China’s New Foreign Investment Law: The “Actually Controlling Person” Requirement is Going to be Tough
One of the features of China’s new Foreign Invested Enterprise (FIE) online filing registration for is the requirement that the foreign investor state who will be the WFOE’s “actually controlling person.” The online form provides that the actually controlling person is either the person or persons who collectively have 50% ownership in the WFOE investor OR the persons who actually control the WFOE investor through other means such as control of the board of directors or other decision making body. For background information on China’s new foreign company registration laws, check out China’s New Foreign Investment Law — Less Than Meets the Eye.
For anyone who works with modern corporation ownership and management, it is obvious that this simply posed question will in many instances actually be quite difficult to answer. Anyone who works in the field can give examples of complex structures for non-public companies that are intentionally structured to ensure that no single individual has actual control.
My first response to the form then was to reply “none” when asked who is the actually controlling person. However, the new form does not allow for this response. It appears that the position of the new form is that if the entity that is to own the WFOE is non-public, all of the individual owners of that entity are controlling persons. If the entity that is to own the WFOE is public or has a public entity owner, then that public entity is the actually controlling person, provided that the public entity is not in fact controlled by an individual through separate contractual measures.
This then results in a bizarrely complex scenario that does not seem to be understood by the PRC regulators. That is, the new online company registration system takes the position that every entity is controlled either by a natural person or by a public corporation. There is nothing in between. We all know this is not true, but the PRC online form does not allow for any alternative response.
What are we faced with at this time? In the section on “actually controlling person”, the new form gives the following options that must be chosen through a checkbox (translation supplied by me):
从以下类型中勾选 Select from the following categories：
□境外上市公司 Foreign Listed Company
□境外自然人 Foreign Natural Person
□外国政府机构（含政府基金）Foreign Government Agency
□国际组织 International Organization
□境内上市公司 Domestic Listed Company
□境内自然人 Domestic Natural Person
Note that NO private business entity of any kind is listed here even though that is one of the most common types of business entity my firm sees; the system allows only for a public company or natural person. That means that for every investor that is NOT a public company, we will need to identify the natural person or persons who control the private entity. In many private companies, no individual owns a controlling share. In this situation, it will not work to say that each owner has a 10% share, so no one is in control. It appears instead that the required response will be that the group of individual shareholders are natural persons who are collectively in control, so we will have to list every one of them. And, if one of the owners is an entity, we will need to drill down and report the ownership of that entity until we finally reach the point of reporting the name of a natural person or the name of a public company. Nothing in between will do.
China’s intent with this new system is clear. The PRC government will no longer allow the use of special purpose vehicles and related entity structures to hide the actual ownership of the investors in PRC foreign invested enterprises. And any attempt by a foreign investor to invoke foreign law that allows secrecy with respect to ownership will almost surely be ignored. MOFCOM has plans to carefully audit all FIEs and that audit will include careful reviewing their ownership structures. More important, however, is that a response that does not list out owners will simply not be accepted by the automated system. A response is therefore forced. A false response is a violation of law that can result in penalties and other legal/administrative action by the PRC government and its agencies.
The way the online form is written does not provide any way around this. We often have clients whose situation is such that listing out their ownership structure as required by the new online company registration system would reveal that Chinese individuals are owners of the U.S. investor, and for that reason the whole investment constitutes a round trip investment. This new company registration system is designed to root out just such round trip investments. Note that Chinese individuals are generally not allowed to have ownership in foreign companies without prior Chinese government approval.
For U.S. investors who are not in this category, this requirement will still be a problem because the actual ownership of the investor is often complex and not public. Think private equity, VC funds, angel funds, family trusts, and limited partnerships. It also is not normal in the United States for private entities to publicly reveal their shareholders. In fact, there are private entities that do not even know who their ultimate individual shareholders are.
The new rules go beyond requiring identifying the controlling persons; they require identifying of each source of investment in the FIE. The online form requires the investor state a) the amount of the investment, b) the type of investment (cash, equipment, land, buildings, intellectual property, etc.) and c) the specific source of each of those types of investment. Under this approach, it is not possible to bury round trip investments from China under other investments that come from outside China. Even if a small part of the total investment is sourced from China, this source must be clearly identified.
As I noted in my earlier post, this new online registration system will not reduce the amount of information that must be provided to MOFCOM. It is just the opposite. To properly complete the online form, substantially more information will need to be gathered and provided to MOFCOM. In addition, local governments will still require their own documentation, and that documentation will still require authentication and other similar procedures. So in the end, China’s new foreign company registration system will end up being even more complex and cumbersome than its current system.
To make it worse, since the MOFCOM report is filed online, there will be no government official available in a local office from whom we can obtain clarification on what is required. This means the form will be submitted without a prior “pre-approval” from the local agency. This will have two negative results. First, it could result in numerous submissions to the online system as an attempt is made to do it right while operating in the dark. Second, due to the vagueness of the requirements, there is substantial risk that MOFCOM officials will find a mistake or defect on subsequent audits.
Registering a China WFOE just got tougher.
My post yesterday, How to Do Business in China AND Sleep at Night, highlighted a very thoughtful comment from an experienced China businessperson. That businessperson emphasized how his China business philosophy is to figure out the laws that apply to foreign companies doing business in China and comply with them.
As China lawyers, my firm wholeheartedly agrees with that sort of philosophy. We have to. We are hired to help our clients discern China’s laws and how to comply with them. If a company is comfortable with violating Chinese law, they don’t have a lot of need for a China attorney. Yesterday’s post concluded with my saying the following:
Yes, scrupulously following the law in China can at times be difficult and expensive, but it is the ONLY way to achieve long term success there. It also is the only way — at least for most people — to sleep soundly at night.
* * * *
Bottom Line: If you want to succeed in China and avoid legal problems, work with the right people and do things the right way. It is that simple. The foreign company doing business in China that operates this way will virtually never get into trouble in China.
A reader who clearly did not like this blog post left the following comment:
It bothers me that you’re a victim of confirmation bias and don’t seem to realize it. You ONLY hear when people have problems. And, let’s face it, there is a tone of “you deserve all the grief you get, you morons!” running through the posts. It’s like this blog is a form of therapy to allow one man to vent his anger at being forced to be highly paid to deal with problems.
This attitude is sorely lacking in real-world, shoe leather experience. What do you do when you call the labor bureau about your question, and they just shrug and tell you “chabuduo”? What do you do when the tax bureau can’t even get you the right forms to file in a timely manner? Or when there’s one strict, expensive standard for foreign companies and another totally lax standard for local companies? One that will drive you out of business if you actually follow it? Or, or, or, a thousand times or. “Go bankrupt” isn’t an option so let’s just eliminate that one already, shall we?
As mentioned in yesterday’s post, just about whenever we talk about foreign companies getting into any sort of trouble in China, we get emails from readers who accuse us of exaggerating. This comment hints at that by accusing us of unrealized confirmation bias. We do not dispute that as attorneys we get contacted a lot after companies have already had a China problem, but by the same token, most businesspeople do not reveal these sorts of problems openly, so there is a confirmation bias going the other way as well. But be that as it may, all we do here is report on what we see and we see a whole lot of foreign companies get into big trouble in China for not following the law. Does anyone really believe this is not the case?
I really don’t know how to respond to the accusation that I believe people “deserve all the grief” they get because they are “morons.” you morons, other than to say that I do not feel that way at all. I also am not the least bit angry at “being forced to be highly paid to deal with problems.” I love my job and I actually find it more interesting to help extricate companies from problems than helping them prevent them. Anyone who accuses me otherwise on this doesn’t know me.
But enough about me; let’s examine the substantive portion of this comment.
The reader asks “what do you do when you call the labor bureau about your question, and they just shrug and tell you “chabuduo”? First off, we don’t just go to the labor bureau with a question. We go to them with a question and with our own analysis of how we see the answer, based on our extensive legal research. When you go to a Chinese governmental body like this, it is the rare time where they give you no answer at all. And in this rare instances, we analyze the situation and give our client our best recommendation, based on a totality of the circumstances.
The reader also asks what do you do “when there’s one strict, expensive standard for foreign companies and another totally lax standard for local companies?” We have written about this situation many times on here and the answer is that you follow the law. Pretty much every country (and even state and city) favors its locals. If you are a foreigner, that is just a cost of doing business, not an excuse for violating the law unless you are willing to pay the penalties for doing so. We have never said that businesspeople in China have no choice about abiding by the law there. Of course they do. But our job as lawyers is to be clear about what the law is and what the risks are for not following it. If someone wants to take those risks, it is entirely up to them, but they should not shoot the messenger for calling out the risks.
