Foreign Investment in China

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:

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

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

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

First,

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

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

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

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

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

What will you do?

Doing business in Thailand

 

By: John DiDominic*

With all that has been happening with China lately on trade, Thailand is emerging as a highly attractive investment destination. Thailand has consistent and well-defined investment policies, increasing regional connections, and a government committed to improving its transportation infrastructure. It also (for the most part) has had long-term political and economic stability.

Thailand is Southeast Asia’s second largest economy with a well-established market system. In addition to being an attractive production base, its 70 million people make for a dynamic consumer market.

Thailand is well located between India and China and it shares maritime boundaries with Vietnam, Indonesia, and India. Thailand is the anchor economy for the neighboring developing countries of Laos, Myanmar and Cambodia and it is strategically located to serve markets in and beyond Southeast Asia.

The business climate in Thailand is welcoming to foreign investment and further deregulation and trade liberalization are taking place on many fronts, largely driven by Thailand’s participation in the Association of Southeast Nations (ASEAN) Economic Community (AEC). According to a recent World Bank study Thailand’s business climate has improved considerably since 2013 and it now ranks as the second most promising economy in East Asia. The World Bank rightly describes Thailand as “one of the great development success stories. Due to smart economic policies it has become an upper middle income economy and is making progress towards meeting the Sustainable Development Goals.” The World Bank Group’s 2017 Doing Business report “ranks Thailand in 26th place among 190 economies in the ease of doing business for small and medium enterprises around the world, up from 48th place when applying the same methodology to last year’s and this year’s data. The report also recognizes Thailand as one of top 10 economies that have improved most in the ease of doing business in the last year worldwide.” China came in at number 78.

Thailand is already a major destination for foreign direct investment and China’s trade problems have put that into hyperdrive. I moved to Thailand to live and work in 2007 and this is the best I’ve ever seen it.

Thailand 4.0

Thailand’s industrial sector is looking to move up the value chain and expand its capabilities to produce greater value-added products in a variety of modern industries.  These include the fields of Robotics, Medicine, Aviation, Advanced Manufacturing, Biotechnology, Nanotechnology, Advanced Material Technology, and Digital Technology. These efforts are known as Thailand 4.0, a master plan to move the country from one of an abundance of cheap unskilled labor to an innovation-based value economy. This strategy seeks to spur industries to progress up the technology ladder.  Thailand 4.0 mandates broad reforms that address economic stability, ease of doing business, human capital, equal economic opportunities, environmental sustainability, competitiveness, and effective government bureaucracies.

Incentives

In the current competitive global marketplace, simply possessing a favorable geographic location, efficient infrastructure, stable government and stable access to natural resources is often not enough to attract interest from multinational businesses searching for the optimal placement of their next factory. To stay ahead of regional rivals in competing for finite investment dollars, Thailand offers several financial and other incentives for companies keen to set up shop there. These incentives can vary by product and location but include the following:

·         Tax Incentives:

o   Exemption of up to 15 years on corporate income tax for certain industries

o   ASEAN’s second-lowest corporate tax rate (20%)

o   Double deductions for transportation, electricity and water supply costs

o   An additional 25% deduction for the cost of installing or constructing facilities

o   Exemptions on import duties for some essential materials and machinery

o   Tax deductions of up to 300% for qualified R&D expenditures

o   Tax deductions of 200% for qualified expenditures made in intellectual property acquisition and licensing fees for commercializing technology, technology training; donations to specific research and training institutions, and sourcing support

·         Non-Tax Incentives:

o   Special four-year visas for skilled workers and high-level executives

o   The right to lease state land for up to 99 years.

o   Permission to bring in foreign workers, own land, and take or remit foreign currency abroad.

o   Subsidies for energy conservation programs

·         Industrial and Special Economic Zones:

o   infrastructure and logistical advantages, such as electrical power, water supply, transportation, communications and waste treatment

o   Some of these infrastructure expenses are tax-deductible.

o   Easing restrictions on cross-border traffic of goods and labor to establish cross-border supply chains.

Trade Agreements.

·         Country Agreements.  Thailand is a WTO member and has free trade agreements with China, Japan, South Korea, India, Australia and New Zealand.

