China manufacturing lawyers

Like most lawyers, I am hyper logical. That’s our training and that is who we are. We like order and we like clear explanations for when there is disorder. Clear enough so that we know how to prevent future disorder.

China is not terribly orderly, but well over 95% of the time, the problems foreign companies face in and with China are neither new nor unpreventable. Put another way, when I look at what has gone wrong for foreign companies in China I can usually find a number of things the foreign company  should have done differently to have prevented the problem or to have ameliorated it or at least to have positioned itself to have had real recourse once it occurred. Note that positioning yourself to have “real recourse” is often the single best way to prevent a problem in the first place. See e.g., You Need an Enforceable China Contract No Matter How Much You are Feeling the Love and You Need an Enforceable China Contract No Matter How Much You are Feeling the Love, Part 2. Or on the flip side, check out A Lifetime Sentence for Operating in China Without a Lawyer, Well Sorta, where we discuss the case of someone who is not allowed to leave China and highlight all the things this person did wrong to cause his present situation.

So when someone calls one of my firm’s China lawyers with a China problem for which they are entirely blameless my world gets rocked, at least just a bit. I mean, if that were to happen all the time, there would be no need for people to pay for lawyers, right? The one area where our China attorneys most often see this is when a foreign company has had a great relationship with its China factory for ten or twenty years and then all of a sudden the factory just disappears. What was the foreign company supposed to do? Fly out and visit its factory every two weeks to make sure everything was still okay? Get real.

So I was delighted the when a fellow lawyer sent me the link to a blog post titled, 10 Red Flags Your China Supplier is Going Bankrupt, as this post succinctly lays out the following warning signs for spotting a China manufacturer in trouble:

  1. Excess capacity.
  2. Poor lead times.
  3. Layoffs before the Chinese New Year.
  4. Workers aren’t being paid.
  5. Turnover has been rising for weeks.
  6. New payment terms.
  7. Quality is slipping.
  8. Phone calls and emails go unanswered
  9. Factory abruptly changes location.
  10. High customer complaints.

All of these make sense but I particularly like the following for the following reasons:

##3, 4 and 5. Layoffs, turnover and workers not being paid. If the people with whom you regularly work at your China supplier are disappearing or you hear of workers complaining, ghosting very well is about to happen. Our China manufacturing lawyers have seen this before.

#6. New payment terms. Almost always a sign of a factory in rapid decline or a bank switch scam. Either way, beware.

Any additions to the above?

China lawyersPotential clients often ask our China lawyers, “what’s the worst thing that can happen if I don’t do ________.” My usual response is I don’t know or you get sued or you get arrested or you will never be allowed to leave China.” See Doing Business in China with Deportation or Worse Hanging Over Your Head. Whenever I mention prison or getting stuck in China forever I can “hear” the eyes roll on the other end of the computer or the phone because few take this risk seriously.

Guess what people. Get over your First World rule of law biases and start dealing with the real world, or as a friend of mine who regularly deals with China hostage situations is always saying, “this is China.”

The “this” about China hit me hard today via our China Law Blog Facebook page (go here to check that out where, purely coincidentally, my most recent post is how the portion of my Chinese TV interview from yesterday where I discussed hostages in China was completely deleted). Anyway, here is today’s story and it is filled with absolutely critical lessons for anyone doing business in China AND for anyone doing business with China who has any intention of ever going to China.

So I wake up this morning with a Facebook message from someone in trouble in China asking us to publicize his situation on our blog to help in a fundraising campaign. The fundraising campaign is here and it is titled, Being wrongfully sued and not allowed to leave China and rather than have me tell the story, I will pull it word for word from this campaign (see below) and then “unpack” it. Just as an aside, I visited the Getty museum in Los Angeles about a week ago and our tour guide used that word (unpack) before analyzing each and every painting and sculpture. The first time she used it I loved it but by the tenth or so time I hated it. This being your first time….

In 2013/2014, we started a personal training fitness gym in Shenzhen, China with 3 foreign partners. The initial agreement and plan between the partners was to grow the gym, however 2 years into operation, due to a variety of factors beyond our control, we could no longer afford to operate the business at the standard that we wanted. We had to pay high costs and find a way to close the business while respecting the staff and community.

The attempted transfer and closing process took many months while we interviewed potential investors and people who wanted to take it over. It ultimately came down to a young Chinese man who had spent many months in the gym, wanted to own his own gym and was getting to know the operations and the members. Unfortunately for us, this man’s intentions were not honest, and he manipulated the situation to his favour. Since we are foreigners in China, we were not knowledgable about certain legal processes and trusted him in this transfer. He devised a way to take over the business by paying the business’s then upcoming bills due, and some debts owed – amounting to RMB 217,000 (approx US$ 32,000). He then wrote up a pre-agreed contract stating that the RMB217k was a loan and that the business and equipment would serve as collateral should the loan not be paid back. Since we wanted to simply move on from the business, and were not able to handle the expensive monthly overhead, we agreed to this process, meaning we received nothing in the end for a business we had spent 3 years building, but would be free of the business liability.

