, someone will call one of our China lawyers wanting to discuss “working with you to help your clients get money out of China. These are nearly always phone calls (not emails) and we typically do not take the calls. Our feeling is that we’ve been doing this long enough (and discussing this long enough with ultra-high level finance and banking people and with really good China attorneys from other law firms), such that these callers are not going to tell us anything new.

But a few weeks ago a “we can work together to help your clients get money out of China” caller got through. I my defense I was on my treadmill and expecting another call and this caller somehow managed to get my firm’s receptionist to patch his call through to my cell phone and I picked it up. So while on mile four, I listened to this person explain his “foolproof and completely legal method” on how both his company and my law firm could “make a lot of money working together, while all the while I am telling him we were not interested and how it would not work.

He then followed this call up with an email reiterating that “we are on the same team” and setting forth the following method in writing:

  • Client transfers RMB to one of our RMB accounts in China (we have both private and corporate accounts)
  • Client sends RMB payment slip
  • We confirm receipt of funds and match off with an existing client
  • The following business day we will transfer the equivalent in GBP (British Pounds) from our UK regulated company to the client’s GBP bank account
  • We provide the relevant document to support the audit trail of funds for the client

Advantages

  • Transfers in 1-2 working days
  • Unlimited transfer amounts
  • Working with an FCA regulated company based in London
  • Full audit trail for transfer
  • Guaranteed funds. Safe and secure route for RMB transfers

We looked at the plan and sent the following response and never heard back.

What you are proposing is a standard procedure for illegally getting money out of China that has been used for years. Two sets of linked accounts: one bank account in China and then a linked bank account in some other country. There are some Chinese banks that refer their customers to this kind of broker as a service to their customers. The idea is that even though the practice is illegal, a broker introduced by the bank is more likely to be trustworthy. This is particularly true when the initial deposit is made in the bank that made the introduction. The risk skyrockets when the work is done by a broker with no connection with a major bank. In other words, this sort of service is already available to any Chinese person who wants to make use of it and who is willing to pay the broker’s fee and skirt Chinese laws. So there is no need for a foreigner from England to provide the service in China.

Why is the practice illegal?

1. The obvious goal is to evade China’s laws on outbound fund transfers. Any contract set up with that purpose is void and that means it is unenforceable. That means that if something goes wrong, there is no way to enforce it on the Chinese side. Is there a way to enforce it in England? I would think not, under the same principal; the courts of England will not normally allow themselves to be used to assist in enforcing an illegal contract, in the same way courts generally will not enforce an illegal gambling contract.

2. The China side of this operation is not described. But it is clear these Chinese bank accounts are not being operated legally. There will be substantial sums coming into a bank account in China. Whose account? For what legitimate business purpose? Evading Chinese foreign exchange rules is not a legitimate purpose. Acting as an unregistered bank is not a legitimate purpose. How would taxes be paid?  What happens to the funds? The funds are by definition stuck in China. For whose benefit? Used to do what?

3. I assume similar questions would be asked on the England side. The Chinese party is acting on trust. They expect the corresponding deposit to be made. But what happens if the deposit is not made? The Chinese party is stuck in China. What can they do?

4. Into what account in England is the money deposited? Part of Chinese foreign exchange control is that Chinese individuals and companies are not permitted to open foreign bank accounts without first securing Chinese government approval to do so and this approval requires a legitimate business purpose. Note that China has a worldwide taxation system, so the money that “just shows up” in these accounts must be reported to the Chinese tax authorities. But such a report would reveal that an illegal transfer had been made. So no report is made. This then is a currency transfer/tax evasion scheme, illegal in China and I would assume illegal in England as well.

So like I told you on the phone, if you are going to do this, you better not ever go to China or to any country that has an extradition treaty with China.

Beyond that, best of luck.