We recently wrote two posts (Doing Something China Doesn’t Like? Don’t Go There and How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think). Whenever we blog about foreign companies getting into trouble in China, and especially when we write about foreign personnel being detained or held hostage in China, we receive angry emails from readers. These readers always insist that we are exaggerating the problem and that China is pretty much perfectly safe.
These angry readers have a point. They have a point because it is a really small percentage of foreign companies doing business in China that get in big trouble in China and that is because it is a very small percentage of foreign companies doing business in China that do anything that will get them in big trouble in China. The big question I always have though is what percentage of those doing those thing that will get them in big trouble in China end up getting into big trouble in China? That is the percentage I think is much higher than people realize. And I say that because it just seems that a large percentage of companies our law firm turns down as clients because of how they intend to operate in China are eventually forced to leave China.
But enough with the negative. This post is going to focus on the positive. A very experienced China businessperson, Ward Chartier, left the following comment on here the other day:
Based on what I’ve read since repatriating from China and what I observed in the seven years I worked there, many Western businesspeople regard doing business in China as a sort of Wild West, anything goes situation. This is exacerbated by Chinese nationals hired as consultants or general managers saying things like, “If you want to be successful, this is how we do things in this district. No, it doesn’t meet the requirements of the law, but this is how we get things done here.” “But what about auditors from Beijing?” the hapless Westerner asks. “The mountains are high, and the emperor is far away (old Chinese maxim).” the consultant replies.
The media doesn’t help by reporting on malfeasance in China, thus encouraging readers to think that money (bribes) and influence will pave the way towards success and riches doing business in China.
What worked for me was scrupulously following both the law and the local regulations, involving the local government bureaus in any legal and regulatory gray area decisions to gain their input before taking action, and treating Chinese employees absolutely correctly. Doing these things fully avoided very unhappy surprises from the government.
Thank you Ward for advertising exactly how my law firms’ China lawyers conduct their legal work in China and exactly how we advise our China clients to conduct their business in China. Yes, scrupulously following the law in China can at times be difficult and expensive, but it is the ONLY way to achieve long term success there. It also is the only way — at least for most people — to sleep soundly at night.
Oh, and just to follow up a bit on what Mr. Chartier says about advice from locals (or in this case ersatz locals) I strongly urge you to read one of my favorite blog posts of all time, Your Chinese-American VP Don’t Know Diddley ‘Bout China Law And I Have Friggin Had It.
Bottom Line: If you want to succeed in China and avoid legal problems, work with the right people and do things the right way. It is that simple. The foreign company doing business in China that operates this way will virtually never get into trouble in China.
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.
One of the most common questions our China attorneys get asked, is “whether it is safe for me to go to China” or “whether it is safe for me to stay in China.” In light of the very recent and highly covered Crown Resorts detention, we have been getting these questions even more often of late. For more on the Crown Resorts situation, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think and Doing Something China Doesn’t Like? Don’t Go There, and for more on getting held hostage in China, check out China Hostage Situations With a New Twist).
As lawyers, we have to answer both questions pretty much the same way, which is that we have no way to quantify the exact risk of someone being detained by either the Chinese government or by some private Chinese party using (or not using) the Chinese government for the detention, but detentions happen a lot more often in China than widely realized and it would no doubt be safer to wait out your problems from the safety of your home country or from a country near to China but not China.
In the end, the risk assessment will usually be up to you.
I am riveted by what has been happening in China to “representatives” of Crown Resorts Limited. And every day my fascination increases. Today I read an article in World Casino Directoy entitled Crown Resorts Limited previously warned to stop enticing Chinese VIP gamblers.
Now before I talk more about that article or more about Crown Resorts China problems, let me make the following perfectly clear:
1. Everything I know about Crown Resorts I am getting from the media. None of my firm’s China lawyers have ever represented that company nor do we have any inside information about it.
2. I have no idea whether what I am reading in the media about Crown Resort or its China problems is true or not and probably not all of it is true. But for purposes of this post, I will assume that it is.
According to what I have been reading, 18 Crown Resort representatives in China have been detained by Shanghai police for alleged gambling-related crimes following several months of investigations as part of an operation dubbed “Duanlian”, which translates as “to break the chain.” For my first post (earlier on in my fascination with this case, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think.
Now I learn from a Bloomberg News article, entitled, China Warned Crown, Others About Marketing to Gamblers Last Year. In that article, Bloomberg states that “Chinese authorities warned Crown Resorts Ltd. last year to halt its efforts to attract high rollers from the mainland to gamble overseas, according to a person familiar with the government’s move to detain 18 of the Melbourne-based company’s employees.
Bloomberg notes that Crown Resorts got this warning back in 2015 following the arrests of employees from South Korean casino operators Paradise Group and Grand Korea Leisure Company Limited.
Bloomberg then states that “[a]fter receiving the caution, senior executives from Crown Resorts Limited reportedly began making shorter business trips to China instead of spending long periods in the country. Chinese officials also supposedly observed that the company had shifted its marketing activities to focus more on resorts instead of casinos although local police felt that neither of these moves had amounted to a material change in the operator’s activities.”
If the above is true, one should ask whether Crown really believed that shorter trips by its people to China would solve the problem? And if they did, why on earth did they?
Once again, if you are doing anything that involves China and is viewed as illegal by China, don’t go to China. And again, for more on this check out my prior post on this here.
It is not uncommon for foreign companies doing business in China to brag about how they have not been forced to comply with a particular Chinese law. Much of the time when our China lawyers hear this sort of thing, our response is that there are many laws in China that are not vigorously enforced until they are. And oftentimes they get enforced at the worst possible moment, like when the foreign company seeks to engage in a new and different transaction or get money out of China, or pay taxes.
I was reminded of this the other day when a friend of mine wrote me the following email, regarding the same sort of thing happening regarding newly enacted requirements for factories in China to export their products:
Are you aware that China Customs has issued a new edict requiring all 加工贸易 companies to provide a renewed 商务証 and that in order to get this they (or some other agency) has specified that we must have current land title, workplace safety certificate, environmental certificate and fire safety certificate? If not, you will be hearing more soon. Most of the factories in China cannot come up with all of these because they are illegal. The s**t has really hit the fan here in ________ over this and the edict is said to apply to the whole of China. It was announced in the last week of August and came into force on 1 September and nobody can open a new customs book 手册 until they can come up with the documents.
I have been in my current factory, which is in an industrial park and owned by the local government (镇), for _______ years and just discovered that although my land title is okay, they actually built ___% of the park over farmland. One consequence of this is that they have never been able to issue a proper fire safety certificate, which actually I never knew I needed because they do regular inspections and sign off on something or other. But the fire hydrants in the factory have never been connected and I never understood the reason until now. They were unwilling to explain the real reason and have just fudged all these years saying that it was going to happen soon. Now the chickens have come home to roost. One of the problems is that, as well as being illegal, the underground reticulation system that feeds into the factory fire fighting systems was substandard because the officials seem to have pocketed much of the budget that was set aside for it, probably in the form of kickbacks from the contractor. So all have dirt on their hands and want to keep this quiet. At this stage it seems they have come up with a fudge-around solution in cooperation with the next level up (区) and so I can probably get the docs I need. I hope so. Anyway typical s**t that we have to deal with here, although this one is a magnitude more serious because without the right to import we are out of business.
The problem in China is that you never know what it is that you do not know until it is too late. The say here that the “water is deep” and that is certainly the case when it comes to the doings of the local authorities.
One of the China stories I love telling is of an American company that retained my law firm many years ago to form a WFOE in a fairly remote part of China. This American company had a Chinese General Manager based in that remote city on whom it relied for pretty much everything. Early on in the WFOE formation process, it became clear that there was a lot of tension between how our China lawyers wanted to form the China WFOE (completely by the book) and how the Chinese General Manager wanted to form the China WFOE (really quickly and without dealing with most of the formalities). So at some point we put it to the American company: either give us full control over how this WFOE formation is going to be done or just fire us. Because having us involved and paying lawyer fees to do this “the Chinese way” (the General Manager’s term, not mine) makes no sense at all. The American company agreed with our assessment and told us that it had to go with its General Manager because without that person it would have no Chinese company. We parted on very amiable terms.