This Chinese man is a loan shark, and once we had parted ways with him, believing everything was agreed to and wrapped up, we moved on with our lives.

Fast-forward two years, and unbeknownst to us, this man had filed a lawsuit, claiming that the business owed him the RMB 217k. The case was filed, and was ruled in his favor, since we had no knowledge of the case and thus never showed up to court to contest this man’s false version of events. It wasn’t until John tried to leave the country that we came to find out about its conclusion as he was told that he would not be allowed to leave China. In China the legal system greatly favours Chinese, and the entire case was processed and closed without our knowledge and thus no response from us, and as it stands now we are being ordered to pay a whopping RMB 250k ($40K).

We want to chance to set the record straight and show the court the documentation which shows the agreement we had and how this man has committed fraud. We want to re-open the case, and respond to the verdict that was passed without our knowledge. In order to fight the case we need to hire a lawyer and pay court costs and so are asking our family, friends and any citizens of the world who can support our cause and pursuit for the truth.

Initially we are trying to raise RMB 55K ($8K) to cover the legal and court fees, so we can do everything possible to clear our good name and release the government hold on John’s passport. This will be a long, difficult battle but we will keep you updated every step of the way and maintain full transparency throughout this process.

Thank you so much for taking the time to read this, and for your support, whether financial or just by sending positive energy and thoughts our way.

Now for the legal unpacking (that’s only by second time with that word) and an analysis of what likely went wrong and what probably should be done to try to solve it. The quotes from above are in normal font and our analysis is in italics.

  1. “He then wrote up a pre-agreed contract stating that the RMB217k was a loan and that the business and equipment would serve as collateral should the loan not be paid back. Since we wanted to simply move on from the business, and were not able to handle the expensive monthly overhead, we agreed to this process, meaning we received nothing in the end for a business we had spent 3 years building, but would be free of the business liability.”  Mistakes: Not using a lawyer with this contract. Based on the above, it very much appears that this was a loan contract for RMB217k and this person(s) did not fully realize that. Any competent lawyer could have told them that. I am guessing the contract was in Chinese — why wouldn’t it be as it was a Chinese transaction —  and that may also explain why it was not fully understood. Or maybe it was a situation where eagerness took precedence over common sense. Who knows? Bottom line is that you should never sign a contract without fully understanding it and you should virtually never sign a contract without the assistance of a qualified lawyer.
  2. Fast-forward two years, and unbeknownst to us, this man had filed a lawsuit, claiming that the business owed him the RMB 217k. The case was filed, and was ruled in his favor, since we had no knowledge of the case and thus never showed up to court to contest this man’s false version of events. Mistakes: Maybe none, or maybe this person received notice of the lawsuit but did not realize what it was. I say this because Chinese courts tend to be very good at getting their notices out and they also tend not to rule until it has been confirmed that notice was received.
  3. It wasn’t until John tried to leave the country that we came to find out about its conclusion as he was told that he would not be allowed to leave China. Mistakes: Chinese law allows the government to not allow people to leave who owe money. This is why our China lawyers are constantly telling people not to go to China if they MIGHT owe money and to get the hell out of China as quickly as possible if they are there. See Maybe Owe Money To China? Don’t Go There. 
  4. In China the legal system greatly favours Chinese, and the entire case was processed and closed without our knowledge and thus no response from us, and as it stands now we are being ordered to pay a whopping RMB 250k ($40K). Mistakes: I’m guessing a Chinese defendant would have had the same result as it sounds like a fairly garden variety loan agreement and this amount probably included interest and perhaps attorneys’ fees as well.
  5. We want to chance to set the record straight and show the court the documentation which shows the agreement we had and how this man has committed fraud. We want to re-open the case, and respond to the verdict that was passed without our knowledge. In order to fight the case we need to hire a lawyer and pay court costs and so are asking our family, friends and any citizens of the world who can support our cause and pursuit for the truth. Mistakes: Is it even possible to re-open the case at this point? I do not know but I doubt that it is. I could be wrong about this, but it seems to me that this person is doubling down on his mistakes by again not hiring a lawyer to figure out the best way to get out of this. Let’s just suppose it is not to late to try to “re-open” the case. In most countries of which I am aware, to be able to re-open a case like this you must not only show that you were not given notice of the case you also must show that if the case were to be re-opened that you have at least some chance of overturning the ruling on the merits. If this is a legal and valid and garden variety loan agreement, that chance may very well not be there. If re-opening the case is going to be impossible, no money should be spent on that route. It probably should instead be spent on trying to strike a deal with the lender and in return for whatever payment he accepts, a settlement agreement is signed (this settlement agreement should be in Chinese and pursuant to Chinese law) and then used to get the hold on leaving China lifted. 

But in the end, this person does need money to hire a Chinese lawyer (probably ideally based in whatever city in which the lawsuit was brought) to figure out how to figure out the situation and help this person get out of China.