For more on getting money out of China, check out the following six part series we wrote last year:

  • Getting Money Out of China: It’s Complicated. How incredibly frequently Western companies have been needing legal help in an (often desperate) effort to get money out of China so they can get funds due to them on all sorts of deals.
  • Part 2. How most of the interest in getting money out of China involves purchasing single family homes in the United States or in Europe and how those deals are just not going to happen legally if they require money from the PRC. In this post, we also discussed how the Chinese government seems to apply a three part test in determining whether to allow funds to leave China to go to a Western company. Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements.
  • Part 3. This post focused on the “benefit to China” element of China’s three part test.
  • Part 4. This post focused on what is/was happening in China that is slowly down payments from China.
  • Part 5. This post focused on increasing your odds of getting paid.
  • Part 6. This post focused on what you can do to increase your odds of money leaving China legally.
China NNN Agreements and trademarks
Drawing by David Shrigley.

Yesterday in China Lawyers: The Fakes and the Quasi-Fakes, I wrote about how “with the recent decline in China’s economy we [the China lawyers at my firm] have in the last few months been seeing a precipitous increase in a new sort of “China lawyer” problem: Chinese law firms that seem to know nothing about international law representing foreign companies shockingly badly at shockingly law prices.

I then explained the sort of thing we are seeing by using the following three examples:

1. Three different companies write ask us to challenge the rejection of their China trademark applications. A quick perusal tells us that they have zero or virtually no chance of prevailing because someone else clearly beat them to the trademark for which they filed. Our response to them is something like the following:

There is virtually no chance of our being able to prevail on an appeal of your trademark rejection. In fact, in our view, it never made sense for you to file for this trademark at all. I am sorry that your company wasted time and money on this application and we suggest you not waste more time and money appealing the rejection. Instead, we propose that you retain us on an hourly basis to work with you in figuring out your other options.

We then hear enough back from these companies to enable us to piece together the following scenario:

These are all small companies with not much money. They chose ultra-low cost Chinese law firms (at least I think these are Chinese law firms) online. The law firms they chose are not on any map of leading Chinese law firms and their pricing reflects this. These law firms were contracted to try to register XYZ as a trademark and that is exactly what they did, but NOTHING else. These law firms provided no legal counsel regarding whether it made sense for these companies to register XYZ as a trademark in China. These law firms provided no legal counsel to these companies regarding the class and subclasses in which XYZ should be registered. And perhaps most importantly, these law firms appear not to have conducted any trademark search before filing for these trademarks, which trademark search would have told an experienced and legitimate law firm with information that would have sent them back to these companies to discuss alternative approaches. Two of these companies told us that they trusted their law firms because they touted their “direct connections” to China’s trademark office. I explained to them that every Chinese law firm can make that same claim and that a good Chinese law firm would probably never make that claim.

2. Companies pay a Chinese law firm (at least I think it’s a Chinese law firm) a ridiculously low fee for a WFOE registration and get ridiculously little help with that. Let me explain. Foreign company pays Chinese law firm to help them with their WFOE registration. Chinese law firm sends foreign company an incredibly bad translation and tells the foreign company to fill it out. The foreign company has no idea how to fill it out and asks for help from the Chinese law firm. The Chinese law firm provides no help either because it essentially refuses to do so or because it has no ability to do so. Foreign company then comes to us and in about five minutes we suggest that they not even bother with a WFOE registration either because they (1) do not need a Chinese WFOE at all or (2) cannot afford to pay the real costs of a real WFOE registration (which involves about 100 times more than just filling out and submitting an application. See How to Form a China WFOE: A Roadmap) or pay the real costs of operating a WFOE in China or (3) cannot legally form a WFOE in China for what they are seeking to do in China. See Forming a China WFOE: Needed or Not.

3. Companies that pay a Chinese law firm (at least I think it’s a Chinese law firm) or an online template mill an absurdly low price for a China manufacturing agreement (such as a China NNN AgreementChina Manufacturing AgreementChina Product Development ContractChina Mold Ownership Agreement) or China Employment Contract or China Distribution Contract or various other agreement and then come to my firm asking us “to review it.” When they attach the contract they want us to review (which they do most of the time) we super quickly review it and tell them that it is not a good contract and that if they need a good contract they will need to pay us to start completely over, if that is even possible — usually it isn’t because they and their Chinese counter-party just signed it!