So amiable in fact, that about two years later the owner of the American company wrote me to say that though it had managed to get the WFOE formed really easily and really quickly, Beijing had come in and audited the local government and shut down a bunch of improperly formed WFOEs, including theirs.
Bottom Line: You can fool some of the people some of the time, but eventually, if you are not operating legally in China, there will come a time when you will pay the price for that. The Chinese government has stepped up its law and order efforts and that has meant that time is coming more often these days for foreign companies doing business in China.
On October 1, China changed its system for government control over foreign investment. The change was accomplished by revising the statutes concerning wholly foreign owned entities (WFOEs), equity joint ventures and contractual joint ventures and by promulgating a new basic regulation governing registration of foreign invested entities (FIEs).
The big change under China’s new system is that government regulation of foreign invested entities will move from a system that requires MOFCOM (China’s Ministry of Commerce) approval to one that will now just require simple registration with MOFCOM. This change will be implemented through the issuance of a National Negative List. For FIEs that are not restricted or regulated under the National Negative List, MOFCOM requires online registration through a national website employing a standard set of documents. This registration will apply to initial formation of the FIE and to most changes in FIE structure, such as changes in management, ownership and registered capital.
The following essential elements of this new system have already been implemented:
- Final regulations for management of the new registration system were officially promulgated.
- The national website for online filing became operational.
- MOFCOM announced that the 2015 version of the already released Catalogue of Foreign Investment will be treated as the National Negative List. The status of the existing negative lists from the Shanghai and other Free Trade Zones is unclear.
All future Foreign Invested Entities (FIEs) formed in China will now follow the following five-step procedure:
Step 1. Obtain name reservation from the local administration of industry and commerce (AIC).
Step 2. If not restricted by the National Negative List, register online with MOFCOM. Provided the registration is accurate and complete, the regulations require MOFCOM to issue a registration notice within three days. Though the new regulations allow for registration with MOFCOM after issuance of the AIC business license, all of the AIC agencies with which we have spoken have told us that they will require MOFCOM registration prior to issuance of the AIC business license.
Step 3. Register your FIE with the local AIC. Since the local AIC may impose special procedures for FIEs, it is not yet known what impact of the change on this step will have overall. The most likely result at the outset is that each district will impose its own rules. Some districts may impose rules to make things easier. And some districts may impose rules that increase the time and documentation effort required at this stage. Though this result would be contrary to the spirit of the new laws, such a result would be consistent with past local government practice in China.
Step 4. Each local AIC will require compliance with other regulatory requirements such as environmental impact statements, building construction safety reports, neighborhood impact reports, energy usage reports, local employment impact reports, reports required for access to local special benefit programs, land usage and price analysis reports, and similar. The list of required studies and reports can get shockingly long and must be determined on a local AIC to local AIC basis. Dealing with these requirements typically requires a major amount of time and effort and expertise in forming a FIE in China.
Step 5. After receipt of a business license, comply with AIC, tax agency, regulatory agency and banking registration procedures. These requirements may be local, provincial or national, depending on the nature of the FIE business. Compliance with all these requirements is required before the FIE can formally begin business. Such compliance typically adds at least a month to the formation process.
Some China attorneys see the change in China’s FIE laws as a move to “open up” China to increased foreign investment. At this point, and for the following reasons, we do not foresee much change:
- The basic structure of foreign investment does not change. Foreign invested entities are still essentially confined to the former categories of WFOE and Joint Ventures (JVs). Foreigner persons are still prohibited from directly investing in Chinese owned entities. See The China Stock Option Scam.
- There is no change in the industries open to foreign investment. Many analysts hoped that China’s new National Negative List would be simple, short and unrestrictive, but it is identical to the current Catalogue of Foreign Investment, which is complex, long and highly restrictive. The vast areas of the Chinese economy that have been off limits to foreign investment remain off limits. There has been no “opening up” and there is no indication that there will be any opening up. What you see now is what you get. See On Doing Investment Research In China As A WFOE. Not Legal.
- There is no significant reduction in the time required to register a foreign owned entity. The only change in the current registration process is the elimination of MOFCOM approval; registration is still required. This means that the MOFCOM stage of the registration process will, at best, be reduced from one month to three weeks. This is a minimal impact. Under the old system, MOFCOM approval was virtually never a substantial source of WFOE or JV formation delays. The delays nearly always were at steps 4 and 5 described above and the new system has no impact on those two steps. Moreover, under the new system, step 3 (AIC registration) may become an additional source of delay.
- MOFCOM registration requires the FIE identify the persons who actually control the foreign investor. This is a new requirement. This requirement is intended to force foreign investors to reveal whether or not they are wholly are totally controlled by Chinese nationals. The goal here is to prevent illegal “round trip” investments by Chinese nationals and to regulate the use of VIEs and related to evade the restrictions of the National Negative List. The New China Round-Tripper. China WFOEs And JVs Coming Home??!! and China VIEs Are Dead. Done. Over. Stick A Fork In Them.
So the net effect is that China’s new FIE rules do not provide for any major change in the structure of the PRC system of management of foreign investment. There has been no opening up and the time and effort required to form a FIE is not likely to substantially change.
So what has changed for registering WFOEs and Joint Ventures in China? I will discuss that in my next post.
Copyright is an essential part of any substantive IP protection plan in China, but many companies fail to take an extremely important step: registering their copyrights in China. One of the most common misconceptions our China lawyers frequently hear is that copyright registration in China is optional, because you do not have to file anything to have a valid copyright in China.
Like so many China misconceptions, this one has an element of truth to it. As a signatory to the Berne Convention, China has the same basic definition of what is protected under copyright as the 171 other Convention parties: an original creative work that exists in a fixed medium. A “creative work” could be anything from a video game, song, or toy to a database, map, or product design. A songwriter in Nashville, a programmer in Auckland, a furniture designer in Helsinki: all of their creative works are protected by copyright at the time they complete the work in question, and that copyright is just as valid in China as it is in the U.S., New Zealand, and Finland. But there’s a big difference between having a valid copyright in China and having an enforceable copyright in China.
In most situations, the key issue is one of proof. A copyright registration in China is presumptive evidence of ownership, and in some situations it’s the only evidence that is acceptable. Whether you’re trying to take down an infringing video on Youku Tudou or an infringing photograph of your product on Alibaba, have counterfeit dolls seized at Customs, or sue a publisher who is selling your book without permission, a certificate issued by the Copyright Protection Centre of China (CPCC) is the easiest and most efficient way to enforce your rights. And copyright registration is almost always a prerequisite to getting royalty payments from Chinese entities that have licensed copyrighted material.
Meanwhile, if you are trying to prove ownership of a creative work and you don’t have a Chinese copyright registration, it could take weeks or even months – and that assumes a clear, well-documented chain of title. If you’re at the point where you need to enforce a copyright to stop infringement, it’s almost certainly going to be time-sensitive.
China’s copyright registration process is fairly straightforward, and it does not involve substantive examination at the time of registration, but it usually takes a couple months to receive a copyright certificate. In our experience, when our clients have China copyright certificates we usually secure takedowns of infringing materials relatively quickly and easily. But without a copyright certificate, takedowns take considerably longer and sometimes they do not happen at all.
Don’t get caught flat-footed. If you have copyrightable IP that you want to protect in China, register it with the CPCC. Now.
According to the media, Chinese authorities have detained a number of Australians from Crown Resorts for gambling-related offenses and have launched a criminal investigation into their actions. According to the Australian Financial Review, It appears that 18 Crown Resort staff have been detained, including three Australians, “as other foreign casino operators…scramble to safeguard their China-based staff.” The Crown staff were detained in a series of overnight raids “in an apparent crackdown on illegal marketing by offshore casinos.”
This news is relevant many companies doing business in or with China. I say this because our firm constantly hears from companies that have personnel in China that market some product or service (oftentimes an internet service) from China that is illegal in China. I repeat: many foreign companies have sales people and executives in China who market products or services in China that are illegal in China, with offshore and foreign casinos just one example.
To be clear, we have no knowledge regarding Crown Resort outside what we read in the mainstream media.