China lawyers

A China lawyer I know was asked by a reporter whether business relationships between the United States and China will return to normal if a trade deal is reached. His response was as follows (per an email):

No deal between China and the US will cause everyone on both sides to say, “we were just kidding.” The tariffs and the arrests and the threats and the heightened risk have impacted companies and those things are not going to be forgotten. Many companies that could quickly reduce their dependence on China have done so or are continuing to put things in place to do so, no matter what happens on the trade deal. Many are being open about wanting to get out of China as fast as possible no matter what.

Many Americans living and working in China say they feel “hated” there and that makes them very uncomfortable. Many Canadian companies (and American companies as well, but to a lesser extent) have curtailed their travels to China out of sheer (and justified) fear. This will undoubtedly lead to many of them curtailing their China business as well. People are seeing China for what it really is and they don’t like it and they want out. Add in the fact that wages and costs in China just keep rising and you are essentially have the perfect storm for foreign companies to leave China or at least reduce their presence there.

The China lawyers at my firm are hearing the same sort of things. More importantly, we are being tasked with helping our clients reduce or eliminate their presence in China and then working with them on the legal side of doing business with other countries. What countries? So far we are seeing/hearing the following:

1. Thailand is very much open for business.

2. Vietnam is very much open for business, but it has become so “busy” on so many fronts that lead times can be quite slow.

3. Mexico is very much open for business. Some companies refuse even to consider Mexico because of security fears. We see this as a huge mistake because there are plenty of great areas in Mexico that are shockingly safe.

4. The Philippines is very much open for business and we have been shocked at the breadth and depth of the manufacturing there.

5. Malaysia is very much open for business.

6. Taiwan. We have seen many companies that used to be in Taiwan return to Taiwan. Taiwan is a very easy country in which to do business, but it does tend to be more expensive than China.

7. Turkey. I am hearing of a few companies looking at Turkey. I find this very interesting because I did a year of foreign study there and learned Turkish and I have friends from that time who are lawyers there.

8. India, Bangladesh, Pakistan, Cambodia, and Sri Lanka.  Mostly clothing, at least so far.

9. Poland, Portugal and Spain. We see a lot of Spain interest because we have lawyers there, but very little of that is related to China. We are seeing nascent interest in Poland and Portugal, especially for tech (software).

But China is not going to “just go away.” No way. It’s not going to become “an even larger, more powerful North Korea,” as I have heard some threaten will happen if the United States and the EU were to hang tough against China. No way. What I see is American (and European and Australian companies better recognizing what it is like to do business with China or in China. The days of so many companies having stars in their eyes about China are over and this newfound realism can only be a good thing. Will American and European and Australian companies continue to do business with China? Absolutely yes, but in lower numbers than previously. How much lower? Hard to say, but I would anticipate seeing a steady decline (maybe totally around 30%) over the next five years. China will remain a big and important country and that should not be discounted. But the big change we are seeing and expect to see accelerate is foreign companies that would in the past just check the China box are now exploring other countries as well. And this too can only be a good thing.

What are you seeing out there? No really, please tell us in the comments below. 

China confidentiality agreements trade secret agreementsAs part of our China company formation work, our China lawyers help our clients with their employment matters that arise before, during and after their China entity (usually a WFOE) is formed. Among other things, we draft the employment documents needed for a newly established WFOE. When a WFOE is up and running, it needs employee agreements in place for all its employees and we usually recommend what we call an “Initial Employment Package,” which includes the following for each employee:

  1. Employment Contracts
  2. Rules and Regulations
  3. Trade Secrecy and Intellectual Property Protection Agreements and
  4. Sign Off Agreements (acknowledging each employee’s receipt of the Rules and Regulations)

These China employment packages also often include Non-compete Agreements and Education/Training Reimbursement Agreements as well.

One of the common questions we get from both existing and prospective clients is why they need their employees to sign a trade secrecy agreement at all and in this post I briefly explain why our China employment lawyers always recommend having such an agreement.

Consider this scenario. A China employer hires an employee and gives the employee access to some or all of the company’s trade secrets. The employee then leaves employment and takes the material with her. What can the employer do? Suppose the employee never signed either a trade secrecy agreement or a non-competition agreement.

Since the theft of trade secrets is a both a crime in China and gives rise to a civil claim, the lack of a signed trade secrecy agreement does not bar the employer from suing the employee and/or reporting her to the police. But to succeed on either front there must be clear evidence that the employee took something and that what the employee took was in fact a trade secret. And that is where things can get difficult. Very difficult. For information to qualify as a trade secret in China, all of the following must be true:

1. The information is technical or business information unknown to the public.

2. The information must have economic value.

3. The owner of the trade secret undertook reasonable measures to maintain its confidentiality.

Are you certain you will be able to prove all of the above about everything you do not want your employees taking with them? In our experience, this usually ranges from difficult to impossible simply because most companies are not terribly careful about preserving their secrets.

Though it is possible to bring a trade secret lawsuit in the absence of an agreement protecting confidential information, a trade secrecy agreement almost invariably makes that lawsuit faster, cheaper and — most importantly — better. This is because if your trade secrecy agreement says not to steal X, Y and Z and an employee steals X, Y or Z, you can sue that employee for what should be a relatively clearcut breach of contract, rather than having to prove out everything related to trade secrets, as mentioned above. You will not need to prove that what was taken was a trade secret because your trade secrecy agreement with your employee will make clear what the employee can and cannot use outside your company, regardless of whether it is or is not a trade secret.