·         US Treaty of Amity.  U.S. owned businesses enjoy investment benefits through the U.S.-Thailand Treaty of Amity, originally signed in 1833 (This is the United States’ second oldest treaty!).  The Treaty allows U.S. citizens and businesses incorporated in the United States or in Thailand that are majority-owned by U.S. citizens to engage in business on the same basis as Thai companies (national treatment) and exempts them from most restrictions on foreign investment imposed by the Foreign Business Act.

·         ASEAN.  Thailand’s membership in the Association of Southeast Asian Nations (ASEAN) provides businesses in Thailand the advantages of the ASEAN Economic Community, a single market of more than 600 million people covering 10 countries in the region. This enables the free flow of goods, investments, labor and capital within the community.

·         China-ASEAN.  A China-ASEAN free trade deal also helps mitigate the trade-war risk for companies trading with both the United States and China.

Summary.

Is the time right for your business in Thailand? That depends on a variety of factors specific to your business, your industry and, most importantly, your goals. But is the time right for doing business in Thailand? Yes it is.

* John DiDominic spent seven years as a management consultant with the APM Group (Thailand’s leading domestic management consulting company) in Bangkok, Thailand and he has since focused on helping foreign companies navigate and do business in Thailand. For more than a decade, John has been our law firm’s go-to person for just about anything Thailand.

China Law Professor Donald Clarke sent me a great article this week from New York Magazine, entitled, How China Drove Out Mister Softee. Professor Clarke’s email with the link said the following:

Thought you might like this. Interestingly, it is NOT a story of “guy skirts rules, naively trusts Chinese partner, gets screwed.” It’s “guy does everything absolutely by the book, has reliable Chinese partner who does not screw him, and still gets screwed by changing political atmosphere.” For him to get competition eventually is quite normal, and the competition wasn’t using a trade name similar to his. But the rules were not evenly enforced.

This is the sort of story I both love and hate. I love this sort of story because it is interesting and important but I hate it because I constantly and aggressively stress to my clients the need to follow China’s laws to the letter and with that I ought to be able to tell them that by doing so they will have no problems. I also hate this sort of story because it reveals the cynical truth that the reality is really more the opposite: if you do not follow China’s laws you will have a problem. If you do follow Chinese laws the odds of your having a problem will go way down, but hey, it is no guarantee. Truth is that as a foreign company doing business in China you will be a target and this means you must follow the laws to avoid being an easy and legal target but even if you do follow the rules you are still a target.

Quick aside. Why the Jim Carey clip about “messing with the doo?” Two reasons. One, It’s just a great clip. And two, I love soft-serve ice cream and I have fond memories of eating Mr. Softee ice cream when visiting my grandmother in New Jersey. So I see China’s messing with Mister Softee as the equivalent of “messing with the doo.” But I digress.

So if you read the New York Magazine article, you will learn that Turner Sparks brought New York’s iconic Mister Softee trucks for the first time to China” back in 2007 and eventually built his ice cream empire to ten trucks and 25 employees in Suzhou. You will also learn the following:

Mr. Sparks did local TV and newspaper interviews and was a fixture at school and corporate events, where he and his team doled out waffle-cone soft-serve to thousands. During one corporate party at Bosch, an international electronics company, he sold $9,000 worth of $1 cones in just two hours.

Competition was scarce, because he essentially invented the Suzhou ice-cream-truck market. “All these trucks were just going nuts, doing really well. Huge lines all the time,” he told me. “Everyone knew Mister Softee.”

He planned an ambitious expansion, and lined up investors to back it: He wanted to quintuple his fleet to 50 trucks, add more storefronts, and move into new territory.

More importantly, you will learn how tough it can be to do business in China, because you will learn that instead of expanding his business in China, Mr. Sparks ended up leaving China “with just enough money to reinvent his life as a New York stand-up comic.” and that “what happened to Sparks is an illustration of how the landscape has shifted for foreign businesses in China since current premier Xi Jinping has taken over the country, and the climate has become considerably less hospitable for foreign business — small ones, in particular.”

The article talks about how things began to change for foreign companies in China starting in 1978 and how Sparks was able to build up his ice cream empire:

They created a local supply chain from scratch, finding vendors for cones, straws and soft-serve mix at a Shanghai food-and-drink expo. Using secret blueprints from Mister Softee, the truck was built in Nanjing by a company that makes telecommunications trucks, armored vehicles, and ambulances. Workers were hired from a job fair, with many long-distance drivers jumping on the opportunity to work locally and try something different. To give the soft-serve the same taste as back home, they shipped the milk in from the U.S.