There are many things illegal in China (either completely or just for foreign companies) that are widely legal elsewhere, with the following just those that quickly pop into my head:
- Certain types of education services
- Certain types of internet services
- Certain types of communication services
- Many publishing services
Many foreign companies get around China’s laws prohibiting their business by operating all or a large portion of their business outside China. But if you have people working for you (either as employees or otherwise) in China or if you are marketing to China, your people may be at risk for getting “detained” in China. I know I am being vague here, but for many reasons that is deliberate, so sorry.
Our China lawyers are constantly being asked to provide legal risk assessments to companies that may be skirting the edge in China (yes I know I am again being vague here). One of their most common questions is “should I go to China.” Our most common answer — by far — is no, because we simply cannot quantify the risks of their getting detained, nor really can anyone. As attorneys, we are going to be extremely cautious because the last thing we want is for us to give carte blanche to someone going to China and then having that person detained.
We tend to be a bit more positive about our clients going to Hong Kong, but even for going there we are not willing to unequivocally say yes. The below is a brief excerpt from one of many memoranda we have written on the issue of going to Hong Kong in the above (vague again, I know) sort of situation:
This memorandum addresses the risks of _Mr. __________’s going to Hong Kong. Our conclusion is that we see __________’s going to Hong Kong as a low risk endeavor.
If _________ were to travel to China, there is a risk his presence would be reported to the police. If this happens, an arrest could occur. Though it is not possible to quantify this risk, the risk is not low. There is always a very slight chance of spillover risk from the PRC to Hong Kong. However it is important to note that to date, the Hong Kong authorities have not cooperated in China’s _______ crackdown and we have not seen anything to indicate that they will. Though we are not prepared to say that Mr. ________’s going to Hong Kong is wholly without risk, we do not believe the Hong Kong authorities are following the situation with _______ in the PRC and we do not believe that they would do anything to _______ in Hong Kong even if they were to become aware of _________’s situation in the PRC. We also do not believe the PRC would seek Hong Kong’s help against someone from a company like _______. So again, we do not see much risk in Mr. _________’s going to Hong Kong at this time.
We often are asked to give similar legal risk assessments for clients involved in legal disputes with Chinese companies and our advice in those situations is usually (but definitely not always) short and simple: it would be better if you can delay going to China until you have resolved your dispute.
The thing that gets to me about all of this though is how so many companies either have no clue about their risks or willfully choose to ignore them. One of our China lawyers loves to tell of how he met an expat bragging in a bar about his China business and when our lawyer told him that what he was doing was flat out illegal, the response was that the Chinese government didn’t care and actually wanted this sort of business in China, the written laws be damned. And everyone else at that table joined in on this sentiment. Just a few years later this person was arrested and convicted and served not insubstantial time in a Chinese prison.
The area where we see this most often and the area where there is far too little concern is taxes. China is cracking down hard on foreign companies that make money from China (especially those foreign companies that have “independent contractors in China) and do not pay their taxes in China. If you want to operate this way, at least recognize your risks and act accordingly. See China’s Tax Authorities are After You, an article I wrote for Forbes Magazine on how China is stepping up its tax collection efforts, especially as against foreign companies with China-based “employees” but no China company. Most foreign companies though are either blissfully unaware of those risks or downplay them.
If you or your company are doing anything remotely marginal in China, step back a minute (really for at least a few hours) and ask yourself whether what you are doing or about to do is really worth it. I know this sounds simple, almost trite, but far too often hard-charging businesspeople fail to ask this question.
I love telling a story about a long-time client and friend. This person’s business empire stretches across at least four continents and his net worth has to be well north of twenty million dollars. Many years ago he mentioned that he would be going to Iraq the next week to finalize the negotiations on some big construction deal. When he told me this, I immediately told him of how I had met a businessperson who went to Iraq and never came back. I basically asked my friend why with the entire world available to him (and with three kids) he was even considering going to Iraq. He poo-pooed my concerns but then called me back the next day to say that he had given my advice more thought and he had cancelled his plans.
I am not telling you to be afraid of the world, nor am I telling you not to take risks. I am just saying that before you jump, familiarize yourself with where you will be landing.
For more on what can happen to you in China legal difficulties there, check out the following:
- China Hostage Situations With a New Twist
- China, We Have A Problem. A Mostly True Story.
- The Single Best Way To Avoid Being Taken Hostage In China
- How To Avoid Being Held Hostage In China (Forbes Magazine)
Bottom Line: Pause and think before you act and pause and think before you go.
What are your thoughts?
When the employment relationship ends between a China employer and employee, there are always a few things the China employer should do. One of the most important things you as an employer must do is provide your soon to be ex-employee with a Proof of Termination of Employment Relationship document, transferring the employee’s files and social insurance, and completing any relevant other procedures required under the law. Failing to provide such a document gives your ex-employee a near-perfect basis for suing you.
What does this document do? It evidences the termination of your employment relationship. Why do you have to provide this document? Because your employee probably needs it to prove his or her employability. On the flip side, you should require all your new employees provide you with such a document before you hire them. China employees also need this document to claim unemployment benefits and if your delay in getting them this document causes them delay in collecting their unemployment benefits, you are legally responsible for those damages.
Regardless of why the employment relationship has ended, you must perform your legal obligations by providing your former employee with a proof of termination document. It is not relevant that the termination was amicable. Under China’s Labor Contract Law, failing to provide this document subjects the employer to both administrative corrective orders and to having to pay the ex-employee any damages suffered because of your failure to follow the law. If you don’t want an employee suing you for his or her inability to get a new job, you should provide this document to all of your leaving employees as soon as you possibly can.
This document typicaly must specify the term of the employment contract, the date when the employment contract was terminated or ended, the position the employee held, and the number of years of service the employee put in for the employer. It is important to be careful not to go much beyond this because the more you put in, the more likely what you wrote could “backfire” on you. By way of just one example: your ex-employee who is leaving voluntarily asks you to do them a “favor,” by stating in that document that you unilaterally terminated the employment contrac, with the excuse being that they do not want to look like a job-hopper. You go along with this and then he or she flips around and sues you for unlawful termination.
Because a well-crafted Proof of Termination of Employment Document is and should be brief, it will not include enough to protect you as the employer. It does not address why the employee left employment. It does not address any statutory severance the employer may owe. Finally, it does not address any future claim the employee might bring, which claims are being brought more and more often, particularly as against foreign employers. See China Employment Arbitration: Good Luck With That Battle.
A proof of termination document is primarily done for the benefit of the ex-employee and the next employer, not for the employer. For this reason, it usually makes sense for you as the employer to get your deparating employees to sign a settlement/severance agreement. Though this agreement can also serve as proof of termination of employment relationship, it goes beyond that. It should ensure that you will not get sued by your ex-employee one week, one month or one year down the road. Such an agreement should make explicitly clear that the employee is releasing the employer and any of its affiliates from any future claims that could be brought by the employee. This agreement should be in Chinese (the official language) as well as in English (for your reference). You should not submit this agreement to China’s labor authorities, and, in fact, we usually recommend that it it contain hard-hitting confidentiality provisions. You must follow all your internal procedures in having this severance document executed by both parties and it should also comply with and work under China’s employment and contract laws. I will write more about this in future posts.
Bottom Line: When your China employee walks out your door for the last time — no matter what the circumstances, you as the employer need to do a whole host of things to make sure that you do not see that same employee walking through a court door a few months later.
In this series of posts I am looking at themes explored by Lucian Pye in his work Chinese Commercial Negotiating Style. Pye concludes that the way most Sino-Foreign negotiations are conducted helps the Chinese side apply its preferred strategies and tactics. My first post looked at how Chinese companies tend to control the preliminaries during what I have called the “courtship” phase. The second post considered what Pye has to say about the Chinese tendency to prefer agreements on generalities. In this third post I examine what he has to say about specific Chinese negotiating tactics.
According to Pye, Chinese negotiators tend to use the following tactics:
Open with flattery — In response to flattering remarks the foreigner feels compelled to give an enthusiastic affirmation. The foreigner is then called on to give an emphatic denial of a feigned, self-deprecating remark. This puts the foreigner on the back foot from the outset.
Operate on two levels — There is the manifest level of bargaining about the concrete and there is also the latent level at which attempts are made to strike emotional bargains based on dependency. Chinese negotiators seek relations in which the foreigner will feel solicitous toward China, thus implicitly becoming a protector and more a superior than an equal.
Focus on mutual interests — Westerners like to think of themselves as conciliators. The Chinese tend to reject the principle of compromise and prefer instead to stress mutual interests. When mutual interests have been established it is easier to ask the foreign party to bear a heavier burden without protest.