Trade secrecy agreements also make clear to your employees what is okay and what isn’t and they let your employee know that you can sue and win if they violate it. And by doing so, they greatly decrease the risk of an employee walking out the door with your trade secrets — as defined by you, not by complicated regulations and a random Chinese court.

One of the things our employer audits consistently reveal is that even companies that require trade secrecy agreements often (like about 90 percent of the time) fail to get all of their employees to sign these. We have learned this from our employer audits and we have learned this from companies that come to us after one of their employees has taken their trade secrets and joined a competitor or started their own competing business.

China employers should also have a clearly documented secrecy/confidentiality policy that sets forth how they handle and protect their confidential information. This coupled with a trade secrecy agreement will give the employer the maximum legal benefits and protections.

Bottom line: Make sure all your employees execute an English/Chinese trade secrecy agreement at the beginning of their employment and make sure your rules and regulations deal appropriately with your trade secrets as well.

 

 

 

Alibaba Counterfeit Lawyer

I got an email yesterday from a company called Vintage Industrial, out of Phoenix, Arizona. Vintage Industrial makes gorgeous retro furniture pretty much entirely by hand, using old-school techniques. I am not sure why I got this email at my law firm email address. I say this because the email (as I read it) had two purposes. One, to get me to buy furniture from Vintage Industrial.  And two, to tell me about how knock-offs of its furniture are being sold on Alibaba. It accomplished the second of the two purposes by prominently including a New York Times article on its China counterfeiting problems, entitled, A Small Table Maker Takes On Alibaba’s Flood of Fakes.

Not being in the market for furniture (we just last month ordered new conference room tables for two of our U.S. offices!), I went straight to reading the article. The article essentially says the following:

  1. Many companies have knock offs of their products sold on Alibaba.
  2. These knock offs can negatively impact sales of the real thing.
  3. It is really difficult to get Alibaba to remove the knock offs and pretty much as soon as they do, a fresh round of knock offs start up again and keeping knock offs off Alibaba is like whack-a-mole

All true.

Our China IP lawyers are constantly contacted by American and European companies regarding counterfeits of their products being sold on Chinese e-commerce sites, mostly Alibaba (Taobao, Tmall, Alibaba, AliExpress, 1688.com, etc.). These sites have formal internal procedures for removing product listings that infringe a third party’s IP rights. The procedures are actually relatively easy to follow if you are fluent in either Chinese or Chinglish. But because you must follow these procedures to the letter, for most companies, removing counterfeits is usually no easy or fast task. The New York Times article talks about the owner of Vintage Industrial sometimes spending 12 hours a day on counterfeit removal. Among other things, you usually must provide documentation proving (1) you and your company exist and you are the IP owner and you as the IP owner still have the rights to the IP in question. Only after you have submitted these documents and had them verified by the e-commerce site can you even submit a takedown request.

If you do all this and the removal happens, great, but oftentimes things do not go so well with the Chinese e-commerce site and then it is nearly essential to have someone who speaks Chinese, understands Chinese intellectual property law, and is experienced in dealing with the particular Chinese website with which you are having the problem. This person’s job then becomes getting to the high-level employees at the Chinese e-commerce site to explain to them why the listing does in fact violate your IP. The NYT Times spoke with an “Alibaba spokesman [who] said that suggestions that small businesses do not get its attention are “false” and that they can qualify for the streamlined process if their submissions prove reliable. If your company has not built up its own reliability with Alibaba, using a law firm whose Alibaba submissions have been proven reliable will usually be the fastest and best way to get counterfeits of your products taken down.

Our China IP lawyers have succeeded with nearly every takedown request seeking removal of products that infringe our client’s trademarks or copyrights. But about half the time, we tell the potential client they should not bother retaining our law firm for their product removal because there is such a small likelihood of success or because the gain from removal will not be worth the cost — more on that later.  The below summary of an email from one of our China IP lawyers who regularly works on takedown matters across multiple websites (both in China and elsewhere) explains:

Each Chinese website has its own takedown protocols and following those protocols is key to getting counterfeit products removed. We do not advise suing anyone or writing anyone other than the website unless and until we do not succeed in getting your products taken down. Lawsuits are expensive and based on our track record in securing takedowns, the odds are overwhelming that we will never need to file one on your behalf. Writing directly to the seller has a much lower success rate than going to the website and doing that can cause major blowback.

Only the copyright or trademark owner or its authorized representative can make takedown requests. However, sites vary as to the sort of authentication they require for Powers of Attorney. The major Chinese e-commerce sites know our lawyers well enough that they rarely even require we provide them with a formal Power of Attorney to achieve a takedown.

It is usually necessary that we be able prove you have registered your IP (your trademark or your copyright) somewhere. Some Chinese sites sometimes will take down products with foreign IP (i.e., non-China) registrations, but China registrations are always better. Technically, China is obligated to recognize copyrights registered in any Berne Convention signatory nation, but explaining China’s WTO obligations to a 21-year-old customer service representative seldom works. And as you can probably imagine, securing the removal of copyrighted IP for which a copyright has never been registered anywhere is even more difficult.