Suzhou officials worked with Sparks to create a new kind of business permit for their ice-cream trucks, called a Qualified Mobile Vendor License. It let them operate the trucks, but only as “delivery vehicles” for two stores. The license also required they have a staffed office and were restricted to operate at certain spots around the city. The solicitousness of Suzhou officials wasn’t unique. All around China, local governments were inviting in foreign businesses, easing the cost of doing business with tax breaks, and giving them friendly government liaisons to help them navigate the labyrinthine bureaucracy.

Then you will learn how the ice cream empire fell apart, for reasons that will likely not be unfamiliar to most foreign companies that operate in China — taxes and thieving employees who then go out and illegally and even violently compete:

The first inclination Sparks got that things were changing was around 2012, when a local official called him into his office and accused Sparks of not paying enough in taxes.

“Immediately, I knew it was a shakedown,” he said. “This guy was an idiot. He was like, ‘There’s money, I need some.’”

Sparks declined the man’s offer and left, but says that meeting was his first experience with the corruption he’d often heard about in China. Soon after, two new drivers alerted Sparks to a longtime scam by his eight other drivers. They were quietly making extra soft-serve sales and pocketing the money for themselves. Because Mister Softee was a cash business, office workers would count drivers’ ice-cream cones at the start and end of their shifts to make sure they weren’t stealing. To circumvent that control, drivers bought their own cones. When Sparks started measuring the ice-cream mix instead, the drivers would buy extra cones and mix, too.

Eventually, he instituted random checks on drivers and fired several on the spot when they were caught with more mix in their trucks than they had at the start of the day. Soon after, his tires outside his apartment were slashed. Then a fired driver showed up at Mister Softee’s office and threatened to kill the workers there.

Things got more bizarre. In early 2013, just a few weeks after they were fired, Sparks’s former drivers resurfaced with their own unlicensed ice-cream trucks, with knockoff names including Baby Bear, Snow Princess, and Mr. Big. These drivers would park along Mister Softee trucks’ routes to poach customers. Plus, they didn’t have the special city license, which allowed them to operate without having to open storefronts or an office, and they could sell wherever they wanted.

Conway was too far away to help out as problems started cascading. Cai, meanwhile, had moved to the suburbs about an hour away and was starting another printed circuit board business, so had no time to lend a hand.

*   *   *   *

Perhaps the slashed tires and death threats were unique to Mister Softee, but local officials’ deciding to yank support was downright typical of the changing times.

For the record, nothing that happened to Mister Softee in Suzhou is “unique.”

The article then goes on to rightly note that foreign companies that bring technology or know-how that China hasn’t developed on its own are still very much welcome in China, but the others not so much. “One in four foreign businesses are scaling back in China or say they plan to, and most say they feel increasingly unwelcome, according to a 2018 survey from the American Chamber of Commerce in China.”

The article extensively quotes Anil Gupta, professor of University of Maryland’s Smith School of Business, “who’s been researching and writing about China for 25 years” and who has this to say:

Gupta added that blatant knockoff enterprises are so common in China that it’s almost a wonder Mister Softee’s easily replicated business wasn’t copied sooner. Plus, local officials and courts are more likely to back the local knockoffs to support Chinese businesses — to hell with the permits.

“With 99 percent confidence, I would say this was destined to happen,” Gupta said of Mister Softee’s fate. “I would say that God couldn’t even save this business.”

What or who exactly killed Mister Softee. China:

After receiving one-year permits for his trucks without fail from 2007 through 2012, Mister Softee’s permits were withheld without explanation and Sparks couldn’t reach government officials for months to clear up the issue. When Sparks finally heard back from government officials in mid-2013, they told him they would figure out a way to regulate the new trucks. Nearly a year later, with Sparks still operating without a new permit, officials proposed holding a lottery to dole out Suzhou permits to Sparks and the knockoff trucks. Around that time, police started ticketing Mister Softee trucks for parking illegally in spots they’d been working for years.

By 2015, it became clear the lottery would never take place and Sparks’s new round of investment crumbled.

“Part of it was a relief, to know it was over,” Sparks told me. “You feel, obviously, helpless.”