Use meetings as seminars — Negotiations are seen partly as information-gathering operations. Foreign competitors are played off against against one another to extract maximum technical intelligence from presentations. Negotiating sessions are used frequently for training purposes. The foreigner is encouraged to perform so as to impress the passive Chinese host. The obliging guest entertains in repayment for hospitality and brings “gifts of knowledge”. Put simply, Chinese companies often claim to want to do a deal with you when all they really want is to get access to your technology or know-how. I cannot stress enough how often our China lawyers see this sort of situation.
Blur the lines of authority — You can’t tell who reports to whom or where the apparent leader fits in the hierarchy of the Chinese company. Negotiating teams tend to be large but the lines of authority are diffuse and vague. Chinese negotiators are often unsure of their mandates and of the probable decisions of their superiors. They therefore tend to give inaccurate signals about the state of negotiations. Foreigners persist in trying to find a particular person who has command authority at each level. In China it cannot be assumed that power is tied to responsibility. Proof of a person’s importance often lies precisely in their being shielded from accountability.
Never say “no” — Chinese negotiators will frequently seem to be agreeing when they say something is “possible” but often this is an ambiguous way of saying “no”. They will often respond with silence to a proposal and then at a much later date suddenly return with interest.
Never telegraph their next move — Chinese negotiators don’t telegraph their next moves through displays of emotion. The level of friendliness or impersonality remains the same whether negotiations are heading for success or failure. This brings surprises. Warm and progressively friendly meetings can lead to disappointing outcomes. Chinese negotiators are quite prepared to end meetings or negotiations on a negative note. As negotiators often have little authority they often find it prudent to maintain a negative attitude. At the same time, apparently disinterested negotiators can suddenly announce that a positive agreement is possible.
Exploit Chinese members of the foreign team — Ethnic Chinese associated with the foreign team will be sought out in the belief that they are naturally sympathetic to China. Our China attorneys have also seen many instances where an Ethnic Chinese person on the foreigners side is accused of disloyalty for not siding with the Chinese side in the negotiations — always in Chinese, of course.
Use “shaming” — Chinese negotiators may be quick to point out “mistakes” in an effort to put the foreign party on the defensive. There is a deep belief that people will be shattered by the shame of their faults so there is a tendency to make an issue over trivial slip-ups and misstatements. But do not expect the same on the flip side.
Make big asks — Chinese negotiators often have no hesitation in presenting what they must understand are unacceptable demands. These demands are often accompanied by a hint that their excessive demands will be withdrawn in return for only modest or symbolic concessions. Extreme language is often used to obtain symbolic victories.
Stall — Chinese negotiators are masters of creative use of fatigue. They have, according to Pye, great staying power and almost no capacity for boredom. These traits keep foreigners’ hopes alive. This approach may also reflect lack of experience, bureaucratic problems or a subordinate’s fear of criticism from above. Conversely, when agreement reached it is often the Chinese who become impatient for deliveries by the foreigners. For more on this tactic, see Doing Business In China Requires Patience. Don’t Just Be Leaving On That China Jet Plane.
As I have said before, Pye never moralizes or suggests there is anything wrong with the Chinese approach. He merely points out how different it is from the typical Western approach, leaving readers to conclude that foreigners ignore or disregard Chinese negotiating tactics at their own peril. This is certainly consistent with our view that one should not rush to blame the Chinese when things go wrong.
In my final post in this series I will outline Pye’s tips for foreigners when negotiating with Chinese companies.
On October 18, I will be putting on a webinar, Doing Business in China: Structuring Your Deal and Protecting Intellectual Property. This webinar is aimed mostly at lawyers and it is eligible for CLE credits.
It is being put on by Commercial Law Advisors and they describe it as follows:
Who Should Attend? Corporate counsel, in-house counsel, attorneys advising companies or organizations, intellectual property attorneys.
Companies often cannot afford not to do business in China. Whether producing goods there or selling to the Chinese market, companies that engage in business with Chinese partners need up-to-date legal advice on how to protect their technology and other intellectual property (IP) interests from being counterfeited, pirated, or otherwise misappropriated. As IP theft is one of the top issues facing businesses operating in China, there are substantial risks companies must identify and address proactively to protect their valuable IP assets. Deals made in China can threaten IP rights not just in China, but in markets around the world. Understanding the Chinese IP landscape and how to manage the pertinent issues can go a long way to safeguarding your client’s valuable IP interests.
Please join Dan Harris as he explores the nuts and bolts of constructing a good business deal with a Chinese partner, what your agreements should include, and how to manage the Chinese IP rights framework to minimize your client’s IP-related risks.
WHAT YOU WILL LEARN
This webinar will cover:
How to choose a good Chinese partner
Identifying the IP assets that need protection
How to structure your deal
Drafting your deal papers
Drafting China employee contracts to protect your IP
IP registrations: What you should know about trademarks, patents, copyrights, and licensing agreements
China Law Blog readers who use promo code cw16dbc will receive $35 off. Go here to register.
I hope to “see” you there.
I recently spoke on the U.S. Canada softwood lumber dispute at an American Chamber of Commerce in Canada event. I was subbing for my colleague Bill Perry who could not make it because he was in China. My talk focused on the history of the dispute, its key issues, and most importantly, what will likely happen if new AD/CVD petitions are filed and investigations initiated. This post builds off my presentation and it focuses on how China will affect the next round of the US-Canada Lumber wars, expected to start this week.
For the past ten years, the United States and Canada have abided by a 2006 agreement that regulated Canadian lumber imports into the United States with a system of export fees and quotas triggered by specified average US market price points. That 2006 Softwood Lumber Agreement is set to expire this week and with that expiration, a coalition of U.S. lumber producers is expected to immediately file a fifth round of antidumping (AD) and countervailing duty (CVD) petitions seeking US government investigations to determine whether Canadian lumber is unfairly dumped or subsidized and is injuring the U.S. domestic lumber industry.
Many of the issues in this fifth round of the US-Canada Lumber trade war likely will be the same or very similar to issues raised in the previous four rounds. US lumber producers will likely allege that Canadian lumber producers benefit from a wide array of government grants, loan guarantees, tax preference schemes and other subsidies provided by the Canadian federal and provincial governments. The US lumber producers will contend that these subsidies give Canadian lumber an unfair competitive edge.
The primary issue remains whether Canadian lumber is unfairly subsidized by the Canadian system of “stumpage rates,” which is the price paid for the right to harvest lumber from provincial land. Since most Canadian forests are on “crown” land controlled by the Canadian provinces, Canadian stumpage rates are primarily set by each province. Since most US lumber is harvested from privately owned land, US stumpage rates are primarily market determined through competitive auctions. US lumbers producers are unhappy with the benefits Canadian lumber producers allegedly receive from the provincial stumpage system.
This next round of lumber dispute will likely be more than just a simple replay of previous lumber investigations since there have been a significant developments since the last round was settled in 2006. Two China-related developments in particular could have significant impact.
First, China has been the most targeted country for US CVD investigations; the US Department of Commerce (“DOC”) has conducted about forty CVD investigations against China since 2008. In many of these CVD cases against China, the DOC calculated very high subsidy margins, often based on aggressive interpretations of CVD laws and regulations. The CVD investigation practices developed by the DOC in these Chinese cases will likely be applied in the next Canadian lumber CVD investigation. The DOC will no doubt conduct its CVD investigation against Canadian lumber mindful of how it might affect on-going and future Chinese CVD cases. Unlike past Canadian lumber CVD determinations where CVD margins never exceeded 20%, the DOC could very well calculate a much higher than expected CVD rate in Lumber V.
The other significant post-2006 China-related change is the growth Canadian lumber exports to China. In 2006, 82% of Canadian softwood lumber exports went to the United States. By 2011, the United States received only 53% of Canadian softwood lumber exports. China in particular became a significant market for Canadian lumber, much of which was from British Columbia.
In addition to developing alternative export markets (like China), a number of Canadian lumber producers have developed alternative production options by acquiring US lumber mills. As of 2015, major Canadian lumber producers (such as West Fraser, Canfor, and Interfor) now own more sawmills in the United States than in Canada, and they are now also among the top ten largest U.S. lumber producers.