The more sophisticated/well-heeled the website, the more likely they have a formal takedown procedure. For the smaller websites, we generally have to contact someone directly by telephone. But unless the website is a pirate site (which is rare), it will not want to be sued for hosting counterfeit or pirated items and so long as we do all the work for them, they are usually quite willing to take down rogue products and content.

Once the whole takedown process begins, it pretty much continues forever because the pirates and counterfeiters do jot just go away after their first upload is taken down. Even after we stop one or two of the counterfeiters, you should expect more to pop up. This is why companies hire us to monitor and report and after we remove the existing counterfeits, we should discuss what sort of future programs make sense for your company. We recommend you have us try to figure out who is doing the counterfeiting and what we can do to try to stop it or at least slow it down. Oftentimes it is your own factory or distributor.

Our law firm has an Alibaba account that makes us eligible to seek removal of links that infringe our clients’ IP. We do this by providing the following to Alibaba: (i) our client’s “business license,” (ii) any formal IP registration documents and (iii) (sometimes) a power of attorney signed by the client, authorizing us to file the complaint on its behalf. We also submit the following information: the IP registration number(s), the title of the IP, the name of the IP owner, the type of IP, the country of registration, the time period during which the IP registration is effective, and the period during which the IP owner wishes to protect its IP rights. We translate these documents into Chinese to make things easier on the Chinese website company and to greatly speed things up.

Once Alibaba verifies the above information, we provide the infringing links and removal nearly always occurs very soon after that. For complaints concerning patent rights, we usually need to provide proof of the connection between the infringing material and the IP being infringed. Alibaba normally then sends our complaint to the infringing party. If the infringing party does not respond to our complaint within three working days of receipt — by deleting the infringing link or by filing a cross-complaint — Alibaba will delete the infringing link. Absent prior written permission from Alibaba, the infringing party would then be prohibited from posting the same information on Alibaba again. If the infringing party files a cross-complaint, we will need to deny the cross-complaint, and then Alibaba handles the “dispute.” Alibaba normally resolves such disputes within a few days. Counterfeiters rarely file cross-complaints; they typically just slink away. But they seem to be filing them more often now so as to buy time and to force the foreign company to retain a Chinese-speaking lawyer.

If your IP (especially your trademark or your copyright) is registered in China, securing removal of counterfeit products from Chinese websites is usually relatively fast and easy. If your IP is registered in a country other than China, securing the removal of counterfeit products from Chinese websites will be more difficult. If your IP is not registered in any country, your best strategy for securing removal of infringing products is usually (but not always) to register it first (typically wherever it can be done fastest and cheapest) and then seek removal, rather than to seek removal first.  If you want to protect your products from counterfeits popping up on the web (and then staying there), plan now with your IP filings for takedowns later. See China Trademarks: Register Yours BEFORE You Do ANYTHING Else.

Early in this post, I said there are times where “we tell the potential client they should not bother retaining our law firm for their product removal because the gain from removal will not be worth the cost” and promised more on this later, which is now. So I read the New York Times article from beginning to end and I looked at a ton of the Vintage Industrial products on its website and, like I said above, they make great stuff by hand. Great furniture plus hand-made in the United States using old-school methods is not cheap.

Please allow me to digress a bit. Actually, please allow me to digress a lot.

Many years ago I went to an art gallery in Hanoi and saw a painting I loved, going for around USD$4500. I loved it because its colors pop, its brush strokes are emphatic and incredible, and the eyes of the woman in the painting are mesmerizing.  It was a work of art. Later that day I saw copies/counterfeits of that painting all around Hanoi going for around $50. I ended up waiting a couple of days and then buying the original. It now hangs on a wall in my office — it’s the painting above! Here’s the thing: I never once considered buying the copy because the copy lacked everything the original had. The brush strokes were nothing special. The colors looked tired. And the eyes of the woman were off-kilter. I wanted a beautiful and well-done piece of art, not the equivalent of what hangs in the rooms at a Holiday Inn Express. They are not at all the same product and they don’t appeal to the same customer.

Those who buy a $15 knock-off Gucci purse would not pay $4650 for the real thing if there were no knock-offs; they would buy a $14 no-name purse somewhere else.

Way back in 2012, in How To Protect Your IP From China. Part 1, I wrote talked how it is important to keep your eye on the prize when dealing with your IP in China:

But there are of course circumstances where not going into China DOES greatly increase your chances of avoiding China IP theft. In those situations, should you avoid China? Not necessarily. In those situations you should do a cost-benefit analysis, or as I am always telling my clients, you should “keep your eyes on the prize.” Your company is in business to make money, and as important as IP is to your company – and no doubt for many companies, especially biotech companies, IP can be everything — your end goal is to maximize profits. There will be plenty of times where you can make more than enough money in China to justify putting your IP at risk.