Well yesterday’s blog post led to a slew of foreign companies asking us to review their contracts and for me to draft a new email based on my review of three different NNN Agreements, all with similar shortfalls that made them 100% worthless for protecting the foreign company’s IP. These NNN Agreements had the following clear flaws (most had all of these, some had some of these:

  1. A provision stating that the supplier is specifically allowed to pass on the foreign company’s confidential and trade secret information to any “sister companies” and to any “business partners.“ Think about this for just a second. This means that your Chinese supplier can form a sister company in a week (it probably already has one) and then freely turn over whatever information you gave them. This is known as an exception big enough to drive a truck through. But it gets worse. It also allows your supplier to turn over to a “business partner” whatever information you provided to it. In other words, it can go to whomever it wants in China or anywhere else in the world and strike a deal with that company (maybe that deal is that it sells your confidential information for $1000) and that is okay because that company is a “business partner” of your supplier.” These sister companies and business partners are then under no obligation whatsoever to keep your information secret. They are legally free to do with your information whatever they wish. This is a super common loophole used to allow Chinese companies to disseminate confidential information without violating the agreement. This loophole makes your NNN Agreement 100% worthless.
  2. Not satisfied with this first provision, these agreements also include a contract damages provision that provides for a super-low amount of damages for any violation of the NNN Agreement and reads as though the foreign company cannot get damages beyond the super-low amount set forth in the contract. So in other words, even if you could possibly win a lawsuit (and you can’t), your win will be limited to such a small damages amount that there would be no point. For how to properly handle a contract damages provision in your China contract, check out On the Importance of Contract Damages in China Contracts.
  3. They contain a choice of jurisdiction clause so vague that even if you were to sue in a case you cannot win (and if you were to win it would still not be worth suing), it is not at all clear where you should sue and your supplier will be able to force you to incur substantial attorneys’ fees and tie you up for months trying to get the courts sort that out. See Super Common China Contract Mistakes.

For what a proper NNN Agreement (for most countries, not just China) should look like, check out China NNN Agreements .

My advice to all of these companies was that they seek to register their brand name in China as quickly as possible because having their product copied is bad enough, but it is even worse if that product can legally have “your” company’s brand name on it. See China Trademark Registrations Are the Bare Minimum (Still) where I say that when this happens to a company it is often “lights out” for them. I make this suggestion because so often when we see a manufacturer try to scam a foreign buyer out of its product designs we also see that same China manufacturer (using a proxy) run off and apply for a China trademark for the foreign company’s brand name.

About half of these companies then wrote back to ask how they can get the trademarks by themselves from China’s Trademark Office (CTMO). The answer is they cannot. Only licensed Chinese lawyers and trademark agents can apply for a trademark in China. Trust me though when I say that this is a good thing because I doubt very much that there is anyone out there not trained as a China lawyer or China trademark agent who could do even a halfway competent job at trying to secure a China trademark.

Be careful out there.

China lawyers

A few months ago, in China Trademarks: Too Good to be True, I wrote about an American Lawyer Magazine article (That Law Firm’s Website Might Not Be for a Real Law Firm) pointing out the “growing trend of fraudsters posing as attorneys or legal consultants online to exploit those seeking legal services.”  I then used that article to point out how “when it comes to China and Southeast Asia, that growing trend’ has reached epidemic proportions. I noted our my firm’s international lawyers had seen “at least a five-fold increase in the number of instances in which American and European companies have been ripped off and greatly harmed by fraudsters who advertise their legal services on the internet, usually with Google paid ads. I distinguished these fraudsters from the sites that charge $99 (or whatever) for template contracts:

Just to be clear, I am not talking about the sites that charge $99 (or whatever) for template China contracts that are worth less than nothing. These companies provide a joke of a product but they at least provide what they say they are going to provide. For more on that, check out. China Contract Templates for $99 Each. As far as I know, these companies do not flat out steal your money but they oftentimes can be just as dangerous. These companies lead their clients to believe they are communicating with lawyers when in fact they are not. This means there is no attorney-client privilege and the odds of whoever does your legal work knowing your situation and your goals and having the capability to draft a cross-border document or file your trademark in the right category or form your company correctly are slim.

No, I am talking about flat-out criminals and fraudsters who will take your money and claim that they did what they were paid to do and then not provide you with any services whatsoever.

I also made clear that I was not aware of a single licensed lawyer (from China, Vietnam, Thailand, or wherever) that had charged for something and then not delivered it:

And again, just to be clear, I am not aware of a single instance where a legitimately licensed lawyer from any country has done this. No Chinese lawyers. No U.S. lawyers. No lawyers from any country. As far as I can tell those engaging in these schemes are not lawyers at all, though they often claim to be.