Over the next year, he wound down the business, paid his remaining staff and sold off the trucks so some others could spread the gospel of neighborhood soft-serve to nearby cities.

In early 2016 on a Friday, Mister Softee’s tumultuous foray into China quietly ended with Sparks, his lawyer, and accountant filing liquidation papers and figuring out who they still owed money to. Sparks had already sold off the office furniture to his ice-cream cone supplier.

Ignoring for a minute whether any deity could have saved Mister Softee, was there anything it could have done to survive China? Maybe. Were a company like Mister Softee come to me today, I would likely recommend that instead of going into business in China, it seek our a licensee in China for its name and its ice-cream know how and its trucks look and feel. Indeed, my law firm a few years ago did a licensing deal on behalf of a regional American ice cream that has worked out very well for the American company. I constantly find myself trying to steer clients away from what I call “theoretical massive profits” that can allegedly be realized by going into China as a WFOE or a Joint Venture in favor of a licensing or distributing deal. See Forming a China WFOE: Needed or Not. See also my Forbes Magazine on this: Want Your Product In China? Try Using A Local Distributor.

Welcome to China 2018 people.

What are you seeing out there?

UPDATE: Literally minutes after I wrote this I received an email from a China lawyer friend who said I should have talked about how Mister Softee could have prevented “at least some of its problems” by having made its employees sign non-compete agreements. I don’t think those would have worked because China’s courts generally will not enforce those against any but high level employees and I do not think ice cream truck operators would qualify as high level employees. See

the risks of doing business in China

As China governmental power continues to expand and continues to get more concerned about its slowing economy and how it is viewed by its citizens, it continues to get tough on foreign businesses. China is right now in one of its perpetual crackdowns on foreign companies doing business in China. This makes now a good time for foreign companies doing business in China or with China to determine their China risks. The following ten sets of questions are a good starting point for making that calculation.

1. How does the Chinese government view your industry? If your China business is in an industry in which foreigners are restricted (such as mining or publishing or education) or one in which China’s citizenry has major concerns (food and medicine are classic examples), your risk is likely to be high. If your China business is in an industry that requires you joint venture with a Chinese entity, your risk is also high. If your business is in an industry the Chinese government views as its own province, such as SAAS, cloud computing, the internet, or telecom, your risk is high. On the flip side, there are certain businesses (like the Internet of Things or IoT) China wants to encourage and so if your business comes within that sort of category, your risks will be reduced.

2. Are you in an industry the Chinese people consider to be their government’s responsibility, such as health care or education or environmental protection or food? A number of companies in these areas have been subject to government scrutiny for activities that probably would have been ignored in other industries.

3. Is your company primarily making money from China or spending money in China? If it is the former, you are at increased risk. Does your company have 20 foreign employees for every one Chinese employee? Your risk is high. Does your company have 300 Chinese employees for every one foreign employee? Your risk just went down.

4. Is your company based in the United States or exporting products to the United States? Your risk just went up. China is not particularly happy with the United States right now thanks to the US-China trade war. Equally important, you now need to make sure that any products you send to the United States truly come from the country from which you say they come. United States custom is checking almost everything coming from Asia these days and failing to properly label the products you are sending to the United States can bring huge penalties and jail time. See China Tariffs and What to do Now, Part 1 and China Tariffs and What to do Now, Part 2. See also China or Vietnam for Product Sourcing?

5. Are your China contracts written in Chinese for China? If so, your risks are lower. Or are you using English language template contracts written for a Western legal system (like the United States, Canada, Australia, or the EU)? If so, your risks are higher. See China Contracts: Make Them Enforceable Or Don’t Bother.

6. Do you know what your Chinese staff are doing? Chinese staff often fail to realize foreign companies are treated considerably differently in China than domestic companies, and they fail to act accordingly. Your Chinese staff will usually want to do things the “China way,” but the Chinese government and courts will be judged against the “foreign standard.” See China Compliance: Don’t Rely On Your China Staff. Do you think you can do whatever your Chinese competitors are doing? Your risk just went up. Do you believe that as a foreign company you will be more closely scrutinized and that the laws will be likely be enforced against you? Your risk just went down.

7. Are your China employment contracts and your employer rules and regulations in both Chinese and in English? If you answered yes, good for you; you have lowered your risks. See The Top Six Warning Signs of Impending China Employee Problems. Do you constantly update and audit your employment documents and procedures to make sure you are complying with all national and local employment laws and regulations? If so, you’ve greatly lowered your risks.