Where I am going with all this is that companies that see knock-offs of their products immediately get all up in arms — and rightly so –and too often want to do “anything and everything’ to stop it. But that is not always going to be the best use of their time or their money. It generally (but not always) will not be worth it for a company to spend money trying to stop knock-offs in a country in which they are making no sales and have no future plans to sell to. It also is often not worth it for a company to spend a lot of time or money trying to stop knock-offs with which it is not competing.

So read the New York Times article and then ask yourself what it’s really about. Is it about Chinese counterfeiting? Is it about how American companies are impacted by Chinese counterfeiting? Is it about how American companies are economically harmed by Chinese counterfeiting. Is it about how American companies need to find a balance between advancing their company’s profits and fighting off Chinese counterfeiting? I think it is about all these things.

What do you think?

Chinese investment FDI law firm
Who eats their pizza with a fork anyway?

We started this blog way back in 2006, and — needless to say — much has changed since then, including the attitudes our international lawyers have about China and things China. I have taken to quickly skimming old blog posts to see issues that have died, things that have changed, and issues we that need updating. I am starting with 2006 and it is in January, 2006, that I found what turned out to be a prescient post regarding incoming Chinese foreign direct investment (FDI). The post is entitled The Chinese are Coming — China FDI and it took the then almost revolutionary position that we should expect a massive increase in Chinese investment into the United States:

With the exception of the Wall Street Journal, the English language press is not giving enough coverage to China’s increasing liberalization of outbound foreign investment. Massive Chinese overseas investment is coming and those ready for it will profit.

For the last year or so, the Chinese government has been increasingly talking about ramping up outbound foreign investment. The government recognizes that few Chinese companies have the skills required to be true global players and that acquiring foreign assets and operating overseas will hasten the learning curve, just as it did for Japanese companies in the 80’s and Korean companies in the 90’s. It also makes for good world politics.

One of our Chinese clients heads the industry council of a mid-sized Chinese city.  Around four months ago (just around the time the Chinese government increased the overseas investment limit) the government informed the council that its member companies should be investing overseas and that the government would match their investments. This past week, the Chinese government announced that sometime in 2006 it will end limits on foreign currency purchases by Chinese companies and do even more to encourage investment overseas. This will accelerate the buying binge among cash-rich Chinese companies looking to expand abroad.  Many already are familiar with CNOOC’s failed bid earlier this year for Unocal and Lenovo’s purchase of IBM’s PC division, but there are smaller asset purchases and buy-out attempts going on all the time.  Just this past week, Onyx Software Corporation, a publicly traded customer management software company in the Seattle suburb of Bellevue, Washington, turned down a buy-out offer from CDC, one of China’s leading enterprise software companies. The Yuan’s value will eventually increase, making foreign assets cheaper for Chinese companies and further accelerating their foreign investments.

Our sources in China tell us to be on the particular lookout for Chinese individuals looking for foreign real estate and Chinese companies looking to expand overseas in electronics, auto parts, software, and heating and air conditioning. Our law firm’s foreign investment lawyers are already seeing and getting some of this work.

In 2005, China foreign direct investment (this is Chinese companies investing outside China) totaled around $19 billion. In 2006, it more than doubled to nearly $42 billion. And in 2017, it was nearly $280 billion. But here is why this 2006 post/prediction seems so quaint now: Chinese foreign direct investment plunged to $180 billion in 2018 and it would not surprise me one bit if it falls below $100 billion in 2019.

I am also pretty certain that the numbers for North America and the EU are falling even faster and harder than for Africa and the Middle East and Latin America. All I know is what we see and what we are seeing in both the United States and in Spain (these are the countries outside China in which our law firm has offices) is that the number of potential incoming China deals is down and — perhaps most importantly — the number of deals that actually close are down even more. Far too often Chinese companies that want to do foreign deals are being blocked by the Chinese government from doing so. See China’s Economic Downturn AND the US-China Trade War AND their Impact on YOUR Company, where we talk about the increasing difficulty in getting money out of China.

What are you seeing out there?

China lawyersOur China lawyers are constantly getting asked how China’s slowing economy and all that is going on between China and the United States will impact foreign business with China. We get asked this by clients, by reporters, and even by friends and those who ask us usually expect a simple answer, like “not well.” It is though more complicated than that. We have been seeing the following (some of which we predicted, some of which we did not):

  1. The Chinese government — for the most part — seems to be bending over backwards to get foreign companies to set up WFOEs and Joint Ventures in China or to stay in China, at least for now. See The China-US Trade War. It’s All Good Inside China! China seems to recognize that its declining economy very much needs foreign capital.
  2. The Chinese government has done nothing to stop foreign companies from registering their IP (trademarks, copyrights, patents, and licensing agreements) in China.
  3. The Chinese government seems to be doing whatever it can to stop money from leaving China for investments in the United States, but this started even before the trade war. See Getting Money Out of China: NOT This Way.
  4. Foreign companies with Chinese employees are facing increasing pressure not to lay off or terminate employees and doing so has gotten considerably more difficult. See Terminating Your China Employees Just Got Tougher.
  5. Foreign companies that do any sort of deal with Chinese companies are facing more IP theft than ever. See below.
  6. Foreign companies that are operating in China illegally are getting in trouble. Big trouble. See below.
  7. Foreign companies that sell their products in China are getting worried, many of them just assuming they will face a steep downturn, but will they? See below.