We first wrote about fake China lawyers more than a decade ago, in China: Where Even The “Law Firms” Are Fake. That post  was on fake Chinese lawyers taking money for never-filed trademark registrations:

There are those who take money to file trademarks in China and then simply run away. A new client told me he had sent about $750 to what he thought was a legitimate China law firm to have his company’s brand name registered. As soon as the first $750 hit Shanghai, he was asked to send an additional $600 to “cover the filing fees,” which he did.

A week later the website was down and the Shanghai “firm” was gone.

It turns out this scam is actually pretty common and it also turns out that in every case of which I am aware the scammers were neither licensed Chinese lawyers nor licensed Chinese trademark agents. In other words, they are just people who run China trademark registration scams.

It has done pretty much nothing but gotten continually worse since then and as foreign companies move their production from China to other countries in Asia (Vietnam, the Philipines, Thailand, Cambodia, Malaysia, etc.) these scammers are moving their focus as well. We are hearing of many foreign companies that paid for company registrations, trademarks, copyrights, employment contracts, manufacturing contracts and various other things only to receive nothing in return and only to learn months (sometimes even years) later that the “law firm” or “lawyer” they paid for their legal work never even existed. How many foreign companies believe their trademarks are registered in China or in Thailand or wherever when in fact they never were? How many think they have registered companies in China or in Vietnam or wherever when they don’t? There is no way to know the numbers, but I do know that this sort of thing can be relatively easily prevented:

Do some due diligence before you pay/hire a lawyer, especially if you will be paying upfront for something like a China trademark or a China WFOE where it may take you years to realize you were scammed. There are fast and easy steps you can take to confirm that your lawyers actually have a law license. Every U.S. state lists its licensed practitioners online in its Bar Director and most countries have something similar. Check to see how long they claim to have been in business as compared to how long they have had their website. One fake China attorney claimed to have more than 20 years experience but his website appears to have been online for a total of only 5 months. Read as much as you can online about the lawyer or the law firm you will be hiring. If you are looking to hire an international lawyer or law firm and you have a local lawyer, enlist that lawyer to conduct the due diligence on your behalf. See China Partner Due Diligence for some of the most basic things you can and should be doing before entering into any transaction.

But with the recent decline in China’s economy we have in the last few months been seeing a precipitous increase in a new sort of “China lawyer” problem: Chinese law firms that seem to know nothing about international law representing foreign companies shockingly badly at shockingly law prices. Let me explain with the following three examples, necessarily a bit vague to camouflage all parties:

1. Three different companies write ask us to challenge the rejection of their China trademark applications. A quick perusal tells us that they have zero or virtually no chance of prevailing because someone else clearly beat them to the trademark for which they filed. Our response to them is something like the following:

There is virtually no chance of our being able to prevail on an appeal of your trademark rejection. In fact, in our view, it never made sense for you to file for this trademark at all. I am sorry that your company wasted time and money on this application and we suggest you not waste more time and money appealing the rejection. Instead, we propose that you retain us on an hourly basis to work with you in figuring out your other options.

We then hear enough back from these companies to enable us to piece together the following scenario:

These are all small companies with not much money. They chose ultra-low cost Chinese law firms (at least I think these are Chinese law firms) online. The law firms they chose are not on any map of leading Chinese law firms and their pricing reflects this. These law firms were contracted to try to register XYZ as a trademark and that is exactly what they did, but NOTHING else. These law firms provided no legal counsel regarding whether it made sense for these companies to register XYZ as a trademark in China. These law firms provided no legal counsel to these companies regarding the class and subclasses in which XYZ should be registered. And perhaps most importantly, these law firms appear not to have conducted any trademark search before filing for these trademarks, which trademark search would have told an experienced and legitimate law firm with information that would have sent them back to these companies to discuss alternative approaches. Two of these companies told us that they trusted their law firms because they touted their “direct connections” to China’s trademark office. I explained to them that every Chinese law firm can make that same claim and that a good Chinese law firm would probably never make that claim.