8. What have you done to protect your intellectual property from being lost in and to China? If you have the right contracts and the right IP registrations, you have reduced your risks. If you do not, you have increased your risks. See Protect Your IP from China Now not Later. Do you sometimes show your trade secrets to a Chinese company without first making the Chinese company sign a China-specific NNN Agreement? If you do, your IP is probably already gone.

9. What is the culture of your China business? If you are relying on “strategic” relationships to work around the letter or the intent of China’s laws, you are at greater risk. If you do not know well those with whom you are doing business, you are at greater risk. If things are happening that make you uncomfortable, you are at greater risk. If you believe things are happening at your company behind your back, you are at greater risk. If you know your company did not pay every RMB it should have paid in China taxes, you are at great risk. See China Tax Audits: The Day The Music Died.

10. Are you doing business in China without a Chinese legal entity, such as a WFOE, a Joint Venture or even a Representative Office? If you are, you are so off the charts on risk that you and your other personnel should leave China today or tomorrow. See Doing Business in China Without a WFOE: Will the Defendant Please Rise.

China’s government is surprisingly tolerant of problems a foreign company has already fixed, and even of problems a foreign company is truly trying to fix. But the Chinese government rarely tolerates a problem it discovers and about which the foreign company has done nothing. If you check out clean for the above list, congratulations. But if you do not, start making changes now.

China licensing lawyers

True confession. I have been writing too much about foreign companies looking to leave China and not enough about foreign companies looking to get into China. For the last few months, the work lives of the international lawyers at my firm have been inherently tilted towards those looking to leave China, rather than to get in. This is true for the following reasons:

  1. For every phone call or communication we get from a new client, we get 5-10 from existing clients.
  2. Existing clients do not call us to say “everything is going great in China, we’ll talk again soon.” That is not the nature of the lawyer-client relationship. No, they call us to say, “we have this problem in or with China, can you help us?”
  3. The overriding problem our clients have with China these days is the US-China trade war. It is important to note that this is true not just of our US clients, but of our European and Australian and Canadian and Latin American clients as well, because so many of those clients import made in China products into the United States.

But at the same time — and I actually this morning did the best I could with Clio and Lexicata (my law firm’s practice management and client intake software)– the number of companies contacting us to do business in China (including US companies) is much greater the first nine months of this year than the first nine months of last year — by every single possible metric. In other words, as one door is closing, another is opening.

I was reminded of this today after reading an article by Gordon Orr, entitled, Easier to Import into China? Quick aside: Gordon Orr is one of the 2-3 most knowledgable and most thoughtful writers on Linkedin and if you are not following him, you should go here and start doing so. His post needs no question mark because the answer is that it is easier to import into China today than last year and for many, cheaper too.

Orr answers his own question with “Two parts ‘YES,’ one part ‘NO,’ which translates for me to an overall “YES.”

Orr begins his article by discussing the “flood of announcements from China’s government” about how China wants to import more and of how it is moving to make imports easier. He then notes how China’s easing its lending requirements means Chinese companies are right now engorged with cash. All true.

Orr then notes how the following have increased and will continue to increase Chinese imports:

  • Streamlined customs clearance procedures to get product through at a faster pace. Investment at ports and airports will reduce logistical costs.
  • Actual tariff reductions from automotive to pharmaceutical will reduce end user prices by almost US$10bn with collected tariff rates falling to 7.5% from 9.8% last year. Tariffs for electronic equipment and machinery to 8.8% from 12.2%, duties for textiles from 8.4% from 11.5% and for paper products from 5.4% from 6.6%.
  • As trade ministers visit China, they are increasingly handed agreements to take back with them that open up access for products from their home market. For example, over the summer visits by Ministers from the UK led to announcements of the opening up of Chinese markets to UK dairy and beef products
  • Moves to make cross border ecommerce into China easier is an important move for many SMEs, for whom the cost of setting up to export to China has previously been prohibitive. The development of free trade “ports” to hold product in China duty free, the new ecommerce law holding the ecommerce platforms accountable for whether products sold on their platform are genuine, the upgrading of the teams within Alibaba and JD.com to reach out and market to potential exporters to China in dozens of countries globally have all helped SMEs to get to market at lower risk.