Increased IP Theft. The big thing our China lawyers are seeing these days is an increase in Chinese companies sacrificing their relationships with foreign companies by stealing foreign company IP. We wrote about this previously in Your China Factory as your Toughest Competitor, but it is not just factories. Our China IP lawyers are seeing this in all industry sectors, especially technology. Why are China companies so willing to risk losing out on future business? When times are bad, greater risk becomes necessary to pay employee wages and to stay alive.  We’ve become fond of pointing out that “since you will essentially be educating your Chinese counter-party in how to compete with you, you need contracts that will at least limit what they can do when they do so.”

Many China businesses have been hard hit by China’s slowing economy and by international businesses mover to lower wage and tariff-free countries in Southeast Asia. Many Chinese companies rightly believe they need to start competing with their foreign customers and partners just to survive.

Our law firm is getting roughly triple the usual number of emails/calls from foreign companies seeking help in trying to remedy/stop their Chinese suppliers and customers and partners from using their IP. We have have gotten more inquiries in the last three months from companies whose China factories are now directly competing with them than in probably the three years before that combined.  Without a good contract and/or good international IP registrations, there is little we can do. See China Contracts: Make Them Enforceable Or Don’t Bother and 8 Reasons to Register Your Trademarks in China. The best way (essentially the only way) to protect against this is to do so early, when you still have leverage and before your Chinese counter-party has run off with your product, your software, your design, and/or your customers. For what you can do to protect yourself from this sort of competition see China NNN Agreements and China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents, Part 1.

Increased Legal Enforcement in China. In every China downturn for the last twenty years, the Chinese government has gone after foreign companies operating illegally there and this one has been no different. Why should the Chinese government allow illegal businesses to compete with their businesses without paying taxes, especially in a downturn? It shouldn’t and it doesn’t and going after illegally operating foreign businesses is a popular thing to do and it is exactly what the Chinese government has ultra-aggressively been doing for months now. In particular, China goes after foreign companies that are paying individuals in China without paying the required employer and employee taxes. This time around, however, this downturn’s round-up of illegally operating foreign businesses has stepped up a notch and the Chinese government has become quicker to arrest and imprison people on criminal charges. See Doing Business in China Without a WFOE: Will the Defendant Please Rise. If you have “independent contractors” in China, please, please, please do not go there until you change how you are doing business in China. See Doing Business in China with Deportation or Worse Hanging Over Your Head and Hiring A Chinese Employee Without A Chinese Entity. Good Luck With That. 

What is always saddest about these crackdowns is that some businesses that thought they were operating legally are not, either because they misunderstood the laws or because someone lied to them about having done the required registrations and paid the required taxes. Now is the time for to make sure you are doing everything legally in China. Do you really have a WFOE or Joint Venture? See How’s Your China WFOE? Please Check. Does the scope of your China entity (your WFOE or Joint Venture) really include exactly what you are doing? See Forming a China WFOE: Scope is Key. Are you really paying all your taxes? China has gotten quite good at finding and punishing foreign companies that do not pay what they owe in taxes.

You would likely be shocked at how often foreign companies are deceived by their own people into believing that what they are doing in China is legal when it is not or that they have paid for something required when they have not. And then there are still those who operate illegally “because everyone does it.” See China Compliance: A Basic Checklist for the basics you should be checking in an effort to avoid China legal problems.

China’s new e-commerce law, which took effect January 1, 2019, threatens to upend the entire daigou business model. As we’ve written previouslydaigou are individual shoppers who purchase goods overseas and then bring them back in their luggage for resale in China. Estimates of the value of goods brought into China this way each year ranges from about $6 billion to upwards of $100 billion.

The new e-commerce law requires anyone who sells products online to (1) register in China and in the country where they purchase goods and (2) pay all required taxes. If the law is strictly implemented and enforced, this would be the end of daigou, because the vast majority of daigou sales are online, and with few exceptions the daigou business model requires tax evasion.

Most of the articles about daigou refer to their wares as grey market goods. This is, at best, misleading. The term “grey market” suggests the existence of a legal loophole or ambiguity. But China’s rules on import tariffs, sales tax, and consumption taxes are quite clear: if you import goods into China, they are subject to tariffs. If you resell goods in China, they are subject to tax. If daigou paid the proper duties and taxes, they would have no business because they could not compete on price with legitimate importers. The major exception would be for goods that were difficult or impossible to buy directly in China.

It’s true that from a trademark standpoint, China has no per se prohibition on parallel imports. See China Trademarks: Counterfeit Goods and Parallel Imports. But this is irrelevant to the question of tax fraud.

As we have noted previously:

China has attempted to crack down on illegal grey market importation through a number of means, including (1) higher taxes on goods brought in by travelers as part of their luggage, (2) lower taxes on goods imported through legitimate channels; and (3) increased penalties for those caught falsifying customs declarations.