2. Companies pay a Chinese law firm (at least I think it’s a Chinese law firm) a ridiculously low fee for a WFOE registration and get ridiculously little help with that. Let me explain. Foreign company pays Chinese law firm to help them with their WFOE registration. Chinese law firm sends foreign company an incredibly bad translation and tells the foreign company to fill it out. The foreign company has no idea how to fill it out and asks for help from the Chinese law firm. The Chinese law firm provides no help either because it essentially refuses to do so or because it has no ability to do so. Foreign company then comes to us and in about five minutes we suggest that they not even bother with a WFOE registration either because they (1) do not need a Chinese WFOE at all or (2) cannot afford to pay the real costs of a real WFOE registration (which involves about 100 times more than just filling out and submitting an application. See How to Form a China WFOE: A Roadmap) or pay the real costs of operating a WFOE in China or (3) cannot legally form a WFOE in China for what they are seeking to do in China. See Forming a China WFOE: Needed or Not.

3. Companies that pay a Chinese law firm (at least I think it’s a Chinese law firm) or an online template mill an absurdly low price for a China manufacturing agreement (such as a China NNN Agreement, China Manufacturing Agreement, China Product Development Contract, China Mold Ownership Agreement) or China Employment Contract or China Distribution Contract or various other agreement and then come to my firm asking us “to review it.” When they attach the contract they want us to review (which they do most of the time) we super quickly review it and tell them that it is not a good contract and that if they need a good contract they will need to pay us to start completely over, if that is even possible — usually it isn’t because they and their Chinese counter-party just signed it! If the contract is not attached, I send them an email that says something like the following:

That you are asking us to review a contract that you just paid for tells us you have serious doubts about the quality of your contract. If you have serious doubts, we have serious doubts, largely because I cannot remember a situation like yours where once we reviewed the contract our advice was anything but that we would need to start over and charge a lot more than paid for the unworkable contract to draft a brand new contract that actually works for China. Please check out China Contracts: Make Them Enforceable Or Don’t Bother and compare what we describe in that article as necessary for your China contract to work with your contract. If your contract does not tick all (or at least most) of the things we mention in that article, you will need a new contract.

I then tell them what we usually charge for whatever contract is at issue (hint, no matter what the contract it will be a lot more than $99).

How do you avoid the above three sorts of situations? Two ways. One, do your due diligence on the law firms you are considering. Two, heed the old maxim that “If it [the Price] Sounds Too Good to Be True, it Probably Is.”

What are you seeing out there?

 

China employment lawyer

As regular readers of this blog should know, employers in China, (especially foreign employers) face myriad, complicated and hypertechnical local employment laws. One little employer mistake can lead to big and expensive problems. As much as we wish all our employment law clients would first come to us requesting we audit their employment program to bring it into compliance, truth is that about half the time they come to us only after they’ve been hit with a big (and nearly always expensive) employee problem.

The good news is that most who come to us to solve their pressing employee problem realize the benefits of having us work with them to prevent future problems. These are the clients who realize that it makes sense to change their oil every 3,000 miles than to buy a new engine every 40,000 miles. Some clients are convinced (or should I say convince themselves) that their employee problem was just a one-off and that their “relationship” with their other employees means there will be no such problems in the future. About all I can tell them is that my experience and that of every single other China employment lawyer I know says that their future odds are not so good.

In general, the best way to deal with just about every legal problem (in China and everywhere else) is to do both what you can to solve that one and to search out and remedy the root cause of that problem so that the same sort of problem does not recur. This all just seems so obvious to me.

Consider this hypothetical based on one of the two or three most common China employment law issues we see. Employer wants to terminate an employee and approaches the employee to discuss a severance package. The employee responds by saying, “You can’t terminate me because not only do you not have any legal basis to do so, I am also on an open-term contract.” The employer then seeks to check the employee’s contract but cannot find a signed copy of it. Now let’s suppose the employer then has a face-to-face meeting with the employee where the employee says: “I like working here so I will forget about what you said about my termination.” The employer replies, “Great. We appreciate your cooperation.” and then goes on about its business.