The bottom line is that now is a good time to be a seller of foreign products and services into China.

Our China lawyers are seeing how this import push is both directly and indirectly impacting foreign companies. The direct impact shows up with more foreign companies looking to sell into China and more companies seeing their China sales on the rise. The indirect impact shows up with more foreign companies doing brand and technology licensing and distribution deals with Chinese companies looking to leverage foreign technology and branding to their own Chinese customer base. Clio and Lexicata clearly bear this out as well, as our firm has (again, by every possible metric) seen a phenomenal increase in legal work for foreign companies doing licensing and distribution deals with China. We have even seen China be more encouraging of WFOE formations this last year than for perhaps a decade, both in terms of tax incentives and in terms of making the formation itself easier. China also recently liberalized its joint venture laws.  And just to be clear, we have neither heard nor seen American companies being treated any differently than other foreign companies on any of these fronts.

So yes, many foreign companies that manufacture in China are feeling pain these days, but foreign companies that sell in China or sell into China are thriving, perhaps like never before.

What are you seeing out there?

 

 

 

I got a badly written and vituperative email yesterday in response to my post, On the Impact of China Tariffs: Is This a Dead Cat Bounce? In my post I predicted a large decline in manufacturing orders from China, starting in the next few months. The email accused me of “hating China” and wanting “to impede its peaceful” rise and of being “jealous of its progress.” All this because we have been writing of late how so many of our law firm’s own clients and so many others are leaving China, or looking to leave China. We have been getting quite a lot of these sorts of emails lately.

Guess what people. Our post about foreign companies leaving China have nothing to do with our feelings regarding China and everything to do with what we are hearing and seeing. Our statements of fact about companies leaving China are not being made out of animus to China, but out of a desire to tell the truth and help foreign companies figure out what to do about China going forward. Life would be far easier and economically lucrative for us if foreign companies were not running for an exit from China. But from what we see, they are.

We are telling the truth about companies (not just American companies) looking to leave China because part of what we do is help companies legally fulfill their goals and their plans. My firm’s international lawyers help companies negotiate their exits from China and we help companies figure out where to go instead of or in addition to China. We also help companies looking to set up in other countries, do deals involving other countries, protect their IP in other countries, and draft necessary contracts in other countries. In the last few months our international lawyers have been being kept nearly as busy with countries like Vietnam, Cambodia, Indonesia, Thailand, Malaysia, Turkey, India and Pakistan as with China.

The above is but an introduction to what we see as China’s diminished future for foreign companies. Since pretty much the inception of the US-China trade war we have been saying that we do not see its end because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not see China changing on these things, we did not see the trade war ending.

Vice-President Pence’s speech on China earlier this week has only reinforced for me that the trade war between China and the US will not be ending any time soon, if ever. The New York Times has called that speech the Portent of a New Cold War between the United States and China and China’s own Global Times wrote an article entitled, Pence speech shows Washington’s tougher policy on China. Don’t blame us. We are just the messengers. Things are getting very tough between China and the United States right now and the trade war is just a symptom of that, not the disease.

The United States is aggressively and unabashedly doing what it can to isolate China and to remove it from the world of international trade. The new free trade agreement between the United States and Canada is further proof of this as it essentially blocks Canada and Mexico from engaging in free trade with China. See What Trump’s new trade pact signals about China. Word is that shutting out China is going to become a regular thing in all new U.S. trade agreements. See US Commerce’s Ross eyes anti-China ‘poison pill’ for new trade deals. Will the EU and Japan and Latin America play ball on this? I predict that most if not all of them will.

So yes, the above is why we will continue to write about what North American and Latin American and European and Australian businesses should be doing to deal with the new normal regarding China. We are writing these things because we value our credibility and because we presume our readers value our no-holds barred advice — threatening emails or not.

For more on the new normal, check out the following:

And just in case you still believe we are saying the above for political not business reasons, here is your palliative: a great book that asserts the United States is blaming China for the US’s own ills: Blaming China It Might Feel Good but it Won’t Fix America’s Economy, by Ben Shobert, a good friend of mine. Ben — what are you seeing out there in terms of companies looking to leave and/or leaving China? 

What are you-all seeing out there?

So far nobody has written to factually dispute that many (most?) foreign companies are looking to leave and/or are leaving China, but we certainly would welcome such information if you have it! 