Canadian lumber producers that now have the option to ship their lumber within the US from their US sawmills and to export their Canadian lumber to China are going to be well-positioned to withstand settlement terms demanded of them by the US lumber industry. At a minimum, the new cadre of Canadian lumber producers with China and/or internal US options will almost certainly make it harder for Canadian lumber producers to unify around a common negotiating position against their US counterparts.
China’s influence on even Canada-US timber relations will no doubt be felt.
Our China lawyers have been getting a spat of inquiries in the last few months from foreign (mostly American) companies that have lost knock-down drag out disputes with their Chinese manufacturers. The American companies have been getting their clocks cleaned in these disputes to the point that many are having to shut down their businesses.
My goal with this post is to lay out the basics for surviving (when possible) such disputes. First though a bit of background.
Sinosure. Nearly all Chinese manufacturing companies that provide credit to foreign businesses do so because their invoices are insured by Sinosure. Sinosure (a/k/a The China Export and Credit Insurance Corporation) is a massive China State Owned Entity (SOE) that provides Chinese companies with insurance coverage against political commercial and credit risks. Importantly, Sinosure also provides export financing via an agreement it has with J.P. Morgan. Sinosure also covers China SMEs with export volumes of less than two million dollars a year that are unable to bear the political and commercial risks of international trade.
Foreign companies typically never deal with Sinosure until they have a payment dispute with their Chinese product supplier. When that happens, Sinosure usually steps in and threatens to sue the foreign company that owes the money. Sinosure does this by hiring debt collection lawyers in the debtor’s country to pursue the debts of the Chinese manufacturers it insures. Sinosure is very aggressive in pursuing collection cases against American companies, most of whom have little clue about what they are up against.
The Typical Sinosure Case. I cannot promise the below is truly the typical sinosure case, but it is the typical case our China lawyers are hearing about and, most importantly, it is the typical case that has proven so deadly to foreign companies. The below is a composite, written to scare American and European companies straight.
- U.S. company buys $2 million of widgets from Chinese manufacturer for export to the United States.
- U.S company pays Chinese company $1.4 million upfront for the widgets, with the remaining $700,000 to be paid upon approved delivery.
- The widgets that arrive in the United States are of poor quality.
- The U.S. company refuses to pay the remaining $700,000.
- The American company sells the bad widgets at fire-sale prices, netting 500,000 or $200,000 less than the $700,000 it is already out of pocket to the Chinese company.
- The Chinese manufacturer threatens the U.S. company with a lawsuit and the U.S. company threatens the Chinese company with its own lawsuit or with counter-claims for “the bad product and for the damage caused to our reputation. “
- The U.S. company then does nothing for months, figuring there is no way the Chinese company will have the gall to sue and also figuring that suing the Chinese company would be more trouble than it is worth.
- Then all of a sudden, a U.S. lawyer contacts the U.S. company and says that unless the U.S. company immediately pays the remaining $700,000 owed to its by now former China manufacturer, it will soon be sued in the United States. Nine times out of ten, this lawyer has been retained by Sinosure.
- The U.S. company almost always starts out defiant, telling the lawyer that it will never pay anything because it doesn’t owe anything and if the Chinese company were to sue in the United States, it will counterclaim.
- The U.S. company then usually comes to realize that it can no longer get any credit from any manufacturer in China. This is because Sinosure has put the U.S. company on a list of companies to whom China exports will not be insured. Once a company makes this list, it is almost unheard of for a Chinese company to extend that company any credit.
- The U.S. company’s inability to buy from China on credit is usually very tough on them. Remember that this company is already reeling from having lost money on the bad product it received.
- The U.S. company then calls its former manufacturer to try to work out a “win-win” settlement.
- The U.S. company and the Chinese company work out a deal whereby the US company will 1) pay the Chinese company half of the $700,000 it purportedly owes it and start buying from the Chinese company again. 2) The Chinese company will take less than the $700,000 owed to it because it “wants to do business with the U.S. company again.” 3) In return for the $350,000 payment from the U.S. company, the Chinese company will forgive the full debt and, most importantly, it will let Sinosure know that all has been resolved.
Real Life. Unfortunately, as far as I know the above is never ever ever the way it really goes down. Here is what happens in real life:
- The U.S. company pays the Chinese company the $350,000 believing that its emails are sufficient to prove the deal.
- The Chinese company is delighted to have received the $350,000, especially since this is in addition to the full compensation it already received from Sinosure.
- The Chinese company does not tell Sinosure that it received the $350,000 because if it did so, it would need to send that money to Sinosure. Not to mention that it probably has no authority from Sinosure to do such a deal in the first place.
- The Chinese company is not going to start selling its products to the U.S. company again. Why would it when it cannot get export insurance were it to do so?
- At this point the U.S. company is in a terrible position. It is in the hole $200,000 from paying for the bad widgets and it is now in the hole an additional $350,000 for making another payment for the bad widgets. To top this all off, it has an aggressive American law firm (that without any exceptions on those cases in which my law firm has been brought in) has zero clue about anything China. Zero. Nada. Zilch. Rien. Nichts. 没有.
- Unable to afford to hire U.S. litigators to fight the lawsuit that has just been or will soon be filed against them and to hire China lawyers to sort through and explain to a Chinese SOE what has transpired, the U.S. company tosses in the towel.
How to Do It Right. And here’s the thing. The above can all be easily prevented so long as you do not “settle” with your Chinese manufacturer or with Sinosure without making 100% certain that your doing so will actually resolve ALL claims against you. Do not pay anyone anything without first getting a proper written agreement (in Chinese) that makes clear that you have resolved all of the claims against you by both your manufacturer and Sinosure. This agreement needs to work in both China and the United States and it must be signed by all parties (including your Chinese manufacturers) or you could face very troubling additional lawsuits down the road.
And this is only if you are insistent on settling. Most of the time there are various ways to get Sinosure to give up and for you to start getting credit from Chinese manufacturers again.
Countless foreign software companies wish to deliver their software as a service (SaaS) to China. But since China requires commercial ICP licenses for commercial Internet services within China and generally forbids foreign enterprises from obtaining such licenses, directly providing SaaS through a server in China is typically not possible for foreign software companies.
So what can be done? How can a foreign software company get its software to China’s consumers via SaaS? Two methods for providing foreign SaaS in China have been developed. These methods depend on whether the server will be located outside of China or within China. If the server is located outside of China, we use the reseller model. If the server is located within China, we use the license model.
Many foreign software companies waste a lot of time and money in searching for or trying to develop a third model. Many Chinese companies — out of either ignorance or greed — encourage such searching and trying.
In the reseller model, the foreign SaaS provider brings on one or more resellers in China. At a minimum, the reseller locates customers for the foreign company’s SaaS product. The reseller provides the ultimate customer with a user name and password that allows the customer to connect to the foreign server hosting the SaaS product. The reseller collects the fee from the customer and deducts and pays applicable Chinese business and income taxes and then remits the remaining amount to the foreign software provider.
Though very common, this SaaS reseller system does not strictly comply with Chinese law, since the Chinese Government has never reviewed or approved the software content. However, to date, the Chinese government has permitted the reseller model to be used. This reseller model is permitted because it includes the following safeguards that protect the interests of the Chinese government:
- Access to the offshore server can easily be blocked by using China’s Great Firewall. If the SaaS content is not acceptable to the PRC government or if the SaaS is used for an unacceptable purpose, the connection to the offshore server can and will be blocked with no prior notice. This happens regularly in China, often to SaaS/cloud products that seem innocent on the surface. The risk of being blocked is therefore the most significant risk in using the reseller model. Some SaaS is at much higher/lower risk of being blocked than others and part of our role as China lawyers is to help our clients analyze this risk.
- The reseller is liable under Chinese law for the content of the SaaS product. The reseller is not treated as a neutral, ISP type entity; the reseller is treated as though it is the developer of the SaaS product. This is true even where completely independent third parties are the source of content on the SaaS platform. More important, the reseller is liable for quality as well as content. Consider the potential liability here: some SaaS platforms are used for off site medical diagnosis. What happens if the diagnosis is wrong and the patient is injured or dies? The reseller is potentially liable.
- All applicable taxes are withheld and paid. Through the reseller approach, the PRC government is able to impose double taxation. Taxation first on the income of the reseller and then taxation on the income remitted to the foreign software company. This access to tax revenue results in a more accommodating regulatory response from the Chinese government, but also in lower income for the foreign software provider.