Smart move by the employer? NO, NO, NO, a thousand times no. When our China employment lawyers get a matter like this, the first thing we do is try to clarify with the employer why it wanted to terminate the employee in the first place. Was it because there was not enough work? Was it because the employee is incompetent? If there is a legally permissible ground for a unilateral termination, the employee’s consent is not required and the employer can (and oftentimes should) proceed with the termination. In some cases, especially where the employer is dealing with a problem employee, it will make sense for the employer to initiate a unilateral termination as soon as possible and in doing so be sure to preserve its evidence backing up its claimed basis for the termination for any labor arbitration or litigation in the future. In most cases, if the employer does not wish to retain the employee, the employer should talk with the employee about a mutual termination as soon as possible, even if the employee is an open-term employee.

Even if the employer continues to employ the (almost terminated) employee it should do what it can to determine whether the employee was indeed on an open-term employment. Not having a written employment agreement does not necessarily mean the employee has become an open-term employee. If the employee is not an open-term employee, the employer should still decide whether it wants to use a fixed-term or an open-term agreement with the employee going forward.

If there truly is no written employment contract between the parties that accurately reflects the employee’s specific situation, the employer should seek to enter into a written employment contract with this employee as soon as possible. Once the issues concerning this employee have been resolved, the employer should then see what sorts of current employment contracts it has with all of its other employees. Even if the employer does have contracts with all its employee that still will not suffice if the contracts are not current. If there are any imminent employment contract renewals due to an employee’s contract expiring soon (i.e., within 30 days) the employer needs to not delay in dealing with those also. In other words, it must not lose sight of any other employee because of this one employee.

If the employer in the above hypothetical executes an appropriate new employment contract with this one employee but does nothing more we can expect it will have similar employment matters with its other employees soon enough. China employees talk with their fellow employees about these things (just like pretty much everywhere else in the world), and trust me, this one employee will soon be telling your other employees how he or she got a great deal from you and they should too and if they have any shot at all they will try. It is not uncommon for our China lawyers to have to deal with a situation where one employee has complained about an employment contract problem and even before the employer has had time to sign our fee agreement, it is now dealing with three or four employees with the same complaint.

It is nearly always much cheaper to deal with your employment issues proactively and not wait until they come “from nowhere” in the form of a complaint. Think of that first employee complaint as your canary in your coal mine and use it to your advantage to nip impending/future employee problems in the bud with an employer audit.

China distribution contractsInternational distribution contracts are the new black and this is a good thing. I estimate that the international lawyers at our firm will have done about double the number of international distribution contracts in 2018 than in 2017.

I see this increase due in large part to companies better realizing that doing business in a foreign country by setting up a company in that country (be it a wholly owned subsidiary or a joint venture) is almost always invariably difficult, time-consuming, and expensive and that is especially true of China. Going into a foreign country via a distribution contract (or a reseller agreement) is a relatively fast, easy and inexpensive way to stick your corporate toes into a country’s waters.

And here’s one more thing that distribution agreements have over foreign direct investment (which usually means going into a foreign country by forming a company in that country): they allow your company to enter into multiple countries at roughly the same time. These days, it is almost as common for a company to use our international lawyers for multiple distribution agreements as for one. In other words, these companies are pushing their products into many countries all at once and all via distributors and distribution contracts.

Let’s though focus on China.

As our regular readers know well, forming a WFOE in China and then operating that business in China is difficult and expensive. See e.g., Forming a China WFOE: Ten Things To Consider and also Doing Business in China with Deportation or Worse Hanging Over Your Head on why having a WFOE is a must if you will be doing business within China. Perhaps most importantly, the typical US or EU or Canadian or Australian company is not experienced at selling products or services within China and is hindered from doing so by China’s discriminatory Internet regime. Selling products and services into China via a distribution agreement is a way to offload these complicated issues on an experienced China company. For the basics on what is involved in establishing a distribution relationship with a Chinese company, check out the following:

Today’s post focuses on the following key questions you should be asking yourself and your potential China distributor if you are looking to do distribution agreements with Chinese companies — to a great extent, these same questions apply pretty much everywhere in the world.

1. What will be the payment and shipping terms?  China’s letter of credit system is not very effective. If you ship your products before receiving payment for them, you are taking the full risk that the Chinese side will not pay. Conservative manufacturers usually require full payment before they ship. Less risk averse manufacturers ship on 30 days after the date of shipment (Net30) terms. These manufacturers provide for the right to shift to payment before ship terms if there is a problem. Shipping terms can be CIF or ExWorks. ExWorks is more common, since estimating shipping and insurance costs can be difficult.