UPDATE: An international lawyer friend just sent me a link to this blog post by Renaud Anjoran over at the Quality Inspection Blog. Renaud heads up a top-flight quality inspection/product sourcing company out of Shenzhen, China, but his post was written from Vietnam and is entitled Transferring Production from China to Vietnam to Avoid Tariffs. Renaud’s post is essentially a how to on moving production from China to Vietnam. Does anyone believe Renaud went to Vietnam and wrote this post for reasons other than because his clients too are looking to reduce their dependence on China?

 

China employment law firm
Change your mindset for China employment contracts.

If you have or are going to have employees in China, you need a China-centric written employment contract with each of your employees. Around once a month, one of our China employment lawyers will get a company asking us to “translate our existing employment agreements into Chinese for our China office.” Our response to this request is always the same: “Sorry, we cannot do that because the end result will not work at all for China. You need a China specific employment agreement and our translating what you are using (in the United States or the UK or Canada or Australia or Spain or France or wherever) is not going to work.” At all.

I want to be very clear: translating a foreign country employment agreement into Chinese for use in China is a flat out dangerous thing to do. Even if your translation is perfect and it captures everything you want it to say (which seldom happens), an employment agreement not written specifically for China will contain provisions that do not comply with China’s employment laws or are unworkable in your specific locale in China. For these same reasons, our unwillingness to “just translate a contract into Chinese” extends to every contract we do. See Translate Your Contract For China? The Answer is No.

The most common example our China employment lawyers see in foreign employment agreements of something that will not work under China’s employment system and that can be harmful is a provision stating that the employment is at-will. Under an employment at-will system, an employer is said to be able to terminate an employee for good reason, bad reason or no reason at all, but in China, terminating a China employee almost always requires specific cause both allowed under China’s national and local employments laws and under your employer rules and regulations. Putting an at-will employment provision in your employment agreements will not help you but it can hurt you by making your China management team believe they can fire their China employees for any or no reason at all. We have seen many wrongful termination actions brought by employees terminated by managers who believed they could do so at-will.

If you now think that merely eliminating any references to at-will employment will solve the translation problem, you’re dreaming. China’s entire employment law system is very different from those in Western countries and this necessitates very different employment contracts across the board.

Take overtime pay as another example. If your China-based manager is working under the standard working hours system (this usually means 8 hours on a work day and 40 hours in a week), you must pay or otherwise compensate him or her for any overtime incurred. See China Employee Working Hours and The Things You Cannot Skip. If your manager has been approved by the government to work flexible hours, you may be able to avoid paying overtime, but not always. The foreign country managerial contracts we see usually contain a provision making clear there will be no overtime. If one of your China managers sues you for unpaid overtime in China, you should expect this provision will be Exhibit 1.

Many foreign companies have their own policies on how much notice their employees must give when resigning and these sort of notice requirements are often put into their employment agreements. China though has its own very strict notice requirements and an employer that seeks to require resignation notice longer than China’s own minimum requirements is just asking for legal trouble.

We have also found that using a non-China centric employment agreement causes companies to lose sight of what most matters for China. Seniority, for example, is a huge issue for China employees as it is tied to other important employee benefits, such as statutory vacation days, and statutory severance. It is therefore important as a China employer that you deal extensively and clearly with this issue in your China employee contracts. But because this issue is usually not covered or covered very differently in foreign employment agreements, your using your foreign employment contract as your template for your China employment contracts will mean you either fail to address this critical issue or you will do so very badly. Either way, this will end up hurting you if/when you are sued.

This is not to say that what you have in your existing employment contracts is wholly worthless in formulating your China employment contracts because it isn’t. My firm’s China employment lawyers will often like to review our clients’ existing employment contracts before we start drafting their employment contracts for China. We though want to see those contracts not because we intend to translate them or even because we intend to use them as a template for the China contracts. Rather, we want to see them just because they often broadly outline what is important to our client in its employer-employee relationships.

In terms of your own thinking though, it is best for you to start from scratch. China employment laws are that different and that local and so what you know from Barcelona or Boston or Brisbane or Berlin may not matter or may just get you in trouble.

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

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

Let me explain….

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Use a Chinese distributor

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

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

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

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

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

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

China attorney

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

China lawyers
China’s Economy is Slumping

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

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

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

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

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

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

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

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

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

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

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