There are several reasons foreign SaaS providers decide they must locate their server in China. Many do so for the generally faster service speed and connection reliability. Others do so to lower their risk of having their software blocked. Some simply cannot find reliable resellers willing to take on the substantial work and risk. Foreign software companies that use a Chinese server do so via a licensee model.
Under the licensee model, the foreign software company does not directly offer its SaaS product in China nor does it directly control the China server. It instead licenses its software platform to a Chinese entity. that obtains the commercial ICP license that allows for offering the SaaS service to Chinese customers through a Chinese server.
The minimum terms of this sort of SaaS Licensing Agreement are as follows:
- The Chinese licensee owns the ICP license. Acquiring a commercial ICP license is expensive, and the licensee must pay all the costs. Because of the considerable expense, it is difficult to find Chinese companies willing to take on the financial burden of acting as a licensee.
- The licensee owns the URL that provides access to the server.
- The licensee holds a license for the entire content of the SaaS platform software. As with resellers, the licensee is liable for the content and performance of the software.
- If the SaaS platform is hosted on a cloud server, the licensee has the the contractual relationship with the cloud service provider.
- The licensee has direct contact with and collects the income from the customers The licensee pays a license fee to the foreign software provider under normal license royalty rules.
- Since the server is located within China, the Chinese government has the right to access the content of the server at any time.
As the above discussion makes clear, neither the reseller model nor the licensee model are ideal solutions for companies wanting to provide SaaS to China. Most of our foreign SaaS developer clients have used the reseller model successfully. However, the licensee model has been the only solution for some of our clients. For example, for SaaS software that will be used by a Chinese government institution such as a hospital or university research center, Chinese government regulation normally requires the SaaS software be housed on a server located in China. The same rules typically apply for SaaS software used by PRC banks and other financial institutions. Since these situations require a server located in China, the licensee model is the only choice available.
Bottom Line: If you are a software company looking to sell your SaaS software in China, you can do so using either the reseller or licensee model.
Clients often ask us whether they need to register their company name as a trademark in China. As I am the product of an American law school, it’s hard to resist the gravitational pull of responding with “it depends,” but in this instance I have little difficulty. English-language company names have virtually no protection in China. If you don’t want someone else to use your company name in China, you should register it as a trademark.
It’s true that in order to form a business entity in China (e.g., a joint venture, WFOE, or representative office), you must select both a Chinese name and an English name for the entity. But only the Chinese name has any legal relevance. That name needs to be approved by the State Administration of Industry and Commerce (SAIC) and cannot conflict with preexisting company names. The English name, on the other hand, is just a trade name that appears on your company chop. It does not need to be approved, and you can change it at will. It has the same amount of protection of any trade name used without registration: virtually none.
Even your Chinese-language name won’t have any protection as a trademark. Although company formations and trademark registrations are both under the umbrella of the State Administration of Industry and Commerce (SAIC), the departments do not have any meaningful cooperation. A third party could register your entity’s Chinese name as a trademark, and you could register a third party’s trademark as your company name. But because a company’s legal name in China often has little in common with the company’s trade name, most people only care about the latter.
If you haven’t formed a business entity in China, then you have no presence other than the names you use on your products or services. For some companies, like Coca-Cola and McDonald’s, the company name is the brand, and they very much want to protect that name. For other companies, like National Amusements (the parent company of Viacom and CBS) and Yum! Brands (the parent company of KFC, Taco Bell, and Pizza Hut), the company name is not the brand, and they are perhaps not as concerned about protecting it. You’ll have to make that call for yourself.
China has a well-publicized exception that affords protection to “well-known” trademarks even if they’re not registered in China. But as we have written numerous times, this exception is almost never available: unless your company is named Coca-Cola or Nike, you are not well-known. Companies often push back against this and argue that they are well-known in their country among people who know their industry, and that makes their company name well-known. But this is not the standard. For a mark to be considered well-known in China, the mark must be generally known throughout China. Take a big American toy company like Hasbro or Mattel. Most Americans have heard of those companies, even if they don’t follow the toy and game business. But if we stopped 100 people walking down the street in Nanjing, how many do you think would be able to correctly identify either company?
The only protection for your English-language company name in China comes from registering it as a trademark with the Chinese Trademark Office. Relying on any other method is just magical thinking.
Earlier this year, in China’s Two Children Policy: What China Employers Should Know, I wrote how Beijing was in the process of amending its population and family regulations in response to the amended National Law on the same topic. For how China’s employment laws are both national and local, check out China Employment Law: Local and Not So Simple. Beijing has come out with its amendments and this post discusses their most salient points for Beijing employers.
Under its amended regulations, Beijing now requires a minimum of 128 days maternity leave (this is 30 days longer than the statutory minimum before the amendment). The special leave for a spouse whose wife gives birth is now 15 days (8 days longer than before). This is the same as in Guangdong Province but 5 days longer than in Shanghai. The new regulations delete the special leave provision for late childbirth.
Beijing’s new maternity and family leave regulations also provide that upon the female worker’s request and the employer’s consent, the maternity leave can be extended for another one to three months. This makes it possible for a female employee in Beijing to get up to 7.25months of paid leave for childbirth, regardless of whether it is her first or second child. Under a strict interpretation of the Beijing maternity leave amendments, however, if the employer does not give its consent, the female worker cannot unilaterally make her leave longer than 128 days, or about 4.25 months.
However, as is typical of so many China employment laws and regulations, the rules on extending maternity leave are less than clear. In particular, it is not clear whether Beijing employers are free to say “no” to all employees seeking to extend their maternity leave or whether they must grant maternity leave extensions to employees with “good reasons” for not being able to return to work after the standard 128-day maternity leave. Given Beijing’s longstanding pro-employee approach our China employment lawyers are instructing our Beijing clients to have us review all the relevant facts relating to the employee’s request for extended maternity leave and, most importantly, check with the local labor authorities before saying no. And do not forget that just like everywhere else in China, Beijing employers are generally prohibited from terminating an employee during his or her paternity/maternity or to reduce that employee’s wages in any way.
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.
Our China attorneys are often asked some version of the following question:
Why are you so concerned about getting the name of the Chinese party on my contract exactly right?
Answer: Because if it is wrong, the Chinese company may at some point argue (perhaps even successfully) that it is not bound by the contract.
We get this question especially often when our clients are dealing with China’s biggest companies like Baidu, Alibaba or JD.com on the other side. Our clients will ask us to draft a contract with Baidu, for example, but Baidu is really more of a brand name than a company. We then have to push our client to get from their Chinese counterparty (at whatever company it is with which they are actually dealing) the Chinese characters for the specific Baidu entity with which they will be contracting.
The PRC Ministry of Human Resources and Social Security recently released a set of rules regarding providing public notice of China employer labor violations (《重大劳动保障违法行为社会公布办法》). The goal of these new rules is obvious: it is intended to deter employers from violating China’s labor and employment laws and regulations. These rules are set to take effect on January 1, 2017 and will apply to all China employers, domestic and foreign. The following rulings/decisions on employer violations of China’s labor laws may become public:
- Failing to pay “substantial” employee remuneration
- Failing to an employee’s social insurance and the circumstances are “serious”
- Violating the laws on working time or rest or vacation and the circumstances are “serious”
- Violating the special rules on protecting female workers and underage workers and the circumstances are “serious”
- Violating the child labor laws
- Causing significantly bad social consequences due to violations of labor laws
- Other serious illegal conduct
Neither “substantial” or “serious” are anywhere defined.
When publishing these labor law decisions, the following information will be released to the public (with exceptions for national security, trade secrets or individual privacy):
- The employer’s full name, integrated social credit code/registration number, and address
- The name of the legal representative or the person-in-charge
- The main facts of the violation
- The decision made by the authorities
The above information will be published on the labor authorities’ portal as well as in major newspapers, magazines and TV and other media each quarter at the city/county level and twice a year at the provincial and national level. This information will go into the employer’s credit file on integrity and legal compliance and may be shared with other governmental departments. The employer can file a petition with the relevant labor authorities if it does not agree with what has been published and the authorities will render a decision within 15 working days and notify the employer. If the published information has been modified or withdrawn according to law, the relevant authorities will modify the published content within 10 working days.
The rules are not very detailed, which comes as no surprise. China’s local human resources and social security bureaus will be responsible for implementing these rules and they presumably will have considerable discretion in how they do so. Note though that they don’t get to “cherry pick” what to publish: if a violation meets the applicable standard, it will be published.