2. Will you have sales milestones? This is always a good idea in an exclusive distributor arrangement. Sales milestones for China distributors are usually set on a quarterly basis and not broken down by province. The issue of sales milestone is usually a big issue, so setting the milestones in a way that is clear and simple to understand is important.

3. What will be the term of your distribution agreement? f you are going to have here an exclusive agreement its term/length becomes of critical importance. The normal procedure is to provide for a term long enough to give the Chinese distributor time to earn back its efforts in promoting your products. A three year term is typically the minimum, with five years more common. Most China distributors that plan to put in substantial work to market and sell your products will require the distribution agreement to automatically renew if they achieve their sales milestones. The China side will often want a provision stating that if the parties cannot agree on new milestones after the end of the first term, renewal will be automatic based on some predetermined formula. Chinese distributors that do not require something like this are oftentimes not planning to do the work necessary to succeed.

4. What about your brand name? When selling products in China, you typically will need Chinese and English language trademark protection for each product that will be sold. Serious distributors insist such protections be in place. You can use your own China trademark lawyers to handle the appropriate China trademark registrations or you can have your distributor take care of this on your behalf as your agent. In either case, you should take care of the trademark registrations as soon as possible, preferably before any distribution gets signed or, better yet, before any negotiations even begin. See China Trademarks: Register Yours BEFORE You Do ANYTHING Else. If your distributor takes care of this for you, you will want to ensure that the registrations are done in your name and not in theirs.

5. What law will govern your distribution relationship? This really should not even be in the form of a question in that you are going to need your distribution agreement to be enforceable in the PRC and for that to be the case it must be drafted with Chinese law as the governing law and the Chinese language as its controlling language, and with enforcement in a Chinese court. For why we draft our China contracts this way, check out China Contracts that Work and China Contracts: Make Them Enforceable Or Don’t Bother.

6. How will you protect your trade secrets? China NNN (non-use, no disclosure, non-circumvention) language should go into your distribution agreement and if your China distributor will not accept this, find a new distributor.

7. Who will pay for what? Are you going to pay for marketing/advertising your product in China or will your distributor do that or will you share. Clarity is the key here. Will your technical product documents be translated into Chinese? If yes, who will do this and who will pay for this?

8. How are you planning to deal with warranties? A standard approach is for you to draft the warranty and then have your distributer provide this warranty to consumers without any changes. Under this approach you will need to work with your distributor to design an appropriate warranty that a) works for your products, b) works for your company and your distributer, c) meets market demands, and d) complies with Chinese law. The alternative is to allow your distributor to provide whatever warranty it wants to consumers. Your warranty is with the distributor and you will not cover any warranty beyond that which you have specifically agreed with your distributor. Under this sort of arrangement you have no contractual relationship with the consumers and the consumers have no legal basis to assert warranty claims against you. They are limited to making claims only against your distributor. This option is consistent with the legal status of a distributor that buys and then resells your products. However, under this approach you no longer control the nature of the warranty and many companies do not want to give up this control. Much will depend on the nature of your product, your consumers and your trust in your distributer.

9. Who determines the sales price to consumers? Normally, the China distributor is free to set the prices it wants for the products, since it has purchased the product and therefore owns them. However, many of our clients wish to exercise at least some pricing control. Absolute resale price maintenance is not legal in China so you cannot dictate the sales price. You can, however, require your distributor to work with you on pricing and even set a pricing product range, both maximum and minimum.

10. What training will you provide your distributor? Where will your provided this (in China or in your home country)? How will training costs be determined and who will pay those costs?

Go forth and prosper.

 

China employment lawyersIt is fairly easy for China-based employees to leave their employment. Regardless of the circumstances surrounding an employee’s departure/termination, China employers must issue a proof of termination of employment relationship document to the departing employee. It is generally not possible for a China employer to hold the employee to specific performance by making the employee come back work or continue working. Sometimes it is possible for the employer to pursue the departing employee for contract or other damages, but doing so rarely makes business sense. The reverse is NOT true though as it is easy for a terminated employee to hold the employer to specific performance (i.e., reinstatement) and to sue for damages.