Will this new attempt be more successful? Early indications are that it has teeth. Customs officials began cracking down on the import side last fall with enhanced inspections of luggage at airports. Rumors began flying on social media, and then, after LVMH informed investors of such inspections in a conference call last October, luxury goods companies’ stock prices slumped across the board, falling somewhere between 3 and 10 percent later that day.

How and when the e-commerce sites will implement the new law is yet to be seen. Many daigou are already migrating away from “classic” e-commerce and into social media or instant messaging, where they describe their products using code words. You would think this, plus the increased scrutiny at the border, would marginalize daigou as a viable sales option – if you make something difficult enough, only the true believers will remain. But I have learned not to be surprised by the ability of Chinese entrepreneurs (and consumers) to turn on a dime in response to changing market/regulatory conditions – to say nothing of their willingness to ignore tax laws.

It may be more difficult for luxury brands to adapt. I had previously posited that although manufacturers might not be concerned about relying on daigou sales, they should be.

It boggles the mind why any company – let alone a major luxury brand – would have a market entry plan dependent on third parties successfully committing tax evasion. See Grey Market Goods and China, Part Two. But that’s exactly what some brands did, and now they’re scrambling to put together a “real” China strategy. Just for the record, my firm’s China lawyers have always advised against relying on this strategy.

Meanwhile, the trade war lurks as subtext. Right now products brought in by daigou are unofficial in every sense. If they are reported and taxed, then China would reduce its trade imbalance by a significant amount AND increase tax revenues. Easier said than done, even in China. But the trend is clear.

China lawyersChina craves stability. High unemployment can cause instability.

Today’s South China Morning Post, in an article entitled, China’s small businesses forced to cut back on staff just to survive as economic mood sours amid trade war, talks about how China’s slowing economy is leading to government concerns about joblessness:

With the Chinese economy slowing, concern has increased among Chinese policymakers about the outlook for employment, since ensuring a sufficient number of new jobs is seen as a necessary ingredient in maintaining social stability in the country. Employment was the top priority the Politburo set last July when it shifted its economic policy focus to stabilizing growth, leading the government to enact a series of policies to counter rising joblessness. This series will explore the employment challenges faced by different segments of the Chinese economy. The first installment examines the issues confronting small to medium-sized enterprises.

Chinese President Xi Jinping warned on January 21 that the Communist Party needed to pay particular attention to the risks to social stability from rising economic problems, as evidence increasingly suggests that the nation’s employment situation is deteriorating rapidly, particularly among small and medium-sized businesses.

The article goes on to talk about Chinese companies laying off workers but it does not talk about foreign companies doing the same, though of course they are as well, but perhaps more quietly. Our China lawyers are hearing from our clients with WFOEs in China that local government officials are stopping by essentially to make sure no layoffs are coming and if they are, that they are informed in advance.

Our China lawyers have been representing foreign companies in China for more than twenty years and that means we have gone through all sorts of economic and business cycles, including many downturns, though probably none as scary as this one. One of the things we have learned from past downturns is that China really really really does not want foreign companies to layoff or terminate employees during economic downturns and that alone should impact your layoff and termination decisions.

China is going through tough times right now and foreign companies that reduce employment will not be viewed kindly. Before you terminate any employee you should weigh the economic benefits of the termination against the possible detriment in your company’s local standing. If you must terminate any employee, by far the best (safest) way in these troubling times is via a mutual termination that includes a settlement. A private settlement is way less likely to be noticed by your local government and way less likely to cause major concern. For more on employee settlements, check out Terminating a China Employee: Why Mutual Termination is so Often the Key and China Employee Mutual Terminations: The Dos and the Don’ts.

China visas

Are you aware that nearly all of China’s major commercial centers allow you (or at least most of you) to visit visa-free for up to six days? Be honest, did you really know this? I ask because it seems like the China lawyers at my firm often have to explain this to our clients, including to those who go to China often and even to those with a China WFOE, Joint Venture, or Representative office. This 6-day visa free travel is relatively new (for most cities and provinces) and it has not gotten much publicity.

But since the start of this year you can enter into and stay in the following Chinese cities for 144 hours:

  • Beijing
  • Chengdu
  • Kunming
  • Qingdao
  • Shanghai
  • Tianjin
  • Wuhan
  • Xiamen
  • Hebei Province
  • Jiangsu Province
  • Zehjiang Province

To do this you will need a valid passport from any of the 24 Schengen treaty EU countries or one of the following countries along with transport tickets showing you will be leaving China (the PRC) within six days to a country (or is it just a city?) different from the country from which you are entering China:

  • Albania
  • Argentina
  • Australia
  • Bosnia and Herzegovina
  • Brazil
  • Brunei
  • Bulgaria
  • Canada
  • Chile
  • Cyprus
  • Croatia
  • Ireland
  • Japan
  • Korea (South)
  • Macedonia
  • Mexico
  • Montenegro
  • New Zealand
  • Qatar
  • Romania
  • Russia
  • Serbia
  • Singapore
  • UAE
  • Ukraine
  • United Kingdom,
  • United States