Beginning January 1, 2017, if a China employer commits a serious violation of Chinese labor and employment laws, it may be made public by the labor authorities. Make sure you are in compliance and you stay in compliance. And if you do not know whether you are in compliance, figure it out. NOW.
To say we are concerned for our clients for whom we do not conduct regular employer/employee audits is an understatement. It is getting progressively more difficult for foreign companies doing business in China to compete with domestic companies on hiring Chinese workers and a foreign company that gets public excoriated for employer misconduct will no doubt find it even more difficult and expensive to find good workers. We see far too many foreign companies doing business in China with little to no clue about its employment laws. Some still believe China today is the same as China a decade ago, where unhappy employees could be “bought off” with a month or two of wages because they knew they could (and they did) easily move on to another job.
Those days are over and we fear foreign employers will be disproportionately singled out for public approbation.
As we have been pointing out pretty much since we started this blog, going after foreign companies in China is simply good politics. It always has been and it always will be. Read Machiavelli. Read Sun Tzu. Read Animal Farm. Read 1984. Just look at what pretty much every country in the world does.
And going after foreigners virtually always picks up during economic slowdowns, for generally political reasons. Just look at the U.S. election.
Many years ago, in a Wall Street Journal entitled, “China’s Slowdown and You,” Dan Harris, one of the China lawyers at my firm, asserted, among other things, the following on doing business in China during a slowdown:
- The Chinese government “is much more concerned with social harmony than with economic numbers” and that is why it is continuing to encourage wage growth even though higher wages make China’s factories less competitive.
- China’s prioritization of its citizens’ contentment means China is going to get tougher on foreigners, just as it (and nearly every other country) has always done when times are tough. Everything foreign businesses do will be under heightened scrutiny.
- The key to weathering China’s slowdown will be for foreign companies to go back to basics: think afresh about what your company contributes to China’s economy and how that is likely to shape policy makers’ opinions; focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level.
Way back in 2006, in a post entitled, URGENT ALERT: Register Your Company In China NOW, we issued our first “urgent alert,” noting a crackdown on unregistered companies doing business in China and stressing how foreign companies are never going to be treated like domestic companies:
Long ago, when I was a young lawyer, I wrote an article entitled, “Four Essential Principles of Emerging Market Success,” positing that a failure to abide by the law in the country in which you do business is the surest way to lose your business without any basis for complaint:
In many emerging market countries, local businesses take advantage of corruption to avoid complying with laws. This may work for the locals, but it won’t work for you. The easiest way for a local rival to drive you out is for you to do something illegal. Neither you nor your government will have good grounds to complain if your rival gets your business closed down due to your illegal activity. It might even be your own partner who reports you so he can assume full ownership and control of your business.
The strength of my views on this has only increased as my firm has been contacted far too many times by companies driven out of countries for having engaged in illegal conduct no different from thousands of other foreign companies in the same country. These companies assume they have legal redress, but in reality they almost never do. So long as the law of the country in which the company was operating allows for closures and/or penalties (and in every such situation my firm has encountered, it has), the company is essentially out of luck.
There was a time where most foreign business was illegal in China, particularly as a Wholly Foreign Owned Enterprise (WFOE). Those days are pretty much over now and the Chinese government knows it. If you came into China as a representative office (rep office) back when that was the only way, and your “registered office” is engaged in business activities that are improper for such an office, the time is now to get that right also.
If your local people in China are telling you this is not how Chinese business is conducted, you need to remind them you are not Chinese and the government will treat you differently. Also remember that your employee’s knowledge that you operating illegally in China gives them tremendous leverage.
Then in 2007, we wrote of this same disparate treatment issue back in the context of China’s environmental laws, in a post entitled, “China Warns Foreign Companies On Pollution“:
China has always and will always (at least for the foreseeable future) enforce its laws more strictly against foreign companies than against domestic companies. I am constantly writing about this not to complain about it, but simply to point out the reality. Just because your Chinese domestic competitors are getting away with something does not in any way mean you will be allowed to do so.
Beijing is also now at the stage where it is pretty much neutral about all but the largest foreign companies remaining in China. I am not saying it is neutral about foreign direct investment (FDI) in general, but I am saying that it really could not care less about whether your individual business stays in China or goes. And if your business is a polluter, it actually would probably rather see you leave.
Lastly, going after foreign companies is politically popular.
We ended that post with the following:
Bottom Line: Obey the law, particularly the environmental laws. It is good business.
Certainly the same is now true with respect to China’s employment laws.
Similarly, in China Fines Unilever For Mentioning Price Increase. What That Means For YOU, we noted how foreign companies doing business in China cannot expect to be treated like Chinese domestic companies:
As long time readers of this blog know, one of our consistent themes has always been that foreign companies in China should not expect to be treated the same as Chinese domestic companies, no matter what the laws may say. The reality (not just in China) is that it is usually good politics to go after foreign companies and it is usually bad politics to go after domestic companies. The reality also is that when a large number of citizens have a particular problem, it is very good politics for the government to show that it is trying to solve it.
Don’t end up on social media for violating Chinese labor laws: the costs will be high. For more on how to handle the employer-employee relationship in China, check out the following:
- Eight Keys for Navigating China’s Employment Laws
- China Employment Contracts. Watching The Sausage Get Made.
- China Employment Law: A Memo On The Practicalities
- China Employment Law: Local and Not So Simple
- China Employment Contracts: Ten Things To Consider
Just get it right!
Our China lawyers have been getting an influx of cases from investors and their lawyers wanting our help in suing Chinese companies in U.S. courts for corporate governance violations. Nearly every time their plan is to sue the Chinese company for having violated their “minority shareholder rights” or for breaching fiduciary duties owed to them as fellow investors.
First, as we discussed in The China Stock Option Scam, it is not possible under Chinese law for a Chinese domestic company (as opposed to a WFOE or a Joint Venture) to have foreign shareholders. Second, even if — as is often the case — we are not dealing with a true case of foreigners purportedly owning shares in a Chinese company, the duty owed to the foreigners is going to be based on Chinese corporate governance laws, not those of the United States. When we tell our potential clients (and even their lawyers) this, their response is usually to say something like, “but our contract calls for disputes to be resolved in a U.S. Court. We thought we had a slam dunk.”
So what? A contract provision calling for disputes to be resolved in one country’s court should and does have little to no influence on the law that court will apply to the case. Most importantly, it is difficult to imagine a thoughtful American judge applying U.S. corporate governance law to a transaction that took place wholly in Mainland China and that involves Chinese entities.
I thought of these corporate governance cases today after reading a really nice analysis (by Dorsey lawyers Lanier Saperstein and Jeremy Schlosser) of the Second Circuit’s recent decision in the big Vitamin C Antitrust Litigation, holding that U.S. courts must “defer to a foreign government’s interpretation of its own laws.” In their analysis, these lawyers opine that this decision should hardly be a surprise and yet note how it will likely have far-reaching implications:
That should hardly be a controversial proposition, but up until now, lower courts have treated the interpretations of foreign governments regarding their own laws with varying degrees of deference, ranging from strict deference to outright skepticism. But now, the Second Circuit has put litigants on notice that the principles of international comity have to be applied in cases implicating the laws of other sovereign nations.
The Second Circuit’s ruling will affect a wide spectrum of legal issues facing foreign companies and financial institutions, ranging from subpoenas to asset restraints, and from enforcement actions to discovery requests, as well as substantive matters such as antitrust law, intellectual property, and securities laws.
Without going into the Vitamin C case facts and the Second Circuit’s legal ruling, I will just say that if any lawyer still believes that a U.S. court will apply U.S. law in sorting out a China-related corporate dispute, they are just wrong. If you are going to do a transaction in China that involves your getting equity or even profit-sharing from a China-based entity, China law is going to apply to any subsequent dispute you might have against that China-based entity. And this will be true regardless of whether or not your contract (or something else) entitles you to bring your dispute in a U.S. court.
So if you are going to do a deal involving getting equity in or profits from a Chinese company, you should at least know that China’s corporate governance laws put more value on the contracts you sign and less on shareholder protection laws than the United States or Europe. What this means is that unless your contract explicitly provides you with protections, you probably have no protections. What this means in real life is that most of the time when American or European lawyers come to us with a China corporate case they are calling a “slam dunk,” it is anything but.