In other words, if you are a China-based employer, watch out! But I’m guessing all of you already knew that, but with quickly deteriorating relations between the United States and China and between Canada and China and between much/most of the EU and China, this warning has never been more important or urgent.

Consider this hypothetical (based on a real case in Shanghai with the facts simplified and slightly revised). Employer and Employee enter into an employment contract for a fixed term. Employee leaves before the end of the term. Employee demands Employer issue a proof of termination of employment relationship document. Employer provides the requested document but Employee claims Employer put in the wrong start date and so refuses to accept the document. Employee begins working for a new employer several days later. Employee then sues Employer for damages allegedly caused by Employer’s failure to provide a proof of termination document. How will this case turn out for the parties?

The short answer is the employer will probably have to pay damages for having failed to timely provide its former employee with a proof of termination document. Employers generally must issue such a document when the employment contract is terminated and no later than 15 days after the termination. This document is important for China employees because China employers usually require this as part of their new employee on-boarding process, and without such a document, the employee will likely not be able to work for the new employer. China employees also need this document to claim unemployment benefits. Our China employment lawyers often see foreign employers in China get into trouble for failing to get this key document to their former employees or being late in doing so. We have had to settle far too many employee disputes arising from these mistakes.

Note though that in the above hypothetical the employer did provide its employee with the proof of termination document but it was rejected by the employee. In an employment dispute, the employer bears the burden of proving the employee’s commencement date. So when an employer is unable to produce evidence showing the employee’s commencement date is indeed correct on the rejected proof of termination document, the employer will have to bear the adverse consequences of failing to meet its burden of proof. In the actual case on which I based the hypothetical, the employer did not issue a proof of termination document until trial; nor was it able to produce evidence showing that it had issued a proof of termination document within 15 days after termination. The employer was therefore required to pay its former employee damages (calculated based on the local unemployment insurance payment standard) from the 16th day after the employee left the job until the day the employee started her new job. All of this employer’s problems could have been avoided had it properly handled its task of providing this one document to its employee at the time of employee separation.

As a foreign company that employs people in China, you should make sure your employee terminations are performed correctly. This has always been the bare minimum, but this is especially true today.

 

 

 

 

How to form a china wfoe

Our China lawyers are often asked about the steps it takes to form a China WFOE. So often, in fact, that we long along drafted a stock response to that question. Figuring this response would be helpful to you-all, our faithful readers, I am running it below. Please note that the below is a generic roadmap for WFOE formation and the exact details for forming a WFOE in China will depend on, among other things, the WFOE’s business scope and the city/district in which the WFOE will be formed.

Generally, if all goes smoothly, the overall process will typically take 3-5 months. We do not breakdown each of the steps as to time because the time involved for each step can vary wildly, depending on (for instance) how long it takes to prepare financial information, negotiate a lease, obtain documents from the landlord, authenticate relevant documents, and validate the corporate structure. Lately though the Chinese authorities have been quite efficient in processing applications, at least in the major cities and usually once we have provided them with all of the requested information in the exact format they need, they usually provide a response within 2-3 weeks. It is getting to that point that takes so much time.

Generic WFOE Formation – Roadmap

A. Name Approval Application

  1. WFOE Investor(s): corporate structure chart, authenticated corporate documents, passports and other documents identifying key personnel.
  2. Business Scope: define scope of business.
  3. Registered Capital: determine amount of capital to be invested, pursuant to financial projections.
  4. Total Investment Amount: determine maximum investment amount (capital + investor loans).
  5. Capital Contribution Timeframe: default is within 30 years.
  6. Proposed Chinese Name(s) for WFOE: at least 6-10 choices.
  7. WFOE Address: dependent on lease/office space.
  8. Name Approval Application Form: prepared by your lawyers, signed by client.

B. During Formation Process

  1. Select accountant.
  2. Select bank.
  3. Draft labor and employment documents: employment agreements, WFOE rules and regulations, non-compete agreements, confidentiality agreements, etc.

C. Post-Formation

  1. Open bank account.
  2. Carve chops.
  3. Open social insurance accounts and begin tax reporting.
  4. Other post-formation activity as relevant.

For more on what it takes to form a China WFOE, check out